Private ruling: Capital gains tax
Published: June 2014
Ruling period: Year ending 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020
Date scheme commenced: 1 July 2013

Ruling: Question and answer | Will the sale of the subdivided blocks of land be subject to the capital gains tax provisions of the Income Tax Assessment Act 1997 ? | Yes.

Relevant facts and circumstances: You and a relative own a 50% share each in a parcel of rural land. You purchased the land over 50 years ago. Your relative carries on a business on the land. You and your relative were approached by a company (the company) with a proposal to develop a section of the land. It is proposed that the company will develop the land to create a substantial number of lots. You and your relative have signed a property development agreement with the company under which the company will: • carry out all the development activities; • obtain all permits and approvals; • manage the day to day running of the development • meet all the costs of the development; • prepare the final development plan; • be solely responsible for marketing strategies for the sale of the lots; and • accept responsibility for all insurances that are needed. The company will be paid: • a management fee calculated on the total proceeds of the sale of the lots; and • a development fee which will be determined as a proportion of the proceeds from the sale of the lots. The property development agreement states that nothing in the agreement will be construed or deemed to constitute a partnership or joint venture between you and the company. All expenditure on the project, including fees, will be financed by a bank under a loan obtained by the company, with you and your relative providing a third party mortgage over the site, and then ultimately from the project funds as sales are made and debt is repaid.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 15-15 | Income Tax Assessment Act 1997 section 104-10

Reasons for decision: Summary: Your assessable income for an income year includes any net capital gain you make and any ordinary income you derive in the year. Any capital gain realised from the sale of a capital asset is usually assessable under the capital gains tax provisions and not as ordinary income. In your case, we note that you acquired your interest in the land prior to the commencement of the capital gains tax provisions on 20 September 1985. Where a property acquired before 20 September 1985 is sold, section 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997) specifies that your assessable income includes any profit arising from the carrying on or carrying out of a profit making undertaking or plan. However, this provision does not apply to a profit that is assessable as ordinary income under section 6-5 of the ITAA 1997. Case law has established that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable as ordinary income ( FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693). Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) considers the assessability of profits on isolated transactions. 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. Further, 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. The courts have often found 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 (paragraph 36 of TR 92/3). 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). In your case, you have a 50% interest in a parcel of land that you purchased over 50 years ago. Your relative also has a 50% interest in the land and has been carrying on a business on the land. The application of the factors listed in paragraph 49 of TR 92/3 to your circumstances is as follows: a) The nature of the entity undertaking the operation or transaction You have signed an agreement with another party to complete the development and you will not be directly involved with the project. b) The nature and scale of other activities undertaken by the taxpayer You have not been involved with a subdivision project before. c) The amount of money involved in the operation or transaction and the magnitude of the profit sought The amount of money involved in the operation and the magnitude of the expected profit are substantial, however, you will not incur any material costs yourself. d) The nature, scale and complexity of the operation or transaction The scale and complexity of the subdivision is substantial, however, you will not be carrying out any of the development activities yourself. e) The manner in which the operation or transaction was entered into You have contracted with a commercial developer to carry out the subdivision. f) The nature of any connection between the relevant taxpayer and any other party to the operation or transaction You have signed an agreement with an unrelated party and there is no partnership or joint venture agreement in place with the other party. g) The nature of the property The land is a rural holding. h) The timing of the transaction or the various steps in the transaction The property was acquired as a rural holding many years before the planning of the proposed subdivision commenced. There was no intention to subdivide the land at the original time of purchase. Although the subdivision of the land is a substantial development, it is considered that the subdivision and sale of the blocks will constitute a mere realisation of an asset rather than the carrying out of a business operation or commercial transaction because of the following: • you have engaged another party to carry out all the activities associated with the subdivision and sale of the blocks of land; • you will have only a very limited involvement with the project; • you have no experience in the subdivision industry; • you did not acquire your share of the land with the intention of engaging in this subdivision project; and • a lengthy period of time has elapsed between when you acquired the land and the decision to subdivide the land. You have effectively engaged another party to improve the value of your land holding prior to realising its value by sale. Therefore, the proceeds you receive from the subdivided blocks of land will be subject to the capital gains tax provisions of the ITAA 1997.