Private ruling: Capital gains tax -subdivision and sale of units
Date of advice: 1 February 2018
Published: June 2018
Ruling period: Income year ending 30 June 2016 | Income year ending 30 June 2017 | Income year ending 30 June 2018 | Income year ending 30 June 2019 | Income year ending 30 June 2020 | Income year ending 30 June 2021
Date scheme commenced: 1 July 2015

Ruling: Q1: Will the profits of the sale of the units be assessable income under section 6-5 of the Income Tax Assessment Act 1997? | A1: Yes. | Q2: Will the profit of the sale of the units be assessable under the capital gains tax provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 ? | A2: Yes, however section 118-20 of the Income Tax Assessment Act 1997 will apply to reduce the capital gain to the extent that the profit from the sale of the units is otherwise included as assessable income under section 6-5 of the Income Assessment Act 1997 ( ITAA 1997).

Relevant facts and circumstances: You, being J and K are spouses. J purchased the property (the property) which consisted of a house (the house) and land (the land). J resided in the house until marrying K. After marrying K, J and K have continued to reside in the house. You are both approaching retirement age and considering your retirement. Due to your ages, you both considered downsizing and moving to a smaller residence. You investigated the local property market but found the house prices and associated purchasing costs to be prohibitive and as a result you considered demolishing the existing house and building three units on the land. Research conducted by you identified that your house if sold would realise an indicative sale price of around $XXX,XXX to $X,XXX,XXX based on sale prices of houses in your location. Similar research conducted indicated the costs of buying a house in the same location would be around $XXX,XXX including stamp duty and legal costs. You have made the choice to demolish the house and construct units on the land (the unit development). You intend moving into one of the units when construction is completed, selling one unit following the construction process and renting out the other unit for a period up to 24 months before selling it. The sale proceeds from the sale of the first unit will be used to pay down the loan and the rental income from the other unit would service the loan. The sale of the second unit would allow any remaining debt to be cleared. As you are nearing retirement age, you intend using the rental proceeds from one of the units and proceeds from the sale of the units for investing in your retirement. You intend subdividing the land with a unit located on each subdivided block. You engaged an architect to draw up plans for the construction of the units (the units) as part of the unit development. You obtained a valuation of the property with the undeveloped land being valued at $X,XXX,XXX to $X,XXX,XXX. Planning approval was granted by the local Council. Recently J transferred an ownership interest in the property to K. A builder was engaged and the house was demolished. The construction of the units has not commenced at this point, but is expected to be completed within the next 12 months. You have not engaged a manager or another professional to manage the subdivision and construction of the units. You appoint professionals to carry out work when required. The development and building costs for the units, including demolition costs, is estimated to be $XXX,XXX. The units are expected to be valued at $XXX,XXX to $XXX,XXX each, with each unit being identical in size and occupying the same land area. You expect to make a profit on the sale of the units. You have obtained finance to fund the unit development, with the loans being secured against the property. The loans extend for a considerable period and allow for interest only payments to be made during part of the loan period. You have not undertaken any property development in the past and you don’t plan to undertake any other property development in the future, other than the unit development subject to this private ruling. You have not prepared any business plans with respect to the development.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | 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: You are not carrying on a business of property development because your activities do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. However, any profit or loss from the sale of the units will still be accounted for on revenue account as an isolated transaction because you are subdividing the property and constructing a number of units for the primary purpose of making a profit on their sale. Capital gains tax event A1 will still occur on the sale of the units and any capital gain arising from this capital gains tax event will be reduced by the amount included as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997). | Detailed Reasoning - Taxation treatment of property sales: There are three ways profits from property sales can be treated for taxation purposes: 1. As ordinary income under section 6-5, 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, on revenue account, as a result of an isolated commercial 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 (CGT) legislation on the basis that a realisation of a capital asset has occurred. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case. We will consider each of these in relation to your situation as follows: | Detailed Reasoning - Carrying on a business of property development: Section 995 of the ITAA 1997 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law. In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways: It is the words “carrying on'' which imply the repetition of acts and activities which possess something of a permanent character. …activities engaged in for the purpose of profit on a continuous and repetitive basis. Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business. For a one-off land subdivision to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property. The Commissioner’s view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business: ● whether the activity has a significant commercial purpose or character; ● whether there is repetition and regularity of the activity; ● 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; ● whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit; ● the size, scale and permanency of the activity; and ● whether the activity is better described as a hobby, a form of recreation or a sporting 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 flavour. | Detailed Reasoning - Isolated transactions: Profits arising from an isolated transaction as a result of entering into a profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997 , on revenue account, ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 ( Myer Emporium )). This is distinguished from a ‘mere realisation’ which is not ordinary income. Taxation Ruling TR 92/ 3: Income Tax: whether profits on isolated transactions are income (TR 92/3 ) sets out the ATO view as to the application of the decision in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. Paragraph 16 of TR 92/3 states: If a taxpayer not carrying on a business makes a profit, 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. TR 92/3 outlines that 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. A taxpayer’s intention may change from the time of acquiring and holding the asset. Profit from the activity is income when the taxpayer’s intention changes, even though the taxpayer’s intention at the time of acquiring the asset was not to use it for purpose of profit making. Paragraph 42 of TR 92/3 states: For example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either: (a) as the capital of a business; or (b) 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 or a business operation or commercial transaction carrying out a profit making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit making at the time of acquiring the asset. Paragraph 13 of TR 92/3 outlines the following factors which may be relevant when considering whether an isolated commercial transaction amounts to a business operation or commercial transaction: ● 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; ● the nature of any connection between the relevant taxpayer and any other party to the operation or transaction; ● if the transaction involves the acquisition and disposal of property, the nature of the property, and ● the timing of the transaction or the various steps in the transaction. Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) aligns itself with TR 92/3 and provides a list of the following factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on. ● there is a change of purpose for which the land is held; ● there is a coherent plan for the subdivision of the land; ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision; ● 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 business organisation, for example a manager, office and letterhead; ● borrowed funds financed the acquisition and subdivision; ● interest on money borrowed to defray subdivisional costs was claimed as a business expense; and ● buildings have been erected on the land. In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. | Detailed Reasoning - Capital gains tax provisions: The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 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. 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 blocks is not a CGT event. CGT event A1 happens if you dispose a CGT asset. 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 of the ITAA 1997 as a result of the sale, for example, as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Application to your situation: You have demolished your main residence with the intention of constructing units on the land. One unit will remain as your main residence, another unit will be sold following completion of the construction of the units and the third unit will be rented for a period of up to 24 months before being sold. It has always been your intention to sell both units and not retain them for the purposes of long term investment. After reviewing the information and documentation provided, it is the Commissioner’s view that the activities involved with the unit development are not those of an entity carrying on a business of developing property. Your activities do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. The building of the units will be undertaken by another party and the activity is in relation to a relatively small one off project that was not carried on in a manner similar to other property development businesses. You have not undertaken any similar activities in the past in relation to the unit development, nor will you undertake any similar activities in the future. Your activity has not been brought to account as a business asset and there is no business organisation involved. There is no formal manager engaged and no business plan or coherent plan for the subdivision and development of the land. You have not engaged a project manager given the small scale of the development and you have not entered into any financial arrangement with a developer. An objective assessment of the information provided establishes that your intention in entering into the transaction to build the sale units was for the purpose of making a profit or gain from an isolated transaction. J purchased the house with the intention to use it for private purposes. The property was used for that purpose by J and then by you for a number of years. Your intention then changed and your activities show an intention to generate a profit through demolishing your house, subdividing the land and building a number units, one of which will become your main residence, one will be sold immediately to reduce your debt and the other rented for up to 24 months to meet the loan repayments and clear any remaining debt, allowing an any surplus profits to be directed to your retirement. As outlined in paragraph 42 of TR 92/3, when a taxpayer’s intention in relation to an asset changes and the taxpayer decides to venture into a profit-making scheme with the characteristics of a commercial transaction, the activity of the taxpayer will constitute the carrying out of a profit-making scheme. The nature of the property will be changed when the unit development is completed, from having one dwelling located on it to having three units located on it. You have borrowed a significant amount of money which will be used to fund your activities and the profit from the sale of the units will be used to pay the debts arising in relation to your activities. The undertaking of unit development activities will significantly improve the land, increasing its value to reflect the market value of three units (between $X,XXX,XXX to $X,XXX,XXX) which is significantly higher than the value of the house before its demolition or the market value of the undeveloped land. You will rent out one of the units for up to 24 months prior to selling it. It cannot be viewed that the unit is a long term investment property due to the short period it will be rented. Additionally, while the unit will be rented out, your intention to sell the unit will not be abandoned and will remain your intention despite the unit being rented out. Based on the information provided, it is viewed that your unit development activities are a profit making undertaking. Therefore, the profits from the sale of the units will be assessable as ordinary income under section 6-5 of the ITAA 1997. Whilst CGT event A1 will occur on the sale of the units, any capital gain arising from this CGT event will be reduced by the amount included as assessable income under section 6-5 of the ITAA 1997 . | Detailed Reasoning - Application of case law to your situation: There are numerous cases that consider the issue where the potential outcome is between ‘carrying on a business’, ‘profit making undertaking’ or ‘realisation of an asset’. You have cited the following cases in your ruling application to support your contention that the profits from the sale of the two units will be on capital account. These cases are discussed below: Stevenson v FC of T 91 ATC 4476 ( Stevenson’s case) is an appeal from Administrative Appeal Tribunal. Judge Jenkinson of the Federal Court reaffirmed the Tribunal’s findings that the substantial subdivision, development and sale of individual lots from broad acreage land previously used in farming was characteristic of carrying on a business given the degree of systematic organisation, planning, management and repetition of a purposeful profit making activity. Your situation is distinguished from Stevenson’s case because you are constructing buildings on your property, which the taxpayer in the Stevenson’s case sold vacant blocks of land. The only similarity this case has with your situation is that the taxpayer in Stevenson, like you was trying to down size or as stated by the Federal court, the land of the taxpayer in Stevenson’s case had become redundant. The court stated that the realisation of the land is the purported end, but considered the means to achieve the end was achieved by carrying on a business of property development. In Stevenson ’s, the court adopted the reasoning in Whitfords Beach Pty Ltd v FC of T 79 ATC 4648 at 4666: …. In a case where the asset has been divided and the divided parts improved in the course of a business of dividing and improving such assets, it would be rare that one could say that the profits from sale of the individual improved items (after making allowance for the value of the original asset) represented part of the proceeds of a mere realisation of a capital asset as distinct from the profits made in the ordinary course of that business. Where the activities of dividing and improving are of sufficient scale and scope, the fact that no prior independent business existed will not prevent those activities themselves constituting a business of which the profits arising on sale are the ordinary proceeds. You cite Statham and Anor v FC of T 89 ATC 4070 (Statham) and Casimaty v FC of T 87 ATC 5135 (Casimaty) to support your contention that the small scale of your development in building three units, one of which will become your main residence is smaller than the subdivision of blocks that occurred over multiple stages in Statham and Casimaty, which were held to be a mere realisation of a capital asset. In Casimaty the taxpayer, subdivided portions of his broad acre farm into semi-rural blocks with minimal works undertaken to the blocks apa rt from basic fencing around the borders of the blocks. In your case the activities involve transforming a site from a single residential house estimated to be between $XXX,XXX to $X,XXX,XXX to three units with a total market value of between $X,XXX,XXX to $X,XXX,XXX. There was no coherent plan conceived for the subdivision of the whole property in Casimaty and the taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose or object for which the property had been held. In your case there will be a change in purpose in relation to the property as it will be held for the purpose of subdividing and constructing three units, two of which will be sold to generate a profit. Statham is distinguished from your situation in that: ● Statham attempted to sell their property as a whole without any success, while you have made a conscious decision to retain the house, then demolish it and build three replacement units; ● Statham did not erect buildings on the land, while you will erect three units; and ● Statham did not borrow any money in relation to the subdivision activities, but did provide a guarantee to the local council who undertook the subdivision works. You have taken out a loan to the amount of $X,XXX,XXX and incurred risks in taking out this loan and will rely on the profits from the sale of at least one unit immediately to repay part of the mortgage. | Detailed Reasoning - Conclusion: Making an overall assessment on the factors set out in TR 92/3 and MT 2006/1, it is the Commissioner’s view that the subdivision of the land and construction and sale of a unit after it is constructed, and the short term renting of another unit before it is sold, has the necessary indicia of a profit making intention. Therefore any profits will be assessed as assessable income under section 6-5 of the ITAA 1997.