Private ruling: CGT subdivision
Date of advice: 13 December 2018
Published: April 2019
Ruling period: 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 2018

Ruling: Q1: Will the profit or gain derived from the sale of the lots developed under the proposed Development Agreement be assessable income under section 6-5 or section 15-15 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the profit or gain derived from the sale of the lots developed under the proposed Development Agreement be a capital gain under section 104-10 of the ITAA 1997 that is subsequently disregarded under subsection 104-10(5)(a) of the ITAA 1997 to the extent it was acquired before 20 September 1985? | A2: Yes, however any capital gain will be reduced under section 118-20 of the ITAA 1997 for amounts included in assessable income as ordinary income.

Relevant facts and circumstances: You purchased land before September 1985. At the time of the acquisition, the property was zoned residential development zone. The property had an old dwelling which was rented for a period, but became uninhabitable. The property was also used for the agistment of cattle for a period. This was not considered to be a commercial activity, but merely a way in which to manage the land. The property was not otherwise used for any commercial activities or purpose. In or around mid-20XX you decided to subdivide the property. There was no attempt to sell the land as a whole before the choice was made to subdivide the property. You had neither previously undertaken property development activities nor engaged surveyors, town planners, engineers and real estate agents to develop properties. The proposed steps for the subdivision of the property were as follows: ● You would engage surveyors, town planners, engineers and real estate agents to sell the property ● Other than making such decisions as the advisors required you to make, you would not be involved in either the subdivision or the sale of the property ● You would finance the first stage of the proposed development from your own resources and the next two stages would be financed from the sale of the previous stages ● The estimated cost of the development was $Y ● The estimated gross sales of the development was $Z ● At the time, you had engaged in preliminary discussions with a surveyor as to the viability of the proposed development and engaged a valuer. The development commenced in 20XX. In 20XX, stage one of the development (which included the subdivision of XX blocks) commenced. Stage one of the development was completed in around 20XX. A website to promote sales of the lots was created for the subdivision that details the development. Sales of the subdivided blocks have not been as strong as expected. You are now not in a financial positon to complete the full subdivision. You have had discussions with a civil works contractor who has proposed a joint development agreement (the Development Agreement) whereby you make available the land and the civil works contractor will undertake the subdivision and sale of the remaining land. The developer approached you. You considered the choice of completing the subdivision yourself, entering into the Development Agreement or selling the land to a developer. You have chosen to enter into the Development Agreement without making any attempts to sell the remaining land. The total number of lots planned for the entire subdivision including the lots from the earlier stage of the subdivision is XX.

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 section 104-10(5)(a) | Income Tax Assessment Act 1997 section 118-20

Reasons for decision: Summary: The profit or gain derived from selling the lots under the proposed Development Agreement will be considered to be a profit from an isolated commercial transaction and assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Taxation treatment of property sales: 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; 2. As ordinary income under section 6-5 of the ITAA, on revenue account, as a result of entering into a profit-making undertaking or scheme (including an isolated transaction); or 3. As statutory income under the capital gains tax legislation. | Detailed Reasoning - Carrying on a business of property development: Section 995-1 of the ITAA 1997 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. Taxation Ruling TR 97/11 provides the Commissioner’s view of the factors used to determine if you are in business for tax purposes. In the Commissioner’s view, the factors that are considered important in determining the question of business activity 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 factor is decisive. The indicator must be considered in combination and as a whole. Whether a ‘business’ is carried on depends on the large or general impression. | Detailed Reasoning - Application to the current situation: Applying the above factors to the current circumstances, the overall view is that you are not carrying on a business as a property developer. There is a lack of regularity and repetition of the activity as there is no trading pattern of buying, developing and selling land. Any gain made on the disposal of the property will not be assessable income under section 6-5 of the ITAA 1997 as ordinary income from the carrying on of a business. | Detailed Reasoning - Isolated Commercial transactions: Profits arising from an isolated transaction as a result of entering into a commercial profit-making undertaking or scheme will be ordinary income under section 6-5 of the ITAA 1997 and will be on revenue account ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693 ( Myer Emporium )). This is distinguished from a ‘mere realisation’ which is not ordinary income. Paragraph 16 of Taxation Ruling TR 92/3 states that if a taxpayer not carrying on a business makes a profit, that profit is income if: (a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and (b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Paragraph 13 of TR 92/3 outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction: ● 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 the property, and ● the timing of the transaction or the various steps in the transaction. TR 92/3 also states: 41. … If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. However, as the High Court decisions in White v. FC of T (1968) 120 CLR 191; 15 ATD 173 and Whitfords Beach demonstrate, that is not always the case. (See also Menzies J in FC of T v. N.F. Williams (1972) 127 CLR 226 at 245; 72 ATC 4188 at 4192-4193; 3 ATR 283 at 289 and Whitfords Beach Pty Ltd v. FC of T (F.C.) 79 ATC 4648 at 4659; 10 ATR 549 at 567). 42. For example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either: (a)as the capital of a business; or (b)into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset. … 47. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character (see Whitfords Beach at 150 CLR 379; 82 ATC 4044; 12 ATR 707). Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. | Detailed Reasoning - Application to the current situation: You acquired the property many years ago and used it for minor cattle agistment and renting of an old dwelling situated on the land before it became uninhabitable. However, as stated in TR 92/3, if a taxpayer acquires an asset without a profit making purpose, but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a commercial transaction the profit from the activity is ordinary income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset. Therefore, although you may not have had a profit making purpose when you acquired the land, you will have a profit making purpose on the venturing of the remaining land into the land development project under the proposed Development Agreement. Consequently, the profit derived from the project will be ordinary income if the project is considered to be a commercial transaction. Also as stated in TR 92/3, whether a particular transaction has a commercial character depends on the circumstances of the case. In the current case, the size and scale of the works are substantial with a planned total of XX lots for the entire subdivision; approximately half of these to be created and sold under the proposed Development Agreement. The total estimated gross sales of all the lots is approximately $Y million. Under the agreement, the developer can erect a sales office which may be in the form of a display home and make any improvements it thinks appropriate for the better presentation of the estate. The possibility of significant improvements being made to the land points towards the project being more than just a mere realisation of an asset. The time period over which the subdivision has and will take place is lengthy. The subdivision activities started in 20XX and are still continuing. This points to the development being substantial and ongoing, which are elements that mean the activities take on a commercial flavour. You have not tried to sell the remaining land to a developer or looked into the possibility of marketing it to the public at large as an investment opportunity where the purchaser could either continue the subdivision or on sell the land at a later date to a developer. Rather, you propose to enter into a development agreement that in most respects represents a joint venture type agreement. By entering into the agreement instead of simply selling the remaining land, you will take on additional risk, including the risk of holding the land for a further substantial period if the development suffers delays or is not as successful as hoped. The objective explanation for them taking on additional risk is the prospect of a higher profit than would be obtained from simply selling the remaining land now. There is a commercial flavour to the operation and this existed even before the proposed Development Agreement. A website to promote sales of the subdivided lots was created which details the development. Although you will be taking a relatively passive role in the next stage of the subdivision by letting the developer do the bulk of the organising of the subdivision, this does not preclude the project from having a commercial character. That is, even though your role in it may be relatively passive, if the project is considered a commercial transaction then as you entered into it with a profit-making intention, your profit from it will be ordinary income. Taking into account the length of time that has already passed since you first started the subdivision and the likelihood that it will be several more years until all the lots are sold, it is difficult to view the sale of the lots in the future as a mere realisation of an asset when the process to realise the asset will likely take many years in total. Having regard to all the facts it is considered that the property development is more accurately described as a profit making commercial undertaking or plan rather than a mere realisation of an asset. Consequently, the profit or gain derived from selling the lots under the proposed Development Agreement will be assessable as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - CGT: The lots will be CGT assets. However, any capital gain made from the sale of the lots that is not otherwise disregarded as being made from a CGT asset acquired before 20 September 1985, will be reduced to the extent that the amount is assessable as ordinary income (refer to section 118-20 of the ITAA 1997).