Private ruling: Subdivision of land
Published: December 2011
Ruling period: 1 July 2010 to 30 June 2014.
Date scheme commenced: 1 July 2010.

Ruling: Q1: Will the proceeds from the sale of the subdivided land be on capital account and subject to the capital gains tax (CGT) provisions in Parts 3-1 to 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the profits from the sale of the subdivided land be on revenue account and assessable as income under section 6-5 of the ITAA 1997? | A2: Yes. | Q3: If the net proceeds from the sale of the land are partly assessable on revenue account as ordinary income what is the appropriate methodology for ascertaining the assessable component of the proceeds? Not applicable.

Relevant facts and circumstances: The rulees are equal joint owners of land. They inherited the land from their late parent. The land was acquired by her post 20 September 1985. An application for subdivision of the land was lodged with the local council prior to the death of their mother. A planning permit was issued shortly after their death. The taxpayers now intend to arrange the subdivision of the land into those subdivided lots. They will not directly engage in the subdivision and sales activity themselves. They will engage a private company under their control to attend to all subdivision and sales activity. The company was a pre-existing company. In addition to the property development, it currently also manages a commercial rental property. The equal shareholders of the company are several discretionary trusts each of which has one of the taxpayers as a beneficiary. The rulees will engage the associated development company under a formal contract. The key terms of this contract are: a. The associated development company will be appointed to carry out the sub-division. It will engage all necessary contractors, and pay all subdivision related costs. b. The associated development company will be empowered by way of power of attorney to negotiate and conclude sales of the land on behalf of the taxpayers. c. The taxpayers will continue to be liable for and pay usual landholding outgoings such as council rates and land taxes. d. The associated company will bear all commercial and legal liability risks associated with the subdivision. e. The taxpayers will receive an agreed amount of proceeds for the sale. That amount is reflective of the current pre- subdivision market value of the land. f. The balance of the sale proceeds will be received by the associated development company as its fee for undertaking the subdivision and sales activities; and g. The associated development company will not act as an agent for the taxpayers in relation to matters associated with the subdivision of the land. It will be conducting a separate and independent enterprise of providing land subdivision and sales services to the taxpayers for a fee. The land was zoned residential at the time of the application for subdivision. No re-zoning will be necessary to carry out the subdivision and sales of the land. None of the rulees has any relevantly comparable previous history of sub-dividing and selling land. One of them has previously subdivided and sold part of a block of land that his main residence was located on. This was a small scale subdivision. None of the others has previously engaged in any form of land subdivision and sale activity. None of the rulees' vocations involve dealings in real property of any kind. The taxpayers will have no direct personal involvement in the subdivision and sale activity. The land was valued by a professional valuer. That valuation was on an "as-is" basis prior to the commencement of any subdivision works. The associated development company will engage engineers, surveyors, construction contractors, and other professionals as required from time to time. The majority of the associated company's funding will be sourced from proceeds from the sale of lots. Some additional short term funding may be required to be sourced externally. In the first instance the consideration received in respect of the subdivision will be applied against the costs of the subdivision and cash will be used to reduce and ultimately eliminate the debts of the company. Any profits will be taxed and accumulated within the company. It is uncertain at this stage what will ultimately happen with the retained profits; they may be reinvested into further land or other income producing investments or be paid out as dividends to the company's shareholders.

Relevant legislative provisions: Section 6-5 Income Tax Assessment Act 1997 | Section 118-20 Income Tax Assessment Act 1997

Reasons for decision: Summary: Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997 . On balance, it would seem that the nature of the project, including the scale of the undertaking, the interposition of other entities between the taxpayers and the receipt of the consideration and the fact that significant short-term borrowings will be undertaken, are sufficient to take it beyond the realms of a mere realisation of an asset and characterize it as a commercial or profit-making undertaking. As a consequence, the profits from the sale of the properties will be considered to be ordinary income and therefore assessable under section 6-5. As the proceeds are not capital in nature, there will be no assessable capital gain. | Detailed Reasoning - Detailed reasoning: Section 6-5 includes in your assessable income, where you are an Australian resident, all ordinary income which you derive during an income year. Ordinary income is defined as income according to ordinary concepts. Ordinary income generally includes income that arises in the ordinary course of a taxpayer's business. However, in certain circumstances proceeds not within the ordinary course of the taxpayer's business may form part of their ordinary income. The sub-division and sale of land is outside the ordinary course of the activities from which the taxpayers in the present case derive their income and they have no experience as property developers. Therefore, the activity under consideration would be best described as an isolated transaction. The principle has been established that profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium case). Taxation Ruling TR 92/3 discusses the application of principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5. According to Paragraph 1 of TR 92/3, the term isolated transactions refers to: o those transactions outside the ordinary course of business of a taxpayer carrying on a business, and o those transactions entered into by non business taxpayers. Paragraph 8 of the ruling explains that it is not necessary that the intention or purpose of profit-making be the sole or even the dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. For example, if a taxpayer is seeking to dispose of a property inherited as part of a deceased estate that intention is not, of itself, inconsistent with having a profit making purpose. At paragraphs 56 and 57 the ruling explains that a profit is income where it is made in any of the following situations: o a taxpayer acquires property with a purpose of making a profit by whichever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purpose, o or a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit, or o a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means. Paragraph 15 of TR 92/3 provides that if a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but o the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and o the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) and McCorkell v FC of T 98 ATC 2199; (1998) 39 ATR 1112 (McCorkell's case) demonstrate that in circumstances where there is an absence of profit making intention when farming land is acquired, the likelihood of any profit made on the eventual sale of land being income according to ordinary concepts is greatly diminished. However, in both Casimaty and McCorkell the properties were originally acquired for primary production purposes and were subsequently used as such for significant periods of time, a fact which was critical to the decision in each case. In any event, profits on the sale of subdivided land can still be income according to ordinary concepts within section 6-5 if the taxpayer's subdivisional activities have become a separate business operation or commercial transaction. The Commissioner's guidelines in this regard are set out in paragraph 13 of TR 92/3 as follows: a) the nature of the entity undertaking the operation or transaction b) the nature and scale of other activities undertaken by the taxpayer c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained d) the nature, scale and complexity of the operation or transaction e) the manner in which the operation or transaction was entered into or carried out f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction g) if the transaction involves the acquisition and disposal of property, the nature of that property, and h) the timing of the transaction or the various steps in the transaction. Miscellaneous Tax ruling MT 2006/1 discusses isolated transactions and sales of real property from paragraph 262 onward. At paragraph 265, it presents a list of factors which, if present, may be an indication that a business or an adventure or concern in the nature of trade is being carried on. Those factors are: 1. there is a change of purpose for which the land is held; 2. additional land is acquired to be added to the original parcel of land; 3. the parcel of land is brought into account as a business asset; 4. there is a coherent plan for the subdivision of the land; 5. there is a business organisation - for example a manager, office and letterhead; 6. borrowed funds financed the acquisition or subdivision; 7. interest on money borrowed to defray subdivisional costs was claimed as a business expense; 8. there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and 9. buildings have been erected on the land. In applying these principles to the present case, the following facts have been considered: The taxpayers have not been involved in any land development previously When the taxpayer inherited the land, an application for subdivision had already been lodged with the local council Borrowings play a significant role in financing the development, at least in the short term The development is significant in scale at 91 lots It can be said that the activity has a significant commercial component and that there is an intention to make a profit. The total anticipated costs of the subdivision are greater than the undeveloped market value of the property The subdivision involves an arrangement whereby the consideration for the blocks sold will be received by a company associated with the taxpayers which will make disbursements of those funds in part to the taxpayers and retain the balance for possible subsequent disbursement to several discretionary trusts of which the taxpayers are beneficiaries It is typically difficult to apply a blanket rule to sub-division cases and, as a consequence, each case needs to be decided on its own facts. The present case can be distinguished from both Casimaty and McCorkell . In Casimaty , the conclusion was primarily influenced by the fact that the taxpayer acquired and continued to hold his property for use as a residence and the conduct of primary production for more than twenty years. Apart from the activities necessarily undertaken to obtain approval from time to time for subdivision of parts of the property, there was nothing to suggest a change in the purpose or object with which the property was held, namely primary production. In McCorkell , the property had been in the family and used for primary production purposes at least as far back as the taxpayer's birth in 1917. In the present case, the land had been relatively recently acquired by the taxpayers from a deceased estate. That can be contrasted with the cases listed above, where the assets which were realised had been held for long periods. It has been the intention of the taxpayers to dispose of the property since their acquisition. Whilst there is no previous history of land development, the arrangement employed is relatively sophisticated, involving the interposition of a company as recipient of the sale receipts. The expenditure incurred goes beyond the minimum required to realise the asset and in fact may involve significant short-term borrowings. Whilst no one fact is determinative of characterisation, incurring costs in respect of the disposal of an asset which are greater than the undeveloped value of that asset would suggest that the arrangement involves more than mere realisation of the asset. On balance, it would seem that the project is an undertaking on a sufficient scale to take it beyond the realms of a mere realisation of an asset and characterise it as a commercial undertaking. As a consequence, the proceeds from the sale of the land will be considered to be ordinary income and therefore assessable under section 6-5. As the proceeds are not capital in nature, there will be no assessable capital gain, by virtue of section 118-20.

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