Private ruling: Property - Sub-division - Capital or Revenue
Date of advice: 31 October 2016
Published: February 2017
Ruling period: Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2019 | Year ended 30 June 2020 | The scheme commences on: | 1 July 2016.

Ruling: Q1: Will the proceeds from the sale of the sub-divided land be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of you carrying on a business of property development? | A1: No. | Q2: Will the proceeds from the sale of the sub-divided land be assessable as ordinary income under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit? | A2: No. | Q3: Will the sub-division of your land be a mere realisation of a capital asset and therefore subject to the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: A few years after 20 September 1995 you purchased a property of a few acres with a house on it (the property). The house on the property has been your main residence since acquisition. The land surrounding the house has never been used for income producing purposes. Local Council changed the land zoning of the land to residential. This meant that subject to Council approval, the land could be sub-divided and sold as residential lots. You were not involved in the land re-zoning process. A few years ago you engaged land surveyors to provide some suggestions on the best way to develop the land. The surveyor was engaged to provide a 'mud map' of possible development scenarios. The Surveyor suggested a smaller number lot development. You were hoping to sell the land and increase the capital proceeds by providing the 'mud map' to interested buyers, (to show the potential for development of the land). Your original plan was that the sub-division development work would be undertaken by the potential buyer of the property. You tried to sell the land and house as is. You listed the property for sale through a real estate agent for a few months. The market value of the property without any land sub-division possibilities was in a certain range as a hobby farm. This value was before you approached the surveyor for advice and before it was listed for sale with the real estate agent. The real estate agent valued the property and listed it for sale for nearly double the amount based on the envisaged sub-division. You provided them with copies of the land sub-division potential including 'mud maps' and sub-division information that you had already undertaken. Potential buyers were made aware of this information. There was only one offer at a price without any sub-division potential, the price received was not accepted as it was considered too low. Once the contract with the real estate ceased, a property developer offered to carry on the development on your behalf for a fee. The fee was going to be a set percentage on gross sales; however you had not got to the stage of determining the percentage. You were not confident about the ability of the developer to complete the project so you did not accept their offer. You carried out investigations into carrying out the sub-division yourselves and the estimated development costs. You then decided to scale down the size of the sub-division. You did this because it was a more affordable option; it meant you could fund the sub-division without borrowings. It also meant there was no need for streets or services to complete the development. There are minor development works to be undertaken to effect the planned sub-division. The works will include the construction of a private road and connections to services such as sewerage, water and electricity. The works are limited to what is necessary for the Council to issue permit approvals. You will undertake the sub-division in full; the Council will not carry out any of the works. You have engaged professionals to assist with the planning permits and the sub-division process. You will fund the development costs with personal savings, including funds withdrawn from your superannuation fund. You can also access cash savings to fund the project. You will not borrow funds to carry out the project. In regard to various stages of payment for the sub-division works, this has not yet been determined but you expect that payments will be made at various milestones. You will carry out the sub-division in two stages; the first stage will involve a few blocks. You plan to commence this stage once the planning permit has been attained. The estimated cost to carry out this first stage is well under the value of the property. The second and last stage is to sub-divide the remaining few blocks; this will be undertaken when you have sufficient funds available. You will need to sell some of the first sub-divided blocks to fund the sub-division of the remainder. You are not engaging a real estate agent to sell the blocks of land. You will sell them by word of mouth with the exception of some blocks being sold to family members. You will engage an independent conveyancer to prepare any legal documentation required for the sales. You have not identified any specific person or firm to do this yet. In regard to the first stage blocks they will be sold for a certain price range. The blocks that will be sold to family members have not yet been identified but will be sold for the market value. The lot which has the existing main residence will not be sold. You will rent this house, keeping it as an investment once you have built a new family home on one of the second stage blocks. You intend to build the family home within a few years depending on how much funds you have available. The second stage blocks are bigger and you therefore expect to sell them for a higher price range of a certain amount, noting that you will keep one block to build your new home on. You have not undertaken a similar land sub-division project before. You do not have any experience in land sub-division or property development. You both work in unrelated fields of employment. There is no relationship between you and the professionals engaged to carry out the work. One of you will remove some trees, level some land, remove a shed and help out with the fencing.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 15-15 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Subsection 104-10(3) | Income Tax Assessment Act 1997 Section 112-25 | Income Tax Assessment Act 1997 Section 995-1 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Part 3-3

Reasons for decision: Summary: The proceeds from the sale of the sub-divided blocks will not be ordinary income and not assessable under section 6-5 of the ITAA 1997. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Part 3-1 of the ITAA 1997. | Detailed Reasoning - Income or capital: As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the ITAA 1997 or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997. Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997. There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree. The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example: ● In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer's involvement was seen as an indicator of a business being conducted; and ● The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty). From the cases involving the subdivision of land and from Taxation Ruling TR 92/3 (TR 92/3), it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income: (a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and (b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. In determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant: (c) the nature of the entity undertaking the operation or transaction; (d) the nature and scale of other activities undertaken by the taxpayer; (e) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; (f) the nature, scale and complexity of the operation or transaction; (g) the manner in which the operation or transaction was entered into or carried out; (h) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction; (i) if the transaction involves the acquisition and disposal of property, the nature of that property; and (j) the timing of the transaction or the various steps in the transaction. The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment. Application to your situation In your case, you and your spouse: ● purchased the property many years ago; ● where not involved in the re-zoning of the land, (it was initiated and carried out by Council); ● have used the property as your main residence since acquisition, (it has never been used for an income producing purpose); ● will keep a sub-divided block to build a new main residence to live in; ● will sell some blocks to family members at market value; ● will keep block the block (where the existing main residence is located) to rent as a long term investment property; ● will carry out the sub-division in two stages so that there is no need to borrow money. ● the sub-division activities have been limited to the minimum and what is required by Council to obtain approval for the sub-division. ● you will engage professionals to carry out the sub-division works. One of you will only be involved in some basic clearing of the block and assisting with some fencing. ● Will sell the blocks by word of mouth and not actively carry out marketing by engaging a real estate agent. The market value of the land prior to the sub-division is in a certain range. It is estimated that it will cost well below this value to carry out the first stage of the sub-division. Once you have sold some of the first stage blocks you will commence stage two of the sub-division. This will bring the total cost of the sub-division to approximately the value of the land. You will access superannuation funds and cash savings to carry out the first stage. By carrying out the sub-division in two stages you will not need to borrow money to fund any of the sub-division. No other sub-division activities have been undertaken by you and your spouse in the past and you and your spouse do not intend to undertake any similar activities in the future. Based on the information provided, there is nothing to suggest that the sub-division of the property was the beginning of a continuing business of property sub-division. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner's view that you and your spouse's activities in relation to the sub-division of the property are not those of an entity carrying on a business of buying, sub-dividing and selling sub-divided land. Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the sub-division of the property and sale of the sub-divided lots will not be considered commercial in nature but will be a mere realisation of a capital asset, being a long-held privately owned property. In conclusion, the activities involved in the sub-division and sale of the sub-divided blocks will not amount to carrying on a business. The transactions will not have the character of business operations or commercial transactions. There is no indication that the sub-division activities will become a separate business operation or commercial transaction, or that you will be carrying on, or carrying out a profit-making undertaking or plan. Therefore, as it is not viewed that you and your spouse are carrying on a business, or that the sub-division activities will be an isolated transaction, any profit arising from the sale of the subdivided lots will not be assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Mere realisation: The capital gains tax (CGT) provisions are contained in Part 3-1 of the ITAA 1997. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own. CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is sub-divided, the sub-division of the land into sub-divided lots is not a CGT event, according to subsection 112-25(2). Each new sub-divided lot will be viewed as having been acquired on the same date that the original asset was acquired. The mere realisation of a capital asset has been described as “liquidating or realising the old assets” ( Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001). In the High Court of Australia case of Federal Commissioner of Taxation v NF Williams 72 ATC 4188; (1972) 127 CLR 226, at ATC 4194-4195; CLR 249, Gibbs J explained mere realisation of land as follows: An owner of land who holds it until the price of land has risen and then subdivides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of subdivision and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realization of a capital asset are not income either in accordance with ordinary concepts…even though the realization is carried out in an enterprising way so as to secure the best price… In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, at 97 ATC 5152, Ryan J described a salient characteristic of the mere realisation of land as follows: …[to not] undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. In distinguishing mere realisation from a commercial transaction, Ryan J further said: Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. Application to your situation You and your spouse will sub-divide the property. You will keep one block where your existing main residence dwelling is located and rent the house as a long term investment once you have built a new family home on one of the other blocks for yourselves to live in. You and your spouse will sell the other sub-divided lots. You will use the services of professionals to sub-divide the property. As you and your spouse's activities are not viewed as being either those of someone carrying on a business of sub-division and sale of land, or undertaking an activity of a commercial nature, it is considered that any gain made on the disposal of you and your spouse's ownership interests in the sub-divided blocks will represent a mere realisation of the property to its best advantage. Therefore, any gain arising from the sale of you and your spouse's ownership interests in the sub-divided blocks will be accounted for under the CGT provisions in Part 3-1 of the ITAA 1997. Each of the sub-divided blocks will be viewed as having been acquired on the same date that the property was acquired. CGT event A1 will occur when you sell each of the sub-divided blocks. Any capital gain or capital loss made on the sale of the sub-divided blocks will be calculated in accordance with the CGT provisions.