Private ruling: CGT - Property subdivision - income or capital
Date of advice: 7 December 2016
Published: May 2017
Ruling period: ● 1 July 201X - 30 June 201X | ● 1 July 201X - 30 June 201X | ● 1 July 201X - 30 June 201X
Date scheme commenced: November 201X

Ruling: Q1: Was the subdivision and sale of the land undertaken as part of a business of property development? | A1: No | Q2: Is the subdivision and sale of the land part of an isolated business transaction to be accounted for on revenue account? | A2: Yes

Relevant facts and circumstances: The Taxpayers purchased a dwelling and some area of land (the property) at an address on a date in 201X. The property came with fixtures and facilities for handling livestock and facilities for a horticulture nursery. The Taxpayers paid an amount to purchase the property. This value was split between the land and the dwelling. The Taxpayers funded the purchase with their savings, and a line of credit that they repaid with the sale of their previous dwelling. The Taxpayers began to treat the property as their main residence from six months prior to the sale of their previous dwelling not far away on the same road for an amount. The Taxpayers state they purchased the property because they liked the dwelling. They investigated the feasibility of agisting livestock on the additional land, but decided the insurance costs made the return not worthwhile. The Taxpayers enquired about establishing a horticulture nursery but discovered that this was not allowed by the council. The Taxpayers currently have two animals on the remaining land for personal use. The Taxpayers decided to subdivide and sell off the surplus land, retaining the dwelling and surrounding land for their main residence. In order to gain council approval to subdivide the land into four blocks, the Taxpayers were required by council to acquire additional land along the boundary from their neighbour to provide access to the rear block. The Taxpayers acquired this additional area for an amount on a date in 201Y. The Taxpayers employed relevant trade professionals and complete the works. Work included the minimum work required by council to approve the subdivision. The Taxpayers also performed some of the work themselves, including the removal of trees. The Taxpayers built a new fixture on the block they were retaining to replace the existing fixture on one of the subdivided blocks The Taxpayers used the services of a real estate agent to sell the blocks. They did not personally engage in the marketing. The total cost of all the subdivision work was an amount about XXX% of the value of the land before the subdivision took place. The Taxpayers funded the subdivision with their savings and with a line of credit. The financing of the subdivision was not connected with the financing of the purchase of the land. The purchase was not dependent on the sale of the blocks to repay the debt. The Taxpayers pre-sold two of the blocks prior to the subdivision being finalised, with their sale taking place on a date in 201Y year. They sold the third block on a date in 201Y. They have retained one block of a reasonable size with their dwelling. The Taxpayers have in the past engaged in the subdivision and sale of surplus land surrounding their previous dwelling which was nearby on the same road. The Taxpayers state that they are not carrying on a property development business and do not intend to commence one. For the purposes of the ruling some accompanying documents need to be read with and form part of the facts of the ruling .

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Part 3-1

Reasons for decision: Summary: The subdivision and sale of the land was not undertaken as part of a business. Even though the Taxpayers were not conducting a business, the property subdivision and sale was an isolated commercial transaction for tax purposes. Any profits from the sale are taxable as ordinary income at the time the subdivision was completed. | Detailed Reasoning - Detailed reasoning: The subdivision and sale of property can either be treated as on revenue account, and taxed as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) (as either a business of property subdivision; or an isolated profit making transaction), or as on capital account, and taxed as statutory income under the Capital Gains Tax (CGT) legislation. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case | Detailed Reasoning - Carrying on a business of property development: Taxation Ruling TR 97/11 Income Tax: am I carrying on a business of primary production? is about carrying on a business. Whether an entity is carrying on a business has been considered extensively by the courts, using the following indicators: 1. the nature of the activities, particularly whether they have the purpose of profit making; 2. the repetition and regularity of the activities; 3. organisation in a businesslike manner, including 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; 4. the volume of the operations; and 5. the amount of capital employed. In deciding whether a person is carrying on a business, the above indicators are weighed up. However equal weighting may not be given to each indicator. The indictors that carry the strongest weighting are repetition and regularity of activities, organisation in a businesslike manner and volume of operations. | Detailed Reasoning - Isolated profit making transaction: 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 (TR 92/3) 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. 'Isolated transactions' refers to: ● those transactions outside the ordinary course of business of a taxpayer carrying on a business; and ● those transactions entered into by non-business taxpayers. Whether a profit from an isolated transaction is income according to the ordinary concepts and usages of mankind depends very much on the circumstances of the case. However, where a taxpayer who does not carry on a business makes a profit from an isolated transaction, that profit is income if: (a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and (b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. | Detailed Reasoning - Intention: The relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. Where a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the land or property. | Detailed Reasoning - Commercial transaction: Paragraph 13 of TR 92/3 lists factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. Relevant factors include: ● the nature of the entity undertaking the operation or transaction; ● the nature and scale of other activities undertaken by the taxpayer; ● the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained; ● the nature, scale and complexity of the operation or transaction; ● the manner in which the operation or transaction was entered into or carried out; ● if the transaction involves the acquisition and disposal of property, the nature of that property; and ● the timing of the transaction or the various steps in the transaction. In addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, 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 (MT 2006/1) aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on. Relevant factors include: ● there is a change of purpose for which the land is held; ● there is a coherent plan for the subdivision of the land; and ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision. 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. | Detailed Reasoning - Capital gains tax: 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 that you own. A CGT asset is any kind of property or a legal or equitable right that is not property. The inclusion of the profit or gain on the sale of a CGT asset as ordinary income does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. Therefore, while a CGT event will occur when an asset is sold (CGT event A1), any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Application of the law to your facts - Question 1: From the time the Taxpayers purchased the land they intended that the dwelling on the property should be their main residence, and it soon became that. The Taxpayers have stated that they acquired the land solely for the dwelling, and had no specific plans for the surrounding land. At the time they first acquired the dwelling and land they investigated some alternate uses for the land, but they quickly discarded the plans and formed an intention to subdivide and sell the land. Given the Taxpayers previous history of buying a dwelling on land, subdividing and selling the surplus land, it seems reasonable to suppose that this course of events was at least contemplated even at the time of purchase. The Taxpayers purchased the additional area of land from their neighbour to fulfil the requirements of council to allow the subdivision to proceed. Likewise, the work undertaken to build the driveway, water management, fencing and connection of utilities were the minimum amount of work necessary in order for council to permit the subdivision to take place. However, it was a significant amount of work and a significant amount of expenditure. The Taxpayers have carried out the work in a business-like fashion, creating a detailed plan and bringing in experts to perform the work. In this case, we do not consider that the Taxpayers are carrying on a business of property development because their activity does not display enough indicators of a business, which are transactions entered into on a continuous and repetitive basis. The current development is the second property subdivision they have engaged in. With three subdivided lots sold, the scale of the undertaking is towards the low end. Due to its size and scale, the activity is not carried on in a similar manner to that of other businesses in the same industry. The impression that the Taxpayers are not carrying on a business is further supported by the manner in which the subdivision came about. The Taxpayers have carried the work out in their own names, rather than through a business structure. They have relied on a real estate agent to sell the land rather than engaging in marketing themselves. They have retained part of the land for their own use. | Detailed Reasoning - Application of the law to your facts - Question 2: While the Taxpayers are not carrying on a business of property subdivision, the income from the subdivision and sale of the three blocks of land will still be considered ordinary income. From very early after the Taxpayers purchase of the property, if not from the time of purchase, the Taxpayers began to hold the land with the intent of subdividing and selling the surplus land at a profit. The purpose of profit making is not to be determined from the subjective statement of a taxpayer, but by an objective observation of their actions. There was a relatively short time between you purchasing the land and beginning the subdivision. The activities the Taxpayers carried out involve substantially more than merely realising their asset. They had a clear and detailed plan for the subdivision and sale. The Taxpayers have managed the planning and the finances in a business-like way, and carried out the work in a timely fashion. While the Taxpayers have done no more work in the subdivision than the minimum required by the council for the subdivision to take place, that minimum still amounts to a very significant amount of work. The amount spend on the subdivision has exceeded the value of the land, which would be indicative of a major transformation of the asset for the purpose of selling it, moving it beyond mere realisation. Purchasing additional land in order to carry out the subdivision is another indicator of having gone beyond the mere realisation. While again this was a requirement from council to allow the subdivision of the block in the Taxpayers chosen configuration, it is the acquisition of property for the purpose of resale. The combination of this land with the larger block also serves to transform the asset being sold. Again, the transformation moves it beyond a mere realisation. There are some indicators of capital characteristics to the project - the Taxpayers use of the dwelling as their residence, the investigation of possible alternate income producing uses for the land prior to commencing the subdivision, and the fact that they only performed the minimum of work required by council to allow the subdivision to proceed. However, these are outweighed by the commercial characteristics as described above. No alternate income earning activities were ever actually carried out, and no alternate uses for the land ever pursued. The nature of the Taxpayers activity meets the characteristics described in TR 92/3 and MT 2006/1, most specifically, there is a change of purpose for which the land is held; they developed the property for the primary purpose of resale at a profit. The transformation of the land shows more than a mere realisation, and the business-like elements of the way they carried out the subdivision all combine to demonstrate the subdivision was an isolated profit making transaction, and subject to tax on revenue account. Importantly, the net profit or loss from an isolated transaction is determined at the time the transaction or development is completed. The development expenses incurred in years prior to the completion are not deductible in the year incurred as they do not sufficiently relate to the taxpayers assessable income. That is, the associated expenses are taken into account in the financial year that they completed the sales when calculating the net profit. As the renovation is on revenue account, there is no need to consider the CGT provisions.