Private ruling: CGT – subdivision – isolated transaction
Date of advice: 28 March 2018
Published: June 2018
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019
Date scheme commenced: 1 July 2017

Ruling: Q1: 1. Will the profit from the sale of residence 2 (R2) be included in your income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of an isolated transaction? | A2: Yes, however the capital gain will be reduced to the extent that the profit from the sale is included in your assessable income under section 6-5 of the ITAA 1997.

Relevant facts and circumstances: You purchased your main residence in before 20 September 1985. You demolished your main residence with the intention to subdivide the land into multiple blocks and build new houses on each block. You decided to do this in order to downsize for your future. You have had no previous dealings with property and subdivisions. You are engaging a builder to obtain the necessary development approvals from the local council, to subdivide the land and have the two dwellings built on it. Upon completion of the dwellings you will retain the other as your main residence, and you will engage a real estate agent to sell the others. You will be obtaining finance to undertake the building activities. You are relying on the cash flow derived from selling the dwellings to cover the construction cost of your new main residence and to reduce your debt from building the two properties.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 118-20 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: Broadly, there are three ways profits from the subdivision and sale of property can be treated for taxation purposes: 1. as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development 2. as ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business, where the land was acquired or subsequently held for a profit-making purpose, and/or 3. as statutory income under the CGT legislation on the basis that a realisation of a capital asset has occurred. | Detailed Reasoning - Carrying on a business of property development: The definition of business in section 995-1 of the ITAA 1997 simply states what activities may be included in a business; it does not provide any guidance for determining whether the nature, extent, and manner of undertaking those activities amount to the carrying on of a business. For this purpose it is necessary to turn to case law. Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? provides a guide to the indicators that the Courts have held to be relevant to whether or not a person is carrying on a business. The indicators considered relevant are: ● whether the taxpayer has more than just an intention to engage in business ● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity ● whether there is repetition and regularity of the activity ● whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business ● whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit ● the size, scale and permanency of the activity, and ● whether the activity has a significant commercial purpose or character (this indicator comprises many aspects of the other indicators). No one indicator is decisive. The question of whether an activity amounts to the carrying on of a business is a question of fact and degree. Application to your circumstances In your case, you are not, nor have you ever been, in the business of property development and you have no expertise relevant to property subdivision activities. You will have no active involvement in the development and sales processes, engaging a builder to obtain the necessary development approvals from the local council, to subdivide the land and have the two dwellings built, and on completion will engage a real estate agent to sell R2. The size and scale of the activity is small and is not being carried out in a manner similar to other property development businesses. This is a one off project with no repetition or regularity. Consequently, it is the Commissioner’s view that the profit from the sale of R2 will not be as ordinary income under section 6-5 of the ITAA 1997 as a result of carrying on a business of property development. | Detailed Reasoning - Isolated commercial transaction with a view to profit: 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 ). Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. TR 92/3 defines the term ‘isolated transactions’ as: ● transactions outside the ordinary course of business of a taxpayer carrying on a business, and ● transactions entered into by non-business taxpayers. 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: ● the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and ● 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. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income under section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: 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. Paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme. In addition to the above general factors contained in TR 92/3, Miscellaneous Taxation Ruling MT 2006/1 The New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number provides a list of specific factors relevant to isolated transactions and sales of real property. These factors are as follows: ● there is a change of purpose for which the land is held ● additional land is acquired to be added to the original parcel of land ● the parcel of land is brought into account as a business asset ● there is a coherent plan for the subdivision of the land ● there is a business organisation – for example a manager, office and letterhead ● borrowed funds financed the acquisition or subdivision ● interest on money borrowed to defray subdivisional costs was claimed as a business expense ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision, and ● buildings have been erected on the land. No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. Application to your circumstances Although you initially acquired and used the property as your main residence, there is now a clear change in your purpose for holding the property. You have demolished your main residence and are subdividing the land into two blocks. You plan to construct a dwelling on each of the blocks, retaining one as your main residence and selling the other. While your stated intention is that you are not undertaking the activity for the purpose of resale at a profit but merely to fund your transition into a new residence, you are relying on the cash flow derived from selling one of the dwellings to cover the construction cost of your new main residence and to reduce your debt from building the two properties. The savings you will make demonstrate that you will be profiting from the sale of the second dwelling. You have a coherent plan of demolition, subdivision and construction that will considerably increase the value of the property and result in a profit. The nature of the property will change significantly from an older home which was not economical to return to an acceptable standard, to two newly constructed dwellings on separate titles. While you will not carry out the activities of the project yourself directly, the manner in which you have entered into it and the way it will be carried out has the nature of a commercial transaction and your activities are considered to amount to the carrying out of a profit making undertaking. The development is not simple and uninvolved, and is considered to amount to more than a mere realisation of a capital asset to its best advantage. Accordingly, the profit you make from the sale of R2 will be assessable as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Assessable under the capital gains tax provisions: The 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 you own. CGT event A1 under section 104-10 of the ITAA 1997 happens when you dispose of a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of the CGT provisions as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997. In your case, it is the Commissioner’s view that the subdivision and construction of R2 will not be a mere realisation of a capital asset. Accordingly, whilst CGT event A1 will occur on the disposal of R2, your capital gain will be reduced by the profit you include in your assessable income under section 6-5 of the ITAA 1997.

2. Will the capital gain you make from the sale of R2 be included in your assessable income under the capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997?