Private ruling: Capital gains tax - land subdivision
Date of advice: 27 June 2017
Published: October 2017
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020 | Year ending 30 June 2021 | Year ending 30 June 2022
Date scheme commenced: 1 July 2011

Ruling: Q1: Are the proceeds from the development of your property assessable under sections 6-5 or 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Are the proceeds from the development of your property subject to the capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997? | A2: Yes, however any capital gain or capital loss you make on the disposal of each subdivided block will be disregarded for CGT purposes.

Relevant facts and circumstances: Prior to 20 September 1985, you and your spouse purchased an acreage property. The property is now located near a large city. Since you acquired the property, it has been used for domestic purposes and as your main residence. After you acquired the property, it was subject to various rezoning applications to zone the property for residential use. For lifestyle reasons, you now wish to downsize and move to a more manageable property. Some years later you were approached by a developer (the developer) with a proposal to develop and market the property. The developer carries on a broad acre residential subdivision business. You entered into a development agreement with the developer. Under the agreement: ● You will grant development rights to the developer, permitting them to do all things necessary to undertake the development. ● You will pay the developer a development fee, calculated by reference to the net proceeds of the development, subject to the amount payable to you and your spouse, referred to as the 'land owner retention amount’. ● The 'land owner retention amount’ is calculated as the agreed land value plus a percentage of the net proceeds (a minimum amount is specified). ● The developer is solely responsible for the day to day management, costs and marketing strategies of the development. You have granted the developer an irrevocable Power of Attorney. The developer expects the completed subdivision to result in a number of lots, subject to planning approval. The development will be released in a number of stages and is expected to take several years to complete. The property has been subject to a planning overlay as it is considered to be a property in a bush fire prone area. As a result of this overlay, additional conditions have been imposed in relation to the development by the relevant authorities. This has resulted in a large delay with respect to the progress of the development. You have not be involved in liaising with the relevant authorities in relation to the additional conditions, however the developer has handled the requirements and met with authorities as necessary. Current estimates have remained unchanged with respect to the net proceeds of the development. You and the developer agreed to extend the terms by a number of years. Apart from this development, neither you nor your spouse has any prior history of property development.

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 104-10. | Income Tax Assessment Act 1997 Subsection 104-10(5)

Reasons for decision: Summary: The proceeds from the sale of the subdivided land are not ordinary income and not assessable under sections 6-5 or 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997). The proceeds represent a mere realisation of a capital asset under the capital gains tax (CGT) provisions in Part 3-1 of the ITAA 1997. However, as the land was acquired before 20 September 1985, any capital gain or capital loss will also be disregarded for CGT purposes. | Detailed Reasoning - Detailed reasoning: There are three ways profits from property sales can be treated for taxation purposes: 1. As ordinary income under section 6-5 of the ITAA, 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 of the ITAA, on revenue account, 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, which is the commercial exploitation of an asset acquired for a profit making purpose; or 3. As statutory income under the capital gains tax legislation. Under section 6-5 of the ITAA 1997, your assessable income includes the ordinary income you derived directly or indirectly from all sources, during the income year. Additionally, section 15-15 of the ITAA 1997 includes profit arising from the carrying on or carrying out of a profit-making undertaking or plan. Although the legislation does not define income according to ordinary concepts, a substantial body of case law has evolved to identify various factors that indicate the nature of ordinary income. In FC of T v The Myer Emporium (1987) 163 CLR 199; 87 ATC 4363; (1987) 18 ATR 693 ( Myer Emporium ), the Full High Court expressed the view that profits made by a taxpayer who enters into an isolated transaction with a profit making purpose can be assessable income. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income considers the assessability of profits on isolated transactions in light of the principles outlined in Myer Emporium . According to Paragraph 1 of Taxation Ruling TR 92/3, the term isolated transactions refers to: ● those transactions outside the ordinary course of business of a taxpayer carrying on a business, and ● those transactions entered into by non-business taxpayers. Paragraph 6 of TR 92/3 provides that a profit from an isolated transaction will generally be income when both the following elements are present: ● your 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 on a business or in carrying out a business operation or commercial transaction. In contrast, paragraph 36 of Taxation ruling TR 92/3 notes that 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. In your case, you do not carry on a business of buying, selling or developing land. You have held the property for substantial period of time, during which the dwelling on the property was used as your main residence. You will have minimal involvement in the development of the land. Therefore, the proceeds you receive from the development of your property are not ordinary income and not assessable under sections 6-5 or 15-15 of the ITAA 1997. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997. | Detailed Reasoning - CGT provisions: CGT event A1 in section 104-10 of the ITAA 1997, relating to the disposal of a CGT asset, will happen when you dispose of each subdivided block. You will make a capital gain if the capital proceeds from the disposal of the block are more than the cost base of the block. You will make a capital loss of those capital proceeds are less than the reduced cost base of the block. Subsection 104-10(5) of the ITAA 1997, however, contains an exception, where any capital gain or capital loss made is disregarded if the asset was acquired before 20 September 1985. In your case, you acquired the original parcel of land before 20 September 1985. Therefore, any capital gain or capital loss you make will be disregarded for CGT purposes.