Private ruling: Capital gains tax - land subdivision
Date of advice: 8 September 2017
Published: January 2018
Ruling period: Year ended 30 June 20XX | Year ending 30 June 20XX
Date scheme commenced: 1 July XXXX.

Ruling: Q1: Will the proceeds from the sale of the subdivided lots be subject to the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA)? | A1: Yes. | Q2: Will the proceeds from the sale of the subdivided lots be assessable income under section 6-5 of the ITAA 1997? | A2: No.

Relevant facts and circumstances: A relative acquired a property to provide a residence for you and your family. Some years later, your relative passed away and in accordance with their will, the property passed to you. The property was a number of hectares. The property consisted of a house lot frontage on the main road, where the residence was built, with the remainder of the property located behind a number of adjoining properties with frontages on the main road. The property continued behind the adjoining properties to a ridge at the top of a hill. Only a small section of the property was zoned for residential development, while the majority was particularly zoned and not open for development. Restrictions on development were slightly changed by council with respect to the area particularly zone and not open for development. This was rezoned to allow for a residence which meets certain qualifications to be approved for the upper zone of the property, which would be known as the balance lot. You did not initiate or have any input in this change of zoning. The balance lot is approximately two-thirds of the original property. You had not considered that the property could be subdivided or developed as only a third of the property was in the residential zone with no street frontage available, and the land had been landlocked by neighbouring properties with no road access. You entered into a joint venture agreement (JVA) with your neighbour, and their company (the Company), who owned adjoining land. Your neighbour has a history of buying and selling land in the course of their normal business activity and acquired the adjoining land, for the purposes of subdivision. The land owned by your neighbour had a wide street frontage, but was very steep. Your neighbour considered constructing a road to enable development which would be zigzagged across the hillside, ending with a cul-de-sac on your property. This proposal would result in the creation of a number of lots and a balance lot on your property, with your neighbour achieving a similar outcome on their land. You had never solicited or consulted anyone on subdividing your property. Under the JVA, your only contribution to the development was your property, while the Company and your neighbour provided all the expertise, skills and complete finance for the development. A planning application in relation to the development was lodged with council and approved. The subdivision was subsequently completed and titles were issued for the subdivided lots. The subdivision resulted in a total number of lots and two balance lots across both your property and your neighbour’s property. You retained a number of the newly subdivided blocks on your property, while your neighbour received a number of the subdivided lots, including the balance lot. You also retained the lot on which you reside. These lots are mostly in the residential zone, with part of one lot encroaching out of the residential zone. You have engaged a real estate agent to market and sell your vacant lots. You have sold a number of your lots and received a specified amount in net proceeds. At this stage, not all the lots have been sold. You had considered retaining one for yourself to construct a new main residence; however you will continue to reside at your existing dwelling and intend to sell the subdivided lot. You are not a related entity with your neighbour or the Company. You or any related entities have no previous involvement in any subdivision or property development activities. You or any related entities do not intend to be involved in any future subdivision or property development activities.

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

Reasons for decision: Summary: The sale of the subdivided lots will be subject to the capital gains tax (CGT) provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997). | Detailed Reasoning - Detailed reasoning: There are three ways profits from property sales can be treated for taxation purposes: 1. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or 2. As ordinary income under section 6-5 of the ITAA, 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, which is the commercial exploitation of an asset acquired for a profit making purpose; or 3. As statutory income under the capital gains tax legislation. Under section 6-5 of the ITAA 1997, the assessable income of an Australian resident includes ordinary income derived both in and out of Australia during an income year. Ordinary income is defined as income according to ordinary concepts. In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 ( Myer Emporium ), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income. Taxation Ruling TR 92/3 considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium . According to Paragraph 1 of TR 92/3, the term 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. Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present: ● your intention or purpose in entering into the transaction was to make a profit or gain, and ● 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 contrast, 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. | Detailed Reasoning - Application to your situation: In your case, you do not carry on a business of buying, selling or developing land. You have held the property for substantial period of time during which time you did not consider its development. You had minimal involvement in the subdivision of the land and have not contributed any funds, expertise or been involved in the development plans or applications. You contend that your role was entirely passive and found this to be an opportunity for you realise your asset, as you have become older and could no longer cope with the maintenance requirements of the large property. The sale of the subdivided lots is considered to be a mere realisation of a capital asset and the proceeds will be subject to the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997. Proceeds from the sale of the subdivided lots will not be included in your ordinary income.