Private ruling: Assessable income - Land subdivision
Published: October 2013
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
Date scheme commenced: 1 July 2013

Ruling: Q1: Will the proceeds from the development and sale of land be considered assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No | Q2: Will the proceeds from the development and sale of your land be subject to the Capital Gains Tax (CGT) provisions in Part 3-1 of the ITAA 1997? | A2: Yes

Relevant facts and circumstances: You have been operating a primary production business as a sole trader since 2000. Your stock numbers are consistent with others in business in the industry. You have acquired approximately 300 acres of farm land over a number of titles with the intention of using the land in connection with your primary production business. The majority of your land was acquired more than 10 years ago but one parcel was purchased approximately three years ago after the land was rezoned. High density residential development has since been approved for a portion of the overall land area that you now own. The balance of the land remains zoned for farm usage. You had no involvement in the rezoning. Prior to rezoning, all of these land parcels were zoned for farming use. At all times, you solely used the land to graze your stock and/or to grow grass or hay for feed for your stock. When acquired, improvements to the land were minimal. You have since re-dug and resealed dams on the land, totally re-fenced the land and built stockyards. You have also conducted a weed eradication program to make the land suitable to carry stock. As you are approaching retirement you are considering selling the land to clear debts, provide for your retirement and your family. In a recent year, you made contact with a local estate agent to explore the option of selling the land in its entirety. One offer was received but was not acceptable to you. The agent suggested that you might be able to maximise your return by engaging a developer to subdivide and develop the land into residential lots for separate sale to the public. You were subsequently introduced to a professional land development company, and you have been in negotiations in relation to developing the land for sale. The developer has proposed to develop the land for sale in exchange for a fee. The key terms of the proposal are as follows: a. The developer will attend to all matters required to effect the development and sale of the land. This will include matters such as: i. Applying for planning permits; ii. Consultation with authorities; iii. Carrying out construction works; iv. Engaging consultants, contracts, builders etc. as required; v. Marketing lots for sale, and appointing sales agents; vi. Determining minimum sale price for lots; and vii. Collecting sales proceeds and disbursing them to the client. b. You will remain owner of the land throughout the development. No title in the land will pass to the developer or any other entity to effect the development. You will individually enter into contracts of sales with purchasers of subdivided land lots. c. The developer will be responsible for initially paying all development costs and will have the right to be reimbursed these amounts from sale proceeds only as they are received on your behalf. d. In consideration for the development services provided, the developer will be entitled to a "management fee" from the proceeds for the sale of each lot and a "development fee" set at a percentage of the proceeds received for the sale of each lot less the recoupment of the development costs and the management fee. The developer is proposing to develop the land into approximately several hundred lots of various sizes over a number of years. The planning, financing, and approvals phase is expected to conclude during the subsequent financial year. The development works, marketing, and land sales are expected to commence in the subsequent financial year. You intend to continue to use the land in connection with your primary production business for some time after formally committing the land subdivision. This may continue for a few years until such time as works to the land make this impossible. You have no prior direct or indirect experience in land development activity. You formerly owned and operated a non-primary production business for many years.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Part 3-1

Reasons for decision: Summary: As you are not considered to be carrying on a business of land development and we consider that any profit on the sale of subdivided lots will not be the result a profit making undertaking or plan, any such profit will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: There are three ways profit from property sales can be treated for taxation purposes: (1) As ordinary income under section 6-5 of the ITAA 1997, as a result of carrying on a business of property development. (2) As ordinary income under section 6-5 of the ITAA 1997, as a result of an isolated business transaction entered into by a non-business taxpayer or outside the ordinary course of business of a taxpayer carrying on a business. . (3) As statutory income under the CGT legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Carrying on a business of property development: The question of whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the facts. Taxation Ruling TR 97/11 provides the Commissioner's view of the factors used to determine if you are in business for tax purposes. These factors are: · whether the activity has a significant commercial purpose or character · whether the taxpayer has more than just an intention to engage in business · Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity · whether there is regularity and repetition of the activity · whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business · whether the activity is planned, organised and carried on in a business-like manner such that it is described as 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 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 impression gained from looking at all the indicators and whether these indicators provide the operations with a commercial flavour. In applying these factors to your circumstances, you do not have any history of being involved in property development. You have not demonstrated the regularity or continuity usually associated with a property development business. It is considered that you are not carrying on a business of property development. | Detailed Reasoning - Isolated transactions: Profits on the sale of land can be income according to ordinary concepts, or the result of a profit making undertaking or plan, if your activities become a separate business operation or commercial transaction. In determining whether a transaction amounts to a business operation or commercial transaction, the Commissioner's guidelines are set out in paragraph 13 of Taxation Ruling TR 92/3. The factors relevant to your case are as follows: · 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 that property; and · the timing of the transaction or the various steps in the transaction. The cases of Casimaty v. Commissioner of Taxation 97 ATC 5135; (1997) 37 ATR 358 ( Casimaty's case ) and McCorkell v FC of T Re 39 ATR 1112; 98 ATC 2199 demonstrate that in circumstances where there is an absence of profit making intention when farming land is acquired, the likelihood of any profit made on the eventual sale of land being income according to ordinary concepts is greatly diminished. In Casimaty's case the taxpayer acquired a farming property on which he erected a homestead and conducted a primary production business. Because of growing debt and ill health, the taxpayer had to subdivide and sell off a large part of the property. In all there was a total of eight separate subdivisions. The proceeds from the subdivisions and sales were not assessable as the taxpayer acquired and continued to hold the property for use as a residence and the conduct of the business of primary production. A related consideration was the fact that the land was developed and subdivided on a piecemeal basis in response to the exigencies of increasing debt and deteriorating health. Accordingly, the subdivisions were considered to have occurred as part of the mere realisation of a capital asset. The fact that in realising an asset a taxpayer engages in activities which are planned, organised and may produce profits considerably more than could otherwise have been obtained, does not mean that an advantageous realisation converts into a profit-making scheme. | Detailed Reasoning - Application to your circumstances: You advise that you acquired the parcels of property for the purpose of carrying out a primary production business on the property and that the property has solely been used for this purpose during the period of your ownership. Your involvement in the development process will be limited to engaging a development company to act on your behalf to prepare development plans, consult with authorities, carry out construction works, market lots for sale and engage sales agents to organise the subsequent sale of the property. The relevant factors that relate to your case can be summarised as follows: · there is not a complex structure involved · you had not previously undertaken any other property subdivisions or developments · the land was not purchased for investment purposes · the majority of the subject land has been held for a significant period of time and prior to engaging with a developer it was solely used in your primary production business · you will have little involvement in the steps of subdividing and the subsequent sale of the land as you will engage a development management company from the beginning of the process, throughout the development process to the sale of your property. On balance, we consider that the proceeds from the sale of your land will not be assessable under section 6-5 of the ITAA 1997 as either ordinary income or a profit-making scheme. They represent a mere realisation of capital assets in the most enterprising way available so as to maximise the proceeds of sale. Accordingly, any profit on the sale of subdivided lots will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997.