Private ruling: Subdivision
Date of advice: 27 March 2019
Published: May 2019
Ruling period: Year ending 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the profit from the sale of the subdivided lots be assessable as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of you carrying on a business? | A1: No. | Q2: Will the profit from the sale of the subdivided lots be assessable as ordinary income under section 6-5 of the ITAA 1997 as a result of an isolated transaction carried out for profit and commercial in character? | A2: Yes. | Q3: Will the sale of the subdivided lots be assessable under the capital gains tax provisions? | A3: Yes. However, under section 118-20 of the ITAA 1997 any capital gain will be reduced to the extent the amount is assessable under section 6-5 of the ITAA 1997.

Relevant facts and circumstances: You purchased a block of land with a house on it as joint tenants. The house had an existing long term tenant in it and at the time of purchase you intended to rent the property out for a number of years. The tenant was advised that this would be the arrangement. You realised that the property may be eligible for subdivision and thought that perhaps at some time in the future you may demolish the house and subdivide the block. You thought you may sell one block and build a residence for yourselves on the other block. You had no time frame for this at the time of purchase. As your long term idea was to possibly subdivide the property you decided to apply for the approval to subdivide shortly after settlement to ensure that you obtained the approval whilst it was available and not risk having a later application rejected as a result of any future changes in rules. Surveyors were engaged to complete the subdivision on your behalf. Unfortunately, you had overestimated your ability to carry the costs of renting out the property and you did not seek any advice as to whether you could afford to rent out the house prior to purchase. After six months of renting the property, it became apparent to you that the weekly rent and property expenses were not sustainable in the long term. In addition to this, property prices were dropping with no sign of recovery, so there was no potential for capital growth. Bank interest rates were also on the rise. The tenant vacated the property some months after purchase. You decided to cut your losses and get rid of the house and land. After considering your options, you decided to bulldoze the house, subdivide the block and sell both blocks of land. You did this to realise the maximum potential of the asset. The house took up a portion of both subdivided blocks. You signed a selling agent agreement. The real estate agent sold one block. The other block was a private sale. You work in full time roles and the subdivision work was carried out by independent contractors. New titles to the subdivided properties issued. The subdivision costs were $xxx. Demolitions costs were $xxx. You borrowed funds for the property. The subdivided lots sold for $xxx and $xxx. The property was not rezoned during your ownership. You don’t intend to be involved in other subdivisions in the future. You have owned other properties in the past.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 102-20 | Income Tax Assessment Act 1997 section 112-25 | Income Tax Assessment Act 1997 section 118-20 | Income Tax Assessment Act 1997 Part 3-1

Reasons for decision: Summary: Generally, an amount received in relation to subdividing land would be assessable either as: ● ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as business income, ● ordinary income under section 6-5 of the ITAA 1997 as an isolated commercial transaction with a view to a profit, or ● statutory income under the capital gains tax (CGT) provisions contained in Part 3-1 of the ITAA 1997 as a mere realisation of a capital asset. Ordinary income Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year. Carrying on a business of property development Section 995-1 of the ITAA 1997 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? provides some factors that indicate whether or not a business is being carried on. The question of whether a business is being carried on is a question of fact and degree. Based on the information provided, we do not consider that any proceeds you would receive from the sale of the subdivided lots would be derived in the course of carrying on a business. Profits from an isolated transaction Profits arising from an isolated commercial transaction will be ordinary income if the 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 a taxpayer's business ( FC of T v Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693). Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income provides guidance in determining whether profits from isolated transactions are ordinary income and therefore assessable under section 6-5 of the ITAA 1997. The term isolated transaction 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. If a taxpayer not carrying on a business makes a profit from an isolated transaction or operation, that profit is assessable income if both of the following elements are present: ● the intention or purposes of the taxpayer in entering into the 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. Profit-making does not need to be the sole or dominant purpose for entering into the transaction. A profit-making purpose must exist at the time the transaction or operation was entered into. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. In your situation, the property was held for less than 18 months. Within that time you decided to demolish the house and subdivide the property and sell both blocks. Although you are not in the business of property development, to decide if any profit you make is ordinary income, we need to consider if the transaction was entered into, and the profit was made in carrying out a commercial transaction. TR 92/3 lists the following factors which are 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; 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 and the various steps in the 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 ordinary 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. 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, as the case may be. The profit from the activity is income even though the taxpayer did not have the purpose of profit-making at the time of acquiring the asset. In determining whether activities relating to isolated transactions are a profit making undertaking, it is necessary to examine all the facts and circumstances. Application to your circumstances In your case, you are an individual non-business taxpayer who purchased the property. You used the property for rental. In determining whether your project would be viewed as a profit making undertaking, the following general observations have been made: ● there was a plan for the subdivision of the property into lots which is more involved than what would have been involved in the disposal of the land as a whole; ● you applied for subdivision approval a couple of weeks after settlement; ● you decided to go ahead with the actual subdivision less than 12 months after purchase; ● there has been a change in the nature of the property with the demolition and subdivision transforming the property from the existing property with a house into two smaller lots of vacant land; ● you have owned several properties in the past; ● you do not have any plans to undertake further subdivision in the future; ● you funded the subdivision through borrowed funds; ● based on the figures provided, an overall profit was made; ● there was an intention to profit from the subdivision of the property and the transaction has been undertaken in a commercial manner; ● you incurred expenses to undertake the subdivision of the property; ● you engaged the services of a surveyor to undertake the subdivision; A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion the intention for purchasing the property changed to a profit making undertaking. Although the property was initially purchased as a rental property, the tenant only stayed there for less than 12 months and no other tenant moved in. Your intention in relation to the property changed when you committed to the undertaking in relation to demolishing the house, subdividing the property and the sale of the lots. The decision to pursue the subdivision shows your choice to engage in exposure to the risks of the development, including the profits, losses and its general success for the purpose of maximising the potential profit made on the sale of the lots. Your plan to demolish the house and subdivide the property as opposed to selling the property as it existed, shows a profit-making undertaking. Such activities go beyond a mere realisation of a capital asset. Based on all the facts and circumstances of your situation, your activities in relation to the property is a profit making commercial undertaking and the profits from the sale of the lots are considered to be ordinary assessable income under section 6-5 of the ITAA 1997. Capital gains tax Under section 6-10 of the ITAA 1997, assessable income also includes statutory income. Capital gains are included as assessable income under section 102-5 of the ITAA 1997. Section 102-20 of the ITAA 1997 states that a capital gain or capital loss is made only if a CGT event happens to a CGT asset. The property is a CGT asset (section 108-5 of the ITAA 1997). CGT event A1 happens if you dispose a CGT asset. When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided lots is not a CGT event (subsection 112-25(2) of the ITAA 1997). Each new subdivided lot will be viewed as having been acquired on the same date that the original asset was acquired. The cost base of the original asset is apportioned between the newly created assets. 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 Part 3-1 as a result of the sales. Application to your situation As outlined above, the disposal of the lots are an isolated transaction and any profit made on their sale is included in your assessable income under section 6-5 of the ITAA 1997. CGT event A1 occurred on the disposal of your ownership in the lots. Any capital gain made on the disposal of the lots will be reduced to the extent that the profit from the sale of the sale lots is included in your assessable income under section 6-5 of the ITAA 1997.