Private ruling: CGT - Subdivision - Income or capital
Published: January 2014

Ruling: Will your share of the profit from the sale of the subdivided property be assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | Yes. | Will your share of the proceeds from the sale of the subdivided property be accounted for under the capital gains tax (CGT) provisions? | No. | Year ended 30 June 2014 | 1 July 2013 | Several years ago you purchased a property with the intention of keeping the existing house as a rental investment. | At the time of signing the offer and acceptance, the Trustee was aware that the property could be subdivided into a number of lots. | After settlement the trustee renovated the house to improve the rental yield. | You only derive passive income from investments. | The property received rent for several years. | The existing house was demolished in 2013. | The trustee wishes to subdivide the property into lots and sell the lots. | The lots will be advertised as house and land packages. | The contracts will stipulate that you will only be selling the land and that the purchaser will have a separate contract with the builder. | You will only receive proceeds for the land and not the proceeds from the construction of the houses. | The work completed in regards to organising the subdivision of the property has been completed by the trustee. | The work completed to date includes applying for council approval for the subdivision and organizing the demolishing of the existing house. | The trustee is in the business of new house sales and has extensive knowledge on how best to subdivide the land and will be involved in finalising the subdivision of the property. | You have subdivided vacant land in the past and constructed properties on the land which you retain as rental properties. | You do not own any other vacant land and do not intend to complete a similar transaction in the future. | There is an existing loan against the original house. | The subdivision will be funded through capital contributions from the Trustee and associates. Therefore, no interest expenses will be claimed. | There are no buildings on the land and construction will not commence until after the contract has been entered into. | The builder is not related to the Trustee and there will be a third party transaction. | The buyer does not legally have to contract with the builder and may choose a different builder if they wish. | You will be responsible for any costs associated with the sale of the land. | Income Tax Assessment Act 1997 section 6-5. | Income Tax Assessment Act 1997 section 10-5. | Income Tax Assessment Act 1997 section 102-5. | Income Tax Assessment Act 1997 section 118-20.



Reasons for decision: Summary: There are three ways profits from a land subdivision can be treated for taxation purposes: 1. As ordinary income under section 6-5 of the 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 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. 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. | Detailed Reasoning - Ordinary income: In your situation, the Commissioner is satisfied you are not carrying on a business of property development. The repetition, scale and volume of your activity is not of the same nature as is ordinarily carried on by a property developer that is carrying on a business. Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. TR 92/3 defines the term 'isolated transactions' as: · transactions outside the ordinary course of business of a taxpayer carrying on a business; and · transactions entered into by non-business taxpayers. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but: · the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and · the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: a) the nature of the entity undertaking the operation or transaction b) the nature and scale of other activities undertaken by the taxpayer c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained d) the nature, scale and complexity of the operation or transaction e) the manner in which the operation or transaction was entered into or carried out f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction g) if the transaction involves the acquisition and disposal of property, the nature of that property, and h) the timing of the transaction or the various steps in the transaction. In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 ( Casimaty ), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said, at 97 ATC 5152: Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. [Emphasis added] In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: § there is a change of purpose for which the land is held; § additional land is acquired to be added to the original parcel of land; § the parcel of land is brought into account as a business asset; § there is a coherent plan for the subdivision of the land; § there is a business organisation - for example a manager, office and letterhead; § borrowed funds financed the acquisition or subdivision; § interest on money borrowed to defray subdivisional costs was claimed as a business expense; § there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and § buildings have been erected on the land. No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. | Detailed Reasoning - Application to your circumstances: In your case, you acquired a property that you renovated and used as a rental investment for some time. However, when you purchased the property the Trustee was aware that the land could be subdivided. The trustee has recently demolished the existing house and is in the process of subdividing the land into lots. The lots will be advertised as house and land packages in which the builder is an unrelated party. The contracts will stipulate that you will only be selling the land and that the purchaser will have a separate contract with the builder. In accordance with the direction provided in TR 92/3 and MT 2006/1 we consider that the activities amount to more than the mere realisation of an asset to its best advantage. There is a coherent plan in place to carry out a sequence of actions that will result in a profit, there is a change of purpose for which the land is held, the land was originally held as a passive asset which was demolished in order to achieve the subdivision of the property, there is a level of development of the land beyond that necessary to secure council approval, an existing property has been demolished and an arrangement in place to make the land more appealing. On a weighing of the facts of your case we find that the subdivision and construction of a dwelling will constitute an isolated profit-making scheme. Accordingly, your share of the profits from the transaction will be considered ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Capital gains tax: Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst CGT event A1 will occur when each lot of the property is sold, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.