Private ruling: Capital gains tax
Published: October 2014
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the proceeds from the sale of the property under the terms of the contract be assessable as ordinary income pursuant to section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the anticipated gain made from the sale of the property under the terms of the contract be considered a capital gains tax (CGT) event pursuant to Part 3-1 of the ITAA 1997? | A2: Yes. | Q3: If the sale of the property is assessable as a capital gain, can it be disregarded under section 104-10(5) of the ITAA 1997? | A3: Yes. | Q4: Will you hold both pre and post CGT interests in lot A? | A4: Yes. | Q5: When your interest in Lot A is sold, can the subsequent capital gain be disregarded? | A5: Yes.

Relevant facts and circumstances: Individual A first acquired a rural property prior to September 1985. Individual A and Individual B were married approximately X years ago. After their marriage, Individual A continued to hold the property in his own name. After 20 September 1985, Individual A transferred an interest in the property to Individual B. The executed Memorandum of Transfer described the transfer as from Individual A (as Transferor) to Individual A and Individual B as joint tenants. The property is on a single title and is more than 2 hectares in size. The property is zoned rural. The improvements on the property included a dwelling which Individual A and Individual B occupied as their main residence. The property is not used for any other purposes. Individual A and Individual B have been approached by a developer to purchase the land. The purchaser intends to acquire the adjacent land to the property from other vendors. The purchaser will enter into a contract to purchase the property from Individual A and Individual B separately. There are special conditions in relation to the contract between the purchaser and Individual A. The contract is subject to the purchaser obtaining the registration of a plan of subdivision over the property As Individual A intends to continue to reside on the property, the contract will specify that a portion of the property will be carved out for Individual A. In addition to the carved out land, the purchaser will also be required to transfer an interest in certain adjoining land to Individual A. The new lot A will be less than 2 hectares. It will include the whole of the existing dwelling. The new lot A will continue to be used as Individual A and Individual B's main residence. Under the terms of the contract, the purchaser is responsible for making the necessary enquiries with the council and carrying out the necessary works for the purpose of obtaining and registering a subdivision of the property.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 paragraph 104-10(5)(a) | Income Tax Assessment Act 1997 section 109-5

Reasons for decision: Detailed Reasoning - Question 1 & 2: We need to determine whether the proceeds from the sale of the land: • are assessable ordinary income under section 6-5 of the ITAA 1997 as you were carrying on a business of property development • are assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to a profit, or • are a realisation of a capital asset and assessable under the CGT provisions of the ITAA 1997. | Detailed Reasoning - Carrying on a business of property development: Based on the information provided, we consider that any proceeds received from the sale of the subdivided land would not be derived in the course of carrying on a business. | Detailed Reasoning - Profits from an isolated transaction: Profits arising from an isolated business or commercial transactions 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. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but: • the intention or purpose of the taxpayer in entering into the profit-making 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. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: 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 or the various steps in the transaction. Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: • there is a change of purpose for which the land is held; • additional land is acquired to be added to the original parcel of land; • the parcel of land is brought into account as a business asset; • there is a coherent plan for the subdivision of the land; • there is a business organisation - for example a manager, office and letterhead; • borrowed funds financed the acquisition or subdivision; • interest on money borrowed to defray subdivisional costs was claimed as a business expense; • there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and • buildings have been erected on the land. 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 - Application to your circumstances: Having regards to your circumstances and the factors outlined above, we do not consider that the proceeds from the sale of the land will be assessable under section 6-5 of the ITAA 1997. We accept that the disposal of the land will be a mere realisation of a capital asset. | Detailed Reasoning - Question 3: A capital gain on the disposal of an asset can be disregarded under paragraph 104-10(5)(a) of the ITAA 1997 if it was acquired prior to 20 September 1985. Application to your circumstances In this case, your interest in the property was acquired prior to 20 September 1985. Therefore, upon disposal of the property, any capital gain can be disregarded under paragraph 104-10(5)(a) of the ITAA 1997. | Detailed Reasoning - Question 4: Under section 109-5 of the ITAA 1997 you acquire a CGT asset when you the disposal contract is entered into or, if none, when the entity stops being the assets owner. Application to your circumstances In this case, you are selling a property to a developer. However, the terms of the contract stipulate that you will retain an interest in a portion of the property. Prior to the sale, you held a pre CGT interest in the property and the other interest was held by the developer. Therefore, after the transfer takes place, you will hold both pre and post CGT interests in the land held prior to the subdivision. As part of this transaction, you will also acquire land adjacent to your main residence. The date of acquisition of this land will be after 20 September 1985 and will be considered a post CGT asset. Therefore, you will hold both pre and post CGT interests. | Detailed Reasoning - Main residence exemption: Generally, you ignore a capital gain or capital loss from a CGT event that happens to your ownership interest in a dwelling that is your main residence. To get the full exemption from CGT: • the dwelling must have been your home for the whole period you owned it • you must not have used the dwelling to produce assessable income, and • any land on which the dwelling is situated must be two hectares or less. As discussed above, a capital gain on the disposal of an asset can be disregarded under paragraph 104-10(5)(a) of the ITAA 1997 if it was acquired prior to 20 September 1985. | Detailed Reasoning - Application to your circumstances: When you dispose of the property, a CGT event will occur. As discussed, a portion of the property is a pre CGT asset, while the remainder of the property is a post CGT asset. Therefore paragraph 104-10(5)(a) of the ITAA 1997 will only apply to disregard the portion of any capital gain that relates to the pre CGT interest. If the property continues to be used as your main residence, you will be entitled to apply the main residence exemption and disregard any capital gain on the post CGT interest.