Private ruling: Capital gains tax – subdivision – capital vs income
Date of advice: 9 July 2018
Published: September 2018
Ruling period: Year ended 30 June 20xx | Year ended 30 June 20xx
Date scheme commenced: 1 July 20xx

Ruling: Q1: Will the profit from the sale of the subdivided lots be treated as ordinary income under section 6-5 of the Income Tax Assessment Act 1997? | A1: No | Q2: Will the profits from the sale of the subdivided lots be treated as statutory income under the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997? | A2: Yes

Relevant facts and circumstances: You have occupied a dwelling situated on a larger property (the property) prior to 20 September 1985. The property was owned by person X who acquired the property prior to 20 September 1985. Person X moved onto the property and commenced running an orchard, which was run for many years. A second home was built on the property. Person Y moved onto the property into a fibro house. Whilst the property was under the ownership of person X approval was obtained for the property to be subdivided, Lot 1 of the subdivision was sold to the adjoining owner. A new home was erected. Person X died. At the date of death the property was valued at $X,XXX,XXX The deceased’s last Will and Testament stipulated a remainderman interest in the property for you after providing for the life interest of two others. You continued to live in your house on the property throughout the period of the life interests. Following the end of the life interests a form of transfer was executed, transferring your interest as proprietors of the property as joint tenants, for the property to be registered in your names as tenants in common in equal shares as devisees under the terms of the Will. The property you inherited was made up of arable and heavily wooded bushland, with three dwellings on the property. The property was rezoned by the Council, as a result of the changing nature of the district. It was a requirement of the Council that a cluster sub-division must get the necessary development approval and the landowners need to undertake the necessary structural improvements for the road and stormwater drainage. You have not been in business at any time since you moved onto the property. You have never been involved directly or indirectly in the ownership of a broadacre property or property development. The property has been and continues to remain a large bush block on the outskirts of an urban area that has no intrinsic commercial usage other than you have rented the house that was Person X’s old home. Upon your retirement from work you sought to access government payments but you were ineligible to receive the payments because of your land holdings. As a result it became apparent you would need to sell part or all of the property. A number of years after you inherited the property you engaged various service providers including, a surveyor, a town planner, environmental assessors, a civil engineer/development consultant, a Geotechnical specialist, and specialists in removal/demolition. You made a development application to the Council for the property to be sub-divided as a Community Association Lot, whereby the arable land would be split into X separate lots and the heavily wooded bushland would remain a common association lot. The development application was successful and approved. You intend to sell X of the subdivided lots for the construction of residential homes for an estimated total sale price of $X,XXX,XXX You will continue to reside in your home and person Z resides in the dwelling you previously lived in, both on Lot X. You will also keep Lot Y which you currently rent out. Lot Z is the community area and includes the road. Given you and person Z with their family continue to reside on the property you have advised there was never any intention to sell the property as a single un-subdivided lot. You did not receive nor seek an offer for the land in its un-subdivided state. You have not engaged a development manager. You personally meet with the various service providers and government authorities required to complete the process of the subdivision and sale. You maintain a handwritten journal of the costs incurred to date, which are approximately $XXX,XXX inclusive. You received other properties from the deceased’s estate which were sold and the proceeds were put into your superannuation fund. The costs relating to the subdivision to date have been funded from money you have withdrawn from your superannuation fund. Amongst the general requirements to protect the native vegetation and preserve access, was an obligation to construct a full width road, ensuring entry to three of the new community title lots and providing the necessary stormwater drainage A civil engineer and development consultant has provided you with a preliminary estimate for costs for the road, storm water drainage of approximately $XXX,XXX The engineer has also provided an estimate for total development costs which includes the road, storm water drainage, sewerage, energy, telecommunications, council and lodgement fees, specialised investigation and fees for consultants of $X,XXX,XXX exclusive You are unable to borrow funds in your own name as you have no income. It is considered highly likely that you will borrow monies on the back of provisional contracts of sale, which are conditional on the necessary road structures and stormwater drainage being completed. You have not yet completed contracts for sale as you are uncertain as to whether you are deemed to be undertaking a business and therefore are required to register for Goods and services Tax, and therefore apply the margin scheme. You have no experience in selling property and have employed a real estate agent to market the property The real estate agent provided you with an informal estimate in recent years that the un-subdivided land could be sold for $X,XXX,XXX, including Lots X and Y, which contain the residential dwellings you will retain You have no intention to undertake any further property sub-divisions.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 15-5 | 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 subdivision and sale of property can either be treated on revenue account, and taxed as ordinary income under section 6-5 of the ITAA 1997 (as either a business of property renovation; or an isolated profit making transaction), or on the 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 97/11 (TR 97/11) outlines the Commissioner's view on whether a taxpayer is carrying on a business. Ultimately, the question of whether the activities of a taxpayer amount to a business is decided on the facts of each case. The Commissioner and the courts consider that the following matters are relevant in determining whether a taxpayer is conducting a business of acquiring property for the purpose of making a profit on its subsequent sale: 1. whether the activity has a significant commercial purpose or character 2. whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity 3. whether there is repetition and regularity of the activity 4. 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 5. the volume of the operations and the amount of capital employed 6. whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit, and 7. the size, scale and permanency of the activity. In determining whether a taxpayer is carrying on a business, no one indicator will be decisive. The indicators must be considered in combination and as a whole. Whether a business is being carried on depends on the large or general impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial profile. | 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 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 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. Paragraph 36 of TR 92/3 notes that 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. Where the transaction involves the sale of property, it is usually necessary that the taxpayer has a profit-making purpose at the time of acquiring the property for the proceeds to be considered as being income. However, this may not always be the case (paragraph 41 of TR 92/3). Paragraph 49 of TR 92/3 states that the following factors may be relevant in determining whether an isolated transaction amounts to a business operation or commercial transaction: (a) the nature of the entity undertaking the operation or transaction (for example, the existence of a corporate entity may indicate that the transaction is of a commercial nature); (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 (for example, the use of professional agents or advisers may indicate that the transaction was more commercial in nature); (f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction (for example, the involvement of another family member may indicate a family dealing); (g) if the transaction involves the acquisition and disposal of property, the nature of that property (for example, did the property have a commercial use or nature); and (h) the timing of the transaction or the various steps in the transaction (for example, in regard to the acquisition and disposal of property, the holding of the property for many years may indicate that the transaction was not of a commercial nature). | Detailed Reasoning - Application to your circumstances: In your case, you have lived on the property as your main residence for a number of years. You later inherited the property with a remainderman interest. Person Z and their family live in another dwelling on the property. You decided to subdivide and sell some of the lots. You engaged a surveyor to complete the pre development application work for you. You were then involved in the subdivision of your land by engaging various service providers including, a surveyor, a town planner, environmental assessors, a civil engineer/development consultant, a geotechnical specialist, and specialists in removal/demolition. After this you submitted your development application to the council. You were successful with your development application and the council approved the property to be sub-divided as a community association lot, whereby the arable land would be split into a number of separate lots and the heavily wooded bushland would remain a common association lot. You intend to retain two of the subdivided lots. The subdivision will not go beyond what is necessary, as required by the council, to enhance the presentation of individual allotments for sale as vacant blocks and you have engaged a developer/engineer to complete these works. The subdivision is also relatively small in scale. Furthermore, you did not originally acquire the land for the purpose of subdivision and resale. Instead, you originally acquired your land by inheritance and used it for the purpose of residing. You also rented one of the homes on the property, which can be regarded as having the feature of a ‘passive investment’. It follows any sale proceeds from the sale of your land will not be from an isolated commercial transaction or profit-making undertaking because the land was not purchased explicitly for the purpose of resale and because there will be essentially no change in the purpose of the land (since its purpose, as a subdivision, will continue to be both your residential address, where you will retain a residential allotment of the land, and a passive investment). Since any profits from sale will be from a mere realisation of a capital asset rather from than from a profit-making undertaking, section 15-15 of the ITAA 1997 will not apply. Based on the information and documentation provided, there is nothing to suggest that the subdivision and development of the property will be the beginning of a continuing business of property development as it will be a one-time project. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, the proceeds you receive from the development of your property are not ordinary income and not assessable under sections 6-5 or 15-15 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 and 3-3 of the ITAA 1997. | 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. CGT event A1 under section 104-10 of the ITAA 1997 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. Where an amount is included in your income as ordinary income, it will not also be treated as a capital gain. When a CGT asset (the original asset) is split into two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event. Where the original land was acquired after 20 September 1985, each new subdivided block retains its post-CGT status and will be viewed as having been acquired on the same date the original asset was acquired. You will make a capital gain if the capital proceeds received for the asset are more than the asset’s cost base. You will make a capital loss if the capital proceeds received for the asset are less than the asset’s cost base. | Detailed Reasoning - Application to your circumstances: As outlined above, it is not viewed that any profit made on the disposal of the lots will be assessable as a result of you carrying on a business or from a profit making undertaking. Therefore any profit made on the disposal of the lots will be assessable under Parts 3-1 and 3-3 of the ITAA 1997 as a realisation of your asset. Under the CGT provisions you are viewed as having acquired your original ownership interest in the property upon the death of person X. No CGT event will occur when the property is subdivided and all of the subdivided lots will be treated for CGT purposes as if they had been acquired when each of your ownership interests in the property were acquired. CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. Subsection 104-10(4) of the ITAA 1997 provides that a capital gain will arise if the capital proceeds from the disposal are more than the asset's cost base and a capital loss will arise if the capital proceeds are less than the asset's reduced cost base.