Private ruling: Property - subdivision - carrying on a business - profit making undertaking
Date of advice: 7 March 2017
Published: August 2017
Ruling period: Income year ending 30 June 2017; | Income year ending 30 June 2018; and | Income year ending 30 June 2019.
Date scheme commenced: 1 July 2016

Ruling: Q1: Will the profits made from the sale of the subdivided lots be assessable under the capital gains tax provisions in Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will a capital gains tax event A1 occur under section 104-10 of the ITAA 1997 when each of the subdivided lots is sold? | A2: Yes.

Relevant facts and circumstances: You and your spouse owned and operated a business (the Company). Prior to 20 September 1985, the Company purchased the Property. The Property comprises of a number of acres on a single title which has your residence and some structures located on it. The residence was your main residence from the time the Property was acquired. A number of years after the Property was purchased; the Company purchased various parcels of land adjacent to the Property to use in the furtherance of the Company's business. The Company's business ceased a number of years after the adjacent land had been purchased and the adjacent land was sold a number of years after the business had ceased. The Property was transferred into your name as part of the liquidation of the Company a number of years after the Company's business had ceased. The Property has not been used to produce assessable income since the title of the Property was transferred into your name. You were approached with an unsolicited offer to sell the Property for $X,XXX,XXX, however you did not accept the offer. The Property has not been put on the market. You did not apply to have the Property rezoned; however it is currently zoned due to the planning for future growth by the local council. The rezoning of the area from Rural or Low Density to Residential zoning has resulted in the values of local properties rising and has increased the council rates. The Developer approached you with a proposal to subdivide the Property. Due to the rising holding costs and the development surrounding the Property, you decided to sell your Property and had accepted the offer you received from the Developer. Around the same time, you moved from the Property to another location. A number of months after you moved from the Property a feasibility report (the Report) was prepared in relation to the subdivision of the Property which outlined the expenses, costs and proceeds from the subdivision and sale of the proposed subdivided lots. A number of months later a draft Development Agreement (Draft DA) was prepared between you and the Developer. The terms and conditions of the subdivision of the Property are set out in the Draft DA. The Developer has nominated an entity to undertake the subdivision activities arising in relation to the subdivision of the Property in accordance with the Draft DA on its behalf. A planning permit application was lodged with the local council for the subdivision of the Property. You will remain the legal and beneficial owner of the Property throughout the completion of the subdivision of the Property, and the proposed subdivided lots until they are sold. You will be represented in the subdivision activities by a person nominated by you. Neither you nor your nominated person will undertake any activities in relation to the subdivision of the Property other than providing the Property to the Developer. You will fund the costs you are required to pay under the Draft DA using your own funds, which will be paid in instalments. Assumptions The following assumptions have been made for the purpose of providing this ruling: ● the Report accurately represents the expenses and costs incurred in relation to the subdivision of the Property and the proceeds that will be received on the sale of the resulting subdivided lots; ● the Property will be subdivided into XX lots in accordance with the planning permit application lodged with the council; and ● the subdivision of the Property will be undertaken in accordance with the conditions and terms as outlined in the Draft DA originally prepared between you and the Developer.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 104-10 | 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: Detailed Reasoning - Taxation treatment of property sales: There are three ways profits from a land sub-division can be treated for taxation purposes: (1) As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock. (2) As ordinary income under section 6-5 of the ITAA 1997, 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. (3) As statutory income under the capital gains tax (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. There have been a number of Court and AAT cases, which have dealt with the issue of property development and whether the profits from this activity are assessable as income under ordinary concepts or whether the profit can more properly be characterised as a capital gain. As a general principle, if the sale of the land constitutes a business, or part of a business, then the proceeds will be assessable as ordinary income. On the other hand, if the sale is a mere realisation of the land, the proceeds will be a capital amount. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case. | Detailed Reasoning - Carrying on a business of property development: The Commissioners view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? Although Tax Ruling TR 97/11 deals with the issues of determining whether a taxpayer is carrying on a business of primary production, the same principles can be applied to the question of whether a taxpayer is in the business of property development. Paragraph 13 of TR 97/11, 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 flavor. | Detailed Reasoning - Isolated business transactions: Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income, discusses the Commissioners view on whether profits from isolated transactions are assessable as ordinary income. Paragraph 1 of Taxation Ruling TR 92/3 provides that the term isolated transactions refers to: a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and b) those transactions entered into by non-business taxpayers. Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction generally income when both of the following elements are present: a) the intention or purpose of a 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 operation or commercial transaction. 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. In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the individual circumstances of the case. Paragraph 13 of TR 92/3 lists the following factors which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include: ● 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. | Detailed Reasoning - Capital gains tax: 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. CGT event A1 under section 104-10 happens if you ownership interest in a CGT asset is dispose of. Under subsection 104-10(1) of the ITAA 1997, CGT event A1 occurs when you enter into a contract to dispose of the CGT asset. Application to your situation In your case, the title of the Property was transferred into your name as part of the liquidation of the Company and you had resided in the house located on the Property until you moved to another location after you had been approached by the Developer. You have not used the Property to earn assessable income during your ownership period. You have not acquired any additional land for the purposes of subdivision and the subdivision involves the sale of subdivided vacant blocks of land, with no construction of buildings prior to the sale of the subdivided lots. While the Developer's nominated party will undertake the subdivision activities, you can exert influence in relation to the subdivision activities. Under the conditions and terms of the Draft DA you will pay amounts in instalments for the services of the party undertaking the subdivision activities. After weighing up the indicators as outlined in TR 97/11 and the factors outlined in TR 92/3 and applying them to the facts of your situation, we have determined that the profits arising from the sale of the proposed subdivided lots will not be on revenue account. Therefore, any profit made on the sale of the subdivided lots will be assessable under the CGT provisions. A CGT event A1 will occur on the disposal of each of the proposed subdivided lots and the time of the CGT event will be when the contract for each of the subdivided lots is entered into.