Private ruling: Property - subdivision - income v capital
Date of advice: 15 December 2016
Published: May 2017
Ruling period: 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; and | Income year ending 30 June 2022.
Date scheme commenced: 20YY.

Ruling: Q1: Will the profit from the sale of the subdivided lots be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the subdivided lots be subject to the trading stock provisions under section 70-30 the ITAA 1997? | A2: No | Q3: Will the profit from the sale of the subdivided lots be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: Information and documentation has been provided with this ruling which should be read in conjunction with, and forms part of this ruling. After 20 September 1985, you and your spouse purchased the property (the Property) as joint tenants. The land area of the Property is less than 10 hectares. You and your spouse have resided in the dwelling located on the Property on which substantial renovations had been undertaken after the Property was purchased. You have run your own horses and cattle, and have agisted other people's animals on the Property. The properties surrounding the Property were largely rural residential lots used for small scale farming operations and lifestyle purposes when the Property was purchased. The local council released a plan (the Old Plan) which outlined that properties in the area in which the Property is located could be subdivided. A number of years prior to the purchasing of the Property, the council had amalgamated with other councils to form a new council (the Council). A number of years after the Property was purchased, the Council released a planning scheme for the area (the Planning Scheme) which outlined that properties located in the area in which the Property is situation, which were zoned as Rural Residential, would be capable of being subdivided into smaller lots of approximately one hectare with the aim of establishing new, lower density housing in the district. The Property is currently located in the Rural Residential Zone under the Planning Scheme. Due to the encroaching development in the area and its urbanisation, you and your spouse have decided to sell the Property so that you can acquire a replacement lifestyle property in a more rural location for your personal use and enjoyment. It is your intention to subdivide the Property into smaller acreage lots, with you and your spouse initially discussing the prospect of subdividing the Property after the release of the Planning Scheme. In 20XX, you and your spouse engaged the services of a town planning firm (the Town Planners) to prepare and lodge a development application for the reconfiguration of the Property into a specified number of subdivided lots. In 20XX, the Town Planners provided you and your spouse with a fee proposal and scope of works for the subdivision of the Property. A number of months later, a developer (the Developers) provided their proposed fees and scope of works in relation to the subdivision activities. A number of months later, the Council indicated that the subdividing of the Property into a specified number of subdivided lots was a possibility. During the same month, you and your spouse entered into an agreement (the Agreement) with the Developers to undertake the subdivision activities. The Agreement outlines that you and your spouse would pay the Developers $XX,XXX (excluding Goods and Services Tax) for their services in relation to the subdivision of the Property which includes the amounts included in their proposed fees previously provided to you and your spouse a number of months earlier. In the same month, the Developers prepared drawings for the proposed subdivision of the Property. During the following month, a surveyors firm (the Surveyors) prepared a drawing of the proposed subdivision of the Property into the specified number of lots. In the same month, the Town Planner prepared a preliminary development application (the Preliminary Application) for the subdivision of the Property in accordance with the proposed subdivision drawing prepared by the Surveyors. During the same month the Town Planner lodged the Preliminary Application with the Council. Around a month later, the Council requested additional information in relation to the Preliminary Application. A number of months later, the Town Planners responded to the Council's request when they lodged a formal Development Application (DA) which outlines that: ● The proposed development would consist of a specified number of rural residential lots and one internal road providing access to the lots. The lots would be created with road access off a road situation next to the Property; ● The lots would have a land area of less than one hectare; ● The proposed development will comprise of the construction and/or installation of site earthworks and buildings, access driveways, stormwater drains, other ancillary services, and landscaping; and ● The dwelling and other buildings constructed on the Property will be located on Lot X after the subdivision occurs. The market value of the Property prior to the subdivision activities is estimated to be $XXX.XXX. It is estimated that the total costs of subdividing the Property will be $XXX,XXX, excluding interest on loans. You and your spouse expect to receive $X,XXX,XXX for the sale of the subdivided lots, being $X,XXX,XXX for the lots and vacant land and $XXX,XXX for the lot on which main residence will be located. You and your spouse will fund the subdivision of the Property with $XXX,XXX received from the sale of other assets, borrowed funds and the proceeds from pre-sale of the subdivided lots. You and your spouse will not undertake any physical activities in relation to the subdivision of the Property, other than provide assistance to the Town Planner and real estate agent as required. You and your spouse will engage the services of a real estate agent to market and sell the lots once the subdivision is approved. You and your spouse have not previously attempted to sell the Property as a whole. You and your spouse have not undertaken any land subdivision and sale activities in the past and do not intend to undertake any similar activities in the future. The financial projections and budgeted development costs for the subdivision of the Property outline that the development costs will be $XXX,XXX and the proceeds will be $X,XXX,XXX. It is anticipated that the DA approval will be received by late 20YY, with the subdivision of the Property expected to occur within 12 months of the work being commenced, with commencement expected to occur in 20VV. For the purposes of this ruling: ● The subdivision of the Property will be undertaken in accordance with the approved DA; ● The Property will be subdivided into a specified number of lots with the dwelling and buildings to be located on one lot and the other lots being vacant land; ● You and your spouse will engage the services of professionals to undertake the subdivision activities and will not undertake any activities yourselves other than providing assistance to the Town Planner; ● You and your spouse will engage the services of a real estate agent to market and sell the subdivided lots; and ● You and your spouse have not previously engaged in the business of buying, subdividing and sale of land and do not intend undertaking any subdivision activities in the future.

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 70-30 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Subsection 104-10(3) | Income Tax Assessment Act 1997 Section 112-25 | 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: Summary The proceeds from the sale of the subdivided lots will not be ordinary income and not assessable under section 6-5. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the capital gains tax provisions in Part 3-1 and 3-3. Detailed reasoning | Detailed Reasoning - Income or capital: As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 or statutory income under the capital gains tax provisions of the ITAA 1997. Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997. There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree. The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example: ● In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer's involvement was seen as an indicator of a business being conducted; and ● The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty). From the cases involving the subdivision of land and from Taxation Ruling TR 92/3 (TR 92/3), it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income: (a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and (b) 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 determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant: 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. 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. Application to your situation You and your spouse purchased the Property after 20 September 1985, and had used the dwelling located on the Property as your main residence. You had your own horses and cattle on the Property and have agisted other parties stock on the Property. A number of years after the Property was purchased, the Council released the Planning Scheme which allowed properties in the area zoned as Rural Residential to be subdivided into smaller lots of approximately one hectare. You and your spouse commenced discussing your proposal to subdivide the Property after the release of the Planning Scheme due to the encroaching urbanisation of the surrounding area. You and your spouse propose to subdivide the Property into a specified number of lots which will be sold so that you and your spouse can relocate to a more rural area. You and your spouse have engaged the services of professionals to undertake the activities required to subdivide the Property into the subdivided lots. The services of a real estate agent will be engaged to market and sell the subdivided lots. No other subdivision activities have been undertaken by you and/or your spouse in the past and neither of you intend undertaking any similar activities in the future. Based on the information provided, there is nothing to suggest that the subdivision of the Property was the beginning of a continuing business of property subdivision. The activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis given that you and your spouse will not personally be engaged in repetitive property development activities. Instead you and your spouse have engaged the services of professionals to subdivide and sell the subdivided lots. The subdivision activities will not go beyond what is necessary to enhance the presentation of the individual lots for sale as vacant lots. Therefore, it is the Commissioner's view that the activities in relation to the subdivision are not those of an entity carrying on a business of buying, subdividing and selling subdivided land. You and your spouse purchased the Property and had used it as your main residence which can be regarded as having the feature of a “passive investment”. It follows any sale proceeds from the sale of the subdivided lots will not be from an isolated commercial transaction or profit-making undertaking because the Property was not purchased explicitly for the purpose of resale. In conclusion, the activities involved in the subdivision and sale of the subdivided lots will not amount to carrying on a business. The transactions will not have the character of business operations or commercial transactions. There is no indication that your subdivision activities will become a separate business operation or commercial transaction, or that you and your partner will be carrying on, or carrying out a profit-making undertaking or plan. Therefore, as it is not viewed that you and your spouse are carrying on a business, or that the subdivision activities will be an isolated transaction, any profit arising from the sale of the X subdivided lots will be a mere realisation of the Property which will be accounted for under the capital gains tax provisions in Part 3-1 and 3-3. | Detailed Reasoning - Question 2: Summary As outlined above, you and your spouse are not viewed as carrying on a business of trading land. Therefore, the subdivided lots will not be trading stock under section 70-30. Detailed reasoning | Detailed Reasoning - Trading stock: Looking firstly the issue of 'trading stock', it is important at the outset to consider the definition of 'trading stock' in subsection 70-10(1) to determine whether or not section 70-30 has any implications in your circumstances. Subsection 70-10(1) provides that for an item to be considered 'trading stock', it must be held '…. in the ordinary course of a business'. Taxation Determination TD 92/128 Income tax: property development : if land is acquired for development, subdivision and sale but after some initial development the project ceases and is recommenced in a later income year, how is a profit on the sale of the land treated for income tax purposes? provides some guidance on this issue and states: Land can only be treated as trading stock if a business of trading in land is actively being carried on. There must be present the continuity of activity which characterises a business. Taxation Determination TD 92/128 refers to the remarks of Jacobs and Aickin JJ. in F C of T v. St. Hubert's Island Pty Ltd as being of use in determining whether or not a business of trading in land is actively being carried out. In this regard: ● Aickin JJ said, at 78 ATC 4123: In my opinion items of property (including land) can only be regarded as trading stock in circumstances in which the business in which they are employed involves some continuity or repetition of both buying and selling, so that one is able to say in a real sense that the stock is being turned over by a process of buying and selling. ● Jacobs said, at 78 ATC 4117: It seems to me that the essential question in the present case is - what must be found before it can be said that the taxpayer was carrying on the business of trading in the land? More particularly, did the taxpayer commence to carry on the business of trading in the land by acquiring the land for the purpose of developing and improving it, of subdividing it and of selling it off in subdivided lots? If it did not commence to carry on the business of trading in the land at that time of acquisition I do not consider that it can be said to have commenced to trade in the land or to carry on the business of trading in the land at any subsequent point of time. Application to your situation As outlined above, we do not consider that you and your spouse are in the business of trading land. Importantly, when you and your spouse acquired the Property your intention was not to sell the land for a profit, but rather, to reside on the Property, have horses and cattle, and agist other parties stock. As you are not in the business of trading land, the lots of land that will result from the subdivision of the property cannot be 'trading stock' as defined in subsection 70-10(1). As a result, section 70-30 has no application to your circumstances. | Detailed Reasoning - Question 3: Summary The proceeds from the sale of the X subdivided lots will be assessed under the general capital gains tax provisions as you and your spouse are not viewed as carrying on a business and the subdivision activities are not viewed to be commercial in nature. Detailed reasoning | Detailed Reasoning - Mere realisation: The capital gains tax (CGT) provisions are contained in Part 3-1 and 3-3. 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. CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. 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, according to subsection 112-25(2). Each new subdivided lot will be viewed as having been acquired on the same date that the original asset was acquired. The mere realisation of a capital asset has been described as “liquidating or realising the old assets” ( Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001). In the High Court of Australia case of Federal Commissioner of Taxation v NF Williams 72 ATC 4188; (1972) 127 CLR 226, at ATC 4194-4195; CLR 249, Gibbs J explained mere realisation of land as follows: An owner of land who holds it until the price of land has risen and then subdivides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of subdivision and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realization of a capital asset are not income either in accordance with ordinary concepts…even though the realization is carried out in an enterprising way so as to secure the best price… In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, at 97 ATC 5152, Ryan J described a salient characteristic of the mere realisation of land as follows: …[to not] undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. In distinguishing mere realisation from a commercial transaction, Ryan J further said: Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. Application to your situation As you and your spouse's activities are not viewed as being either those of someone carrying on a business of the subdivision and sale of land, or undertaking an activity of a commercial nature, it is considered that any gain made on the disposal of your respective ownership interests in the nine subdivided lots will represent a mere realisation of the Property to its best advantage. Therefore, any gain arising from the sale of your ownership interests in the nine subdivided lots will be accounted for under the CGT provisions in Part 3-1 and 3-3. Each of the subdivided lots will be viewed as having been acquired on the same date that the Property was originally acquired, being 20ZZ and any capital gain made on the sale of each of the nine subdivided lots will be calculated in accordance with the CGT provisions.

Reasons for decision: Legislative references referred to herein are from the ITAA 1997 .