Private ruling: Property - subdivision - disposal - income v capital
Date of advice: 2 August 2016
Published: September 2016
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 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 taxpayer carrying on a business of property development? | A1: No. | 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 statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A3: Yes.

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. After 20 September 1985, you and your spouse jointly signed a contract to purchase the Property. The Property was zoned Rural Residential. You and your spouse purchased the Property as a lifestyle block, to raise your family. A Planning Scheme was implemented by the local Council (the Council) which changed the zoning of the Property to Homestead Residential due to its close proximity to residential activity. A number of years after the Property was purchased, you and your spouse engaged the services of Company A who lodged a subdivision application for the subdivision of the Property into two lots with the Council. The Council approved the subdivision application for the following to occur: • Proposed subdivision of 1 lot into 2 lots, being Lot A having a larger land area with the existing house located on it and Lot B being of vacant land • Electricity, telecommunications to be supplied to each of the subdivided lots; and • Vehicular access to be provided. Around twelve months after the approval of the subdivision was granted, you and your spouse completed the subdivision of the Property into the two lots in accordance with the Council's requirements with Lots A and B being registered at the titles office. You and your spouse retained the ownership interests in Lots A and B. After reviewing real estate sale in your area after the subdivision was complete, you and your spouse decided to speak to your accountant in relation to how you and your spouse would be able to improve the outcome of the realisation of your asset by subdividing Lot B into smaller lots. A number of months later, you and your spouse visited your accountant to discuss how you could best realise Lot B, whether you and your spouse could further split Lot B into smaller lots, and the taxation implications of any further subdivision. Following the discussion with your accountant, you and your spouse decided to subdivide Lot B into smaller lots, with the intention of keeping Lot A so that you can keep living in the existing house. You and your spouse held discussions with Company A to get advice on how to proceed with the subdivision of Lot B. After your discussions with Company A, you and your spouse made the decision to move forward with subdividing Lot B into smaller lots of vacant land. Company A lodged the development application with the Council for the subdivision of Lot B into a specified number of lots. A number of months later a Development Application Decision notice was issued by the Council in relation to the subdivision of Lot B which approved of the subdivision into the specified number of lots in a number of stages subject to conditions being met. During the following month, Company A provided responses to the Council in relation to the Council's Decision Notice and the conditions for the subdivision. Shortly after, you and your spouse met with the Council to appeal the conditions included in the Development Application Decision notice as a number of conditions of the subdivision of Lot B into the specified number of lots were not applicable. During the following month, the Council issued a Negotiated Decision Notice which outlined the approval of the subdivision of Lot B from 1 lot into a specified number of lots, to be undertaken in a specified number of stages. The Council granted approval of the subdivision of the Property into the specified number of lots during the following month. You and your spouse intend undertaking the subdivision of the Property in the number of stages as outlined in the subdivision permit. You and your spouse have engaged the services of Company A to manage the subdivision of the Property, including: • Preparing all drawings and designs • Preparation and lodgement of applications with the Council • liaising with the Council • submitting water reticulation drawings to the state Urban Utilities • undertaking stormwater analysis • preparation of tender documents to call for tenders; and • supervision of subdivision works and organisation of contract administration and finalisation. The estimated combined market value of Lots A and B is higher than the estimated market value of the whole Property prior to the original subdivision, with Lot A being more than twice the value of Lot B. The estimated market value of Lot B has doubled with the approved Development Application. The projected costs for subdividing Lot B into the prescribed subdivided in the prescribed stages will be more than the market value of Lot B with the approved Development Application. You and your spouse will fund the subdivision of the Property using your savings and a bank loan. It is estimated that the subdivided lots will be sold for $XX0,000 each, with sale proceeds of $X,XXX,000. You and your spouse will engage the services of a real estate agent/s to sell the subdivided lots. You and your spouse have not undertaken any similar activities in the past and do not intent undertaking any similar activities in the future. For the purposes of this ruling the following will occur: • You and your spouse will engage the services of others to undertake the activities arising in relation to the subdivision of Lot B into the prescribed number of subdivided lots; • You and your spouse will sell the subdivided lots; • You and your spouse will engage the services of real estate agent/s to sell the subdivided lots; and • The subdivision of Lot B will be undertaken in accordance with the Development Approval provided with this ruling and: • Will subdivide Lot B into the prescribed number of lots • The subdivision will be undertaken in the prescribed number of stages; and • You and your spouse will incur expenses in relation to the subdivision.

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 Subsection 104-10(3) | 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 | Income Tax Assessment Act 1997 Division 115

Reasons for decision: Summary: Legislative references referred to herein are from the ITAA 1997 . Summary The proceeds from the sale of the subdivided lots will not be ordinary income and not assessable under section 6-5. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Part 3-1. Detailed Explanation | Detailed Reasoning - Income or capital: As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997. Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997. The term 'business' ordinarily refers to trade engaged in on a regular or continuous basis. To be engaged in a business of selling property, a taxpayer would need to be buying land and selling property on a regular basis. Whether a business is being carried on is a question of fact and degree. The courts have developed a series of indicators that are applied to determine the matter on the particular facts. Taxation Ruling 97/11 (TR 97/11) outlines the Commissioner's view on whether a taxpayer is carrying on a business. Ultimately, the question of whether the activities of a taxpayer amount to a business is decided on the facts of each case. The Commissioner and the courts consider that the following matters are relevant in determining whether a taxpayer is conducting a business of acquiring property for the purpose of making a profit on its subsequent sale: 1. whether the activity has a significant commercial purpose or character 2. whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity 3. whether there is repetition and regularity of the activity 4. 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 5. the volume of the operations and the amount of capital employed 6. whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit, and 7. the size, scale and permanency of the 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 profile. The Commissioner's view on whether profits from isolated transactions are assessable as ordinary income is found in Taxation Ruling TR 92/3 (TR 92/3). According to paragraph 1 of 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 states that profits on an isolated transaction will be ordinary income when: • the intention or purpose of a taxpayer 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 operation or commercial transaction. 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. 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. Matters listed in TR 92/3, 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. Application to your situation In this case, you and your spouse purchased the Property, with settlement occurring after 20 September 1985. You and your spouse purchased the Property for the lifestyle and to raise your family. The zoning of the Property changed from Rural Residential to Homestead Residential due to the planning scheme implemented by the local council. You and your spouse obtained a planning permit a number of years after the Property was purchased for the subdivision of the Property. The Property was subdivided in accordance with the planning permit into two lots consisting of Lot A on which your house is located, and Lot B, being vacant land. Lots A and B were registered at the titles office and you and your spouse retained ownership of both lots. You and your spouse spoke to your accountant after researching real estate in your area in relation to how you would be able to improve the realisation of Lot B by subdividing it into smaller lots. Following the discussions with your accountant, you and your spouse decided to keep Lot A on which your house is located on and to subdivide Lot B into smaller lots. You and your spouse engaged the services of Company A, who lodged a development application with the council for the subdivision of Lot B into a specified number of subdivided lots. The council approved the development application for the subdivision of Lot B over a number of stages, subject to conditions. You and your spouse appealed the conditions included in the approved development application and as a result the council issued a Negotiated Decision Notice a number of months later which approved of the subdivision of Lot B from one lot to a specified number of lots, to be undertaken in a specified number of stages. The council granted the approval of the Property in the specified number of stages in the month after the Negotiated Decision Notice was issued. You and your spouse have engaged the services of Company A to manage the subdivision of Lot B. You and your spouse will engage the services of a real estate agent/s to sell the subdivided lots. You and your spouse have not previously undertaken any similar activities and have no intention to undertake any similar activities in the future. Based on the information provided, there is nothing to suggest that the subdivision of Lot B and the sale of the subdivided lots will be the beginning of a continuing business of property sales. You and your spouse's activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner's view that you and your spouse's activities in relation to the subdivision of the Property and the sale of the subdivided lots are not those of someone carrying on a business of buying and selling land. Making an overall assessment on the factors set out in TR 93/2, it is the Commissioner's view that the sale of the subdivided lots will not be considered commercial in nature, given that the Property is a long-held privately owned property. In conclusion, the activities involved in the subdivision of the Property and the sale of the subdivided lots will not amount to carrying on a business. The transactions will not have the character of business operations or commercial transactions. There is no indication that your activities will become a separate business operation or commercial transaction, or that you will be carrying on, or are carrying out a profit-making undertaking or plan. Therefore, as it is not viewed that you are carrying on a business, or that the activities will be an isolated transaction, any profit arising from the sale of the subdivided lots, but that it will be a mere realisation of your Property which will be accounted for under the capital gains tax provisions in Part 3-1. | Detailed Reasoning - Capital gains tax: The capital gains tax (CGT) provisions are contained in Part 3-1. 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 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. When a CGT asset (the original asset) is split into two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event, according to subsection 112-25(2) of the ITAA 1997. Where the original land was acquired after 20 September 1985, each new subdivided block retains its post-CGT status and will be viewed as having been acquired on the same date the original asset was acquired. You will make a capital gain if the capital proceeds received for the asset are more than the asset's cost base. You will make a capital loss if the capital proceeds received for the asset are less than the asset's cost base. Application to your situation When Lot B is subdivided, each of the subdivided lots will be viewed as having been acquired by you and your spouse on the date that the Property was acquired. A CGT event A1 will occur when the subdivided lots are sold. As the gain made on the sale of the Property will not be assessable as ordinary income under section 6-5, it will be assessable under the CGT provisions. Therefore, any capital gain or capital loss made on the disposal of your ownership interests in the subdivided lots will be calculated under the CGT provisions. Note: If you meet the conditions contained in Division 115, the 50% CGT discount can be applied to any gain made on the disposal of your ownership interests in the subdivided lots.