Private ruling: Property - subdivision - carrying on a business - isolated transaction - capital gains tax - mere realisation
Date of advice: 7 September 2016
Published: November 2016
Ruling period: Income year ending 30 June 20VV | Income year ending 30 June 20WW | Income year ending 30 June 20XX | Income year ending 30 June 20YY; and | Income year ending 30 June 20ZZ.
Date scheme commenced: 1 July 20UU.

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) as a result of the carrying on a business of property development? | A1: Yes. | Q2: Will the profit from the sale of the subdivided lots be treated as ordinary income under section 6-5 ITAA 1997 as a result of an "isolated transaction" carried out for profit and commercial in character? | A2: No. | Q3: Will the profit from the sale of the subdivided lots be treated as your statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A3: No. You do not have an ownership interest in either of the properties, therefore no capital gains tax event will occur for you on the sale of the subdivided lots.

Relevant facts and circumstances: Information and documentation has been provided with this private ruling which should be read in conjunction with, and forms part of this ruling. Prior to 20 September 1985, Persons A and B purchased a property (Property 1) with a land area of XX hectares. Persons A and B purchased another property (Property 2) before 20 September 1985, which had a land area of XX hectares. The properties were used by Persons A and B in their farming business, with their family home located there. A number of years after the properties had been purchased one of Person A and B's children (Child A) had suffered an injury which had left then permanently disabled. Many years after Child A had become disabled, Persons A and B had transferred their ownership interests in the two properties to Child A to provide them with some security. The change of the ownership interests in the two properties were reflected in the titles of the properties, with Child A being recorded as the owner of the two properties. The family continued to use the two properties as their family home and for farming activities. Around 20 years after the properties were transferred into Child A's name, the family's farming activities on the two properties ceased with the farm house and land being leased to various parties for farming activities since then. Child A has two siblings (Child B and Child C). Child A's circumstances had changed over the years from when the properties had been transferred into their name. As a result, Child A felt the need for all of the siblings to be treated equally in relation to the properties. A number of months after the farming activities had ceased on the properties Child A had transferred their ownership interests in the two properties to their and their sibling's trusts (the Trusts) as follows to implement the expressed wishes of Persons A and B to share the two properties equally amongst their children in accordance with their wills: • Company A ATF Child A Trust, with the directors of Company A being Child A and their spouse • Company B ATF Child B Trust, with the directors of Company B being Child B and their spouse ; and • Company C ATF Child C Trust, with the directors of Company C being Child C and their spouse. As a result of the transfer, Company's A, B and C (the Trustees of the Trusts) each held equal shares in the properties as Tenants in Common. Person B passed a number of years after the properties were transferred into the Trustees names. A number of months after Person B passed away, the Trustees of the Trusts commenced an equal interest common law partnership (You), whose nature was the leasing of the two properties. Person A passed away a number of months after you had commenced. After Person A and B had passed away, Child A, B and C (the Siblings) had discussed selling the properties as broad acres. The Siblings have entered their retirement phase and they wish to dissolve you and sell the properties. In the year after Person A had passed away, a real estate agent (the Agent) had been approached. The Agent advised that it would be easier to sell smaller lots of land rather than broad acres based on their knowledge of the area. No sale price for the properties was set at that time. The zoning of the two properties has not changed since they were purchased. Child B had discussions with the Agent on several occasions in 20AA and 20BB, however no written advice was provided by the Agent. Child B and C held discussions with a representative of a surveying company (the Surveyors) whose services were engaged by the Three Siblings in 20CC. Due to funding constraints, the Surveyor proposed that the subdivision of the two properties be undertaken in a specified number of stages, with the funds from the sales of the lots sold in the earlier stages being used to fund the subdivision work being undertaken in the later stages as follows: • XX hectares of land will be subdivided into XX lots of residential land in either of two specified sized lots, in a specified number of stages; and • The remaining XX hectares will be subdivided into XX lots of residential land, with each lot being a specified size, in a specified number of stages. This land will continue to be rented until work on the specified stages commenced; and • All of the subdivided lots will be vacant land with the exception of the lots on which the existing buildings were located. In the month after they were engaged, the Surveyors lodged a Planning Permit Application for a Development Plan Overlay with the local council (the Council). Over 12 months later, the Surveyors prepared an overall development plan for Property 1. During the following month, the Surveyors lodged a Planning Permit Application for the specified first stages (the First Stages) with the Council. In the following month, the Council issued conditions that needed to be met for the granting of the subdivision approval for the First Stages including new road, drainage, electricity, water, sewerage, firefighting and environmental protection facilities. A number of months later, the Surveyors prepared a proposed plan of the First Stages. The estimated market value of two properties prior to the subdivision activities commencing is $X,XXX,000. It is estimated that the total costs for the subdivision are as follows: • $X,XXX,000 for the First Stages; and • $X,XXX,000 for the stages being undertaken after the initial First Stages (the Second Stages). The estimated selling prices for the subdivided lots in the First Stages are from $XXX,000 per lot for the smaller lots to $XXX,000 for the larger lots. The proceeds from the sale of the First Stages is estimated to be around $X,XXX,000. It is estimated that the selling prices for the lots in the Second Stages will be similar to those in the First Stages, however it is proposed that there will be around four times the number of subdivided lots in the Second Stages than in the First Stages. The subdivision work being undertaken in relation to the First Stages will be in accordance with the approved Planning Permit, with the addition of some basic fencing being erected around the proposed lots to increase their sales appeal for a cost of $XX,000. No new building/s will be constructed on the subdivided lots. The activities involved with the subdivision of the properties will be undertaken by independent contractors. The following parties have been, or will be, engaged in relation to the subdivision of the properties: Type of entity Role and services provided Surveyors • undertaking surveying • lodging permits for the First Stages • completing engineering work associated with the construction of road works, crossovers and drainage along the roads and the connection to a road near the property • will be engaged to undertake all surveying, lodgement of permits and engineering work arising in relation to the Second Stages. It is estimated that Surveyor's total costs will be $XX,XXX, of which some of this amount has already been paid. Power company • installation of power poles for electricity delivery to lots located in Property 1. Total amount paid at this point is $XXX,XXX. Plumbing entity • connecting water and installation of metres. No contract has been signed at this point, however it is estimated that the cost will be $XX,000 Roadwork's contractor Contractor has not been engaged at this point due to waiting for engineering report to be provided with a quote for the works. Total costs are expected to be around $X,000,000. Fencing contractors • fencing contractors It is estimated that the cost of fencing, including materials, will be $XX,000. Legal representatives • engaged to provide all legal and conveyance services Real estate agent • will be engaged to market and sell the subdivided lots for a fee, inclusive of Goods and Services Tax. No borrowings have been obtained at this point to fund the subdivision of the properties. However, short-term borrowings of no more than 12 months may be required if there are any cash flow problems. In early 20VV, contracts of sale for a number of the subdivided lots in the First Stages had been entered into, with settlement expected to occur in the later part of 20VV. The Siblings will be jointly responsible for decision making and signing of contracts in relation to the subdivision of the properties. Child B will also have some involvement in assisting the fencing contractor and will maintain all records. Otherwise, the Siblings will not personally undertake any activities in relation to the subdivision. The Siblings have not undertaken any similar activities in the past and have no intention to undertake any similar activities in the future. It is expected that the Surveyors will lodge the subdivision application for the Second Stages in 20WW. It is expected that the infrastructure activities in relation to Stages 3 and 4 will include: • Road making • Drainage • Electricity connections • Water mains and connections • Crossovers • Street lights • CFA water tanks; and • Street trees. You have not been dissolved at this point, but it is expected that you will be dissolved as soon as practicable after all of the land has been sold and the statutory compliance requirements fulfilled. It is estimated that that will occur in the 20ZZ income year. You have included the following amounts in your income tax returns: Income year Item 5, Label H Non-primary production - Other business income Item 20 Net Australian income or loss Statement of distribution (Distribution to each Trustee) 20GG-AA $XX,XXX -$XX,XXX -$ X,XXX 20AA-BB $XX,XXX $XX,XXX $X,XXX 20BB-CC $XX,XXX $ X,XXX $X,XXX 20CC-DD $XX,XXX $XX,XXX $X,XXX or $X,XXX 20DD-EE $XX,XXX $ X,XXX $ X,XXX 20EE-FF $XX,XXX -$ X,XXX -$X,XXX or -$X,XXX For the purposes of this ruling the following will occur: • The properties will be subdivided into XX lots , in a specified number of stages, in accordance with the development applications; • The services of professionals will be engaged to undertake all of the activities in relation to the subdivision of the two properties who will only undertake the minimum required by Council under the development approval for the subdivision of the properties; and • The services of real estate agents will be engaged to sell the subdivided lots.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 108-5 | 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: You are carrying on a business of property development because your activities display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. | Detailed Reasoning - Detailed reasoning: Broadly, there are three ways profits from a land development, subdivision and sale can be treated for taxation purposes: • as a profit made in the ordinary course of carrying on a business of property development • as ordinary income as you conducted an isolated commercial transaction with a view to a profit, or • as an assessable capital gain as a mere realisation of a capital asset. We will examine each of the above to determine how your gain from the sale of the subdivided lots should be treated for tax purposes. Carrying on a business of property development Section 995-1 of the ITAA 1997 defines 'business' as 'including any profession, trade, employment, vocation or calling, but not 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. Taxation Ruling TR 97/11 (TR 97/11) provides the Commissioners 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 businesslike 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. No one indicator is decisive. The indicators must be considered in combination and as a whole. Whether a 'business' is carried on depends on the large or general impression. Application to your situation In the context of considering the above authorities and factors, the following general observations of the arrangement can be made: • There is a coherent plan for the subdivision of the properties which is more complex than what would have been involved in the disposal of the properties as broad acres. The scope and scale of the property development subdivision is significant, and goes well beyond a simple realisation of the land in an enterprising way. The estimated revenue from the sale of the proposed XX lots is estimated to be over $X,000,000. • A natural consequence of the scope and scale of the arrangement is the sophisticated manner which it will be carried on over a lengthy period of time - undertaken over a number of stages, and estimated to be completed in up to a number of years. • The initial use of the properties by you was to earn rental income. There is a complete lack of nexus of the development of the properties to the previous rental activities which indicates a clear change of intention being to cease, or progressively scale down, one activity and commence a new activity. That is, to change the intention in relation to the properties from earning rental income to developing the properties for the purpose of selling the subdivided lots. • The properties were not offered as broad acres due to the advice provided by a real estate agent that the properties could be sold more easily if they were broken down into smaller land areas. • You have approached the subdivision of the properties in a businesslike way and have sought expert advice, and have engaged the services of professionals in relation to the subdivision activities. • The market value of the properties prior to the subdivision is estimated to be $X,XX,000. The cost of the subdivision of the two properties is estimated to be around $X,XXX,000, with the proceeds from the sale of the subdivided lots estimated to be around $X,XXX,000. • The underlying properties represent significantly less than half of the inputs that you are bringing into the development activities. • The sale of the subdivided lots to unrelated parties at market value shows that you have a purpose of profit as well as a prospect of profit from the subdivision activities. • The decision to pursue the development in this manner shows a choice to engage in exposure to the risks of the development, including the profits, losses and its general success; and • The legal title to the property remains with you and you all have the authority to provide the relevant consents and approvals in relation to the subdivision of the properties. A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion that your intention in relation to the properties changed when you decided to cease renting out the properties and subdivide them into lots for the purpose of selling them. For a property subdivision to be considered revenue, it is not necessary that a profit making intention be the sole motivation, only that it be a significant motivation The amount of money that needs to be invested to bring the development to a conclusion compared to the market value of the land if it was sold as is, the size of the profits expected and the level of risk assumed in the pursuit of return all indicate that on balance profit making is a significant intention for you. It cannot be viewed that the subdivision activities will be a mere realisation of the properties given that the underlying value of the properties is significantly less than half of the costs associated with the subdivision of the properties. You will be significantly improving the properties, increasing their values to a significantly higher amount by undertaking the subdivision activities and changing nature of the properties from broad acres into small semi-rural residential allotments. The simplest way that you could have divested yourself of the properties would have been to have disposed of them without obtaining subdivision approvals and undertaking the associated works. The act of seeking the approval/s and undertaking the subdivision work must in some way contribute towards a finding that the overall activity constitutes more than a mere realisation of a capital asset. In accordance with TR 97/11, it is viewed that the subdivision of the two properties will be a significant commercial activity and that while you had been advised by the Agent that it would be easier to sell the properties a subdivided semi-rural residential lots, your goal is to make a profit from the sale of the subdivided lots. There will be repetition and regularity of the activities even if the subdivision activities are a "one-off" venture. The estimated cost of developing the properties is more than double the estimated market value of the properties if they were sold as-is to a third party/ies. There is significant investment of resources in relation to the subdivision activities and a significant assumption of risk by you in the pursuit of a return that is expected to be considerably larger than what would have been achieved by selling the properties as broad acres. The acquisition of the relevant development approvals is not a simple transaction. It involves obtaining information as to the extent that the properties can be developed, having plans drawn up and liaising with council to have the proposal approved. Based on the information and documentation provided, it has been determined that your subdivision activities will amount to a carrying on of a business of subdividing and selling land. Accordingly, the proceeds from the sale of the subdivided blocks will be assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Profits from an isolated transaction: Profits from isolated transactions will be assessable as ordinary income where the intention or purpose in entering into the transaction was to make a profit or gain and the transaction was entered into and the profit was made in the course of carrying out a business operation or commercial transaction. Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view of the general principles and factors that have been considered in determining whether an isolated transaction is of a revenue nature. Paragraph 1 of TR 92/3 outlines that isolated transactions are: 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. A transaction that is commercial in nature will be a 'business or commercial transaction'. Broadly, a commercial transaction is one that will constitute carrying on a business except that there are no recurring transactions. Further, an isolated transaction refers to a transaction that is outside the ordinary course of business of a taxpayer carrying on a business and those transactions entered into by non-business taxpayers. Application to your situation Your activity has the character of a business operation or commercial transaction. However, unlike an isolated transaction it has the necessary repetitious or recurring transactions that show the characteristics of a business. Therefore, as outlined above, the Commissioner views that your subdivision activities will be undertaken in the course of carrying on a business. Therefore, the proceeds from the subdivision of the properties and sale of the subdivided lots will be a profit from the carrying on of a business under the guidelines provided in TR 97/11, as discussed above. Accordingly, the profit made on the sale of the subdivided lots will be accounted for on revenue account and will be assessable as ordinary income under section 6-5 of the ITAA 1997. The capital gains tax (CGT) provisions are contained in Part 3-1. In general terms, the application of the capital gains provisions is based on three components: • An identified CGT asset • A taxpayer (the owner of the identified CGT asset), and • A CGT event (which generally happens to the identified CGT asset). Section 102-20 of the ITAA 1997 states: You can make a capital gain or capital loss if and only if a CGT event happens. The gain or loss is made at the time of the event. Section 108-5 of the ITAA 1997 states: (1) A CGT asset is: a. Any kind of property, or b. … (2) To avoid doubt, these are CGT assets: a. Part of, or an interest in, an asset referred to in subsection (1), b. … The issue in this case relates to whether or not you are the owner of the subdivided land. Section 104-10 of the ITAA 1997 states: (1) CGT event A1 happens if you dispose of a CGT asset. (2) You dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. … Any capital gain or capital loss from a CGT event happening in relation to a partnership , or one of its CGT assets, is made by the partners individually (Section 106-5 of the ITAA 1997). Application to your situation This case considers the subdivision of land and the sale of the subdivided lots. In this case, the subdivided land is a CGT asset. Broadly, the CGT provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own. The point made clear by the text of subsection 104-10(2) of the ITAA 1997 is that the CGT provisions apply to the owner of the CGT asset immediately before the CGT event happens. In this case, you are not the owner of the properties under common law and you are not the owner of the subdivided lots for capital gains purposes either. Therefore, as you are not the owner of the properties, you are not the relevant party selling your ownership interest in the subdivided lots. Accordingly, there will not be a CGT event for you upon the sale of the subdivided lots and you will not have any assessable statutory income arising as a result of the sale of the subdivided lots.