1 Will any of the proceeds from the sale of the subdivided lots be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997
1 No. Question 2 Will any capital gain arising in relation to the sale of the land component of the subdivided lots be disregarded? Answer 2 Yes. Question 3 Can any capital gain made on the sale of each of the dwellings be reduced by the 50% capital gains tax discount under Division 115 of the ITAA 1997? Answer 3 Yes. This ruling applies for the following periods: Year ending 30 June 20XX Year ending 30 June 20XX The scheme commenced on: 1 July 20XX
Prior to 20 September 1985, a property (the Property) was purchased jointly by you, being Person A and Person B. The Property had a land area of less than two hectares (the Property land) with a house located on it (the House). The Property was purchased to produce rental income and was rented out from the month after it was purchased. Due to the poor condition of the House, it was decided that it would be demolished with a dual occupancy building to be built on the Property. The house was demolished with the construction of the dual occupancy building commenced. The construction of the dual occupancy building was completed several decades after the Property was purchased which consisted of several dwellings (collectively referred to as the Dwellings). The Dwellings have been rented since their construction for higher rental income than earned in respect of the rental income earned for the House. You are considering selling the Property as part of your retirement plan now that the Property can be subdivided following recent changes in Government policy encouraging higher density accommodation. You have not put the Property on the market.
After speaking with a real estate agent, you are considering subdividing the Property due to potential market restrictions of selling the Property as a dual occupancy. It is your view that the Property is more easily saleable as several properties rather than a dual occupancy. You believe the market for a dual occupancy buyer would be limited to an investor type whereas splitting the Property into separate dwellings would open the market up to normal residential buyers. You made enquiries with the local council in relation to subdividing the Property. You engaged the services of Company X to prepare a proposal in relation to the activities to be carried out to coordinate the subdivision and submit a Subdivision Development Application for the Property (the Subdivision Activities). Company A issued a Fee Proposal to you in relation to the Subdivision Activities which included the estimated costs involved with the Subdivision Activities as being less than $XX,XXX. It is estimated that: • The current market value of the Property is $X.X million; and
• The selling value of each of the subdivided lots with a dwelling located on it (the Subdivided Lots) is $X million each or $X.X million in total. It is anticipated that you will receive proceeds of $X.X million from the sale of the Subdivided Lots, less $XX,XXX for commission and legal expenses, for net proceeds of $X million. The services of a real estate agent will be engaged to market and sell the Subdivided Lots. The costs associated with the Subdivision Activities will be funded from your personal savings. You are not property developers and have not previously undertaken: • Any subdivision activities in the past, nor do you intend undertaking any in the future; nor • Any land development activities in the past, nor do you intend undertaking any in the future. During the ruling period: • The services of Company X, or another party, will be engaged to manage the Subdivision Activities. • The Subdivision Activities will occur, and the Property will be subdivided into several lots with one of the Dwellings located on each lot, being the Subdivided Lots.
• Both Subdivided Lots will be sold • A capital gain will be made as a result of the sale of each of the Dwellings; and • The indexation method will not be used to calculate the capital gain made on the sale of the Dwellings.
Income Tax Assessment Act 1997 section 6-5 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
Question 1: Will any of the proceeds from the sale of the two subdivided lots be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) ? Summary The proceeds from the sale of the Subdivided Lots will not be ordinary income and not assessable under section 6-5 of the ITAA 1997. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997. Detailed reasoning Taxation treatment of property sales There are three ways proceeds from property sales can be treated for taxation purposes: • As ordinary income under section 6-5, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or • As ordinary income under section 6-5, 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
• As statutory income under the capital gains tax legislation due to the realisation of a capital asset. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case as considered below. Carrying on a business of property development Section 995-1 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. For a one-off land subdivision to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property. The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? Paragraph 13 of TR 97/11 outlines the following indicators used to determine whether a taxpayer is carrying on a business: • whether the activity has a significant commercial purpose or character • whether there is repetition and regularity of the activity
• 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 • whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a sporting activity. Isolated business transactions 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 Income tax: whether profits on isolated transactions are income 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 6 of TR 92/3 states profit from an isolated transaction is generally income when both of the following elements are present: a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and b) 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. Paragraph 7 of TR 92/3 goes on to state the relevant intention or purpose of the taxpayer (of making a profit or gain) is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer's intention or purpose discerned from an objective consideration of the facts and circumstances of the case. Paragraph 13 lists the following matters which may be taken into consideration when determining 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 that property; and • the timing of the transaction or the various steps in the transaction. Application to your situation The Property was purchased prior to 20 September 1985. The House located on it was demolished with the land remaining, the Property Land. The Dwellings were constructed on the Property land in 19XX that were used for rental purposes following their construction. The Property land will be subdivided with a dwelling located on each lot, being the Subdivided Lots, which will be sold during the ruling period.
The services of other parties will be engaged in relation to the subdivision activities, and the sale and marketing of the Subdivided Lots. You have not undertaken any previous land subdivision activities and/or property development activities in the past, nor will you undertake any in the future. Based on the information provided, the proceeds from the sale of the Subdivided Lots will not be ordinary income and not assessable under section 6-5 of the ITAA 1997as either: • the carrying on of a business in accordance with the factors listed in Taxation Ruling 97/11; or • a profit-making or commercial transaction in accordance with Taxation Ruling TR 92/3. Therefore, any proceeds received on the disposal of the Subdivided Lots will represent a mere realisation of capital assets which will be assessed under the capital gains tax provisions contained in Parts 3-1 and 3-3 of the ITAA 1997. Question 2: Will any capital gain arising in relation to the sale of the land component of the two subdivided lots be disregarded? Summary
Any capital gain made in relation to the disposal of the pre-capital gains tax land component of each of the Subdivided Lots will be disregarded. Detailed reasoning Capital gains tax The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. 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. The most common CGT event, being CGT event A1, happens if you dispose of your ownership interest in a CGT asset under section 104-10 of the ITAA 1997. A CGT asset is a kind of property or legal or equitable right that is not property under subsection 108-5(1) of the ITAA 1997, which also includes a part of, or an interest in an asset as outlined in subsection 108-5(3) of the ITAA 1997. However, any capital gain made on the disposal of a pre-CGT asset can be disregarded. A pre-CGT asset is an asset that is acquired prior to 20 September 1985 under section 149-10 of the ITAA 1997. Building or structure on land acquired pre-CGT
Under subsection 108-55(2) of the ITAA 1997, a building or structure constructed on land that the taxpayer acquired before 20 September 1985 is taken to be a separate CGT asset from the land: (a) if the taxpayer entered into a contract for the construction on or after that day, or (b) where there is no contract - if the construction started on or after that day. When a CGT event happens to the real property, that CGT event happens to each separate asset and a separate capital gain or loss calculation is necessary for each CGT asset. Subdivision of land 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 lots is not a CGT event under subsection 112-25(2) of the ITAA 1997 Each of the new assets will be viewed as having been acquired on the same date as the original asset for CGT purposes. If pre-CGT land is subdivided after 19 September 1985, the land of the subdivided lots maintains their pre-CGT status as there is no CGT event in accordance with Taxation Determination TD 7 Capital Gains: What are the CGT consequences of sub-dividing pre-CGT land?
Application to your situation In this case, the Property consisting of land and the House was acquired before 20 September 1985. The House was later demolished leaving the pre-CGT Property land. The construction of the Dwellings was completed on the Property land some decades after the Property was purchased, and they are separate assets to the pre-CGT Property land, with each of the dwellings being post-CGT assets. When the Property is subdivided you will each hold equal interests in the following CGT assets: • pre-CGT Property land in each of the Subdivided Lots as you are taken to have acquired them when you originally acquired the Property; and • a post-CGT dwelling located on each of the Subdivided Lots that you acquired after 20 September 1985. When the Subdivided Lots are sold a CGT event A1 will occur. Any capital gain made on the disposal of the pre-CGT Property land component of each of the Subdivided Lots will be disregarded. However, as the Dwellings are post-CGT assets the capital gain made in relation to them cannot be disregarded and a calculation will need to be done to determine the capital gain made on their respective sale.
Question 3: Can any capital gain made on the sale of each of the dwellings be reduced by the 50% capital gains tax discount under Division 115 of the ITAA 1997? Summary Any capital gain made in relation to the disposal of each of the Dwellings can be reduced by the 50% CGT discount as you meet the necessary eligibility conditions under Division 115 of the ITAA 1997. Detailed reasoning CGT discount Division 115 of the ITAA 1997 contains the provisions used to determine eligibility to any discount capital gain. To be a discount capital gain, a capital gain must satisfy the requirements contained in Subdivision 115-A of the ITAA 1997: • be made by an individual, with the discount • the CGT event occurred after 21 September 1999 • the cost base of the CGT asset was not calculated using the indexation method; and • the asset must have been acquired at least 12 months before the CGT event.
Subdivision 115-B of the ITAA 1997 sets out how the discount percentage as applied to a discount capital gain is determined. Under section 115-100 of the ITAA 1997 the discount percentage is 50% for individuals who are residents of Australia for taxation purposes. Application to your situation The Dwellings are post-CGT assets, having been acquired after 20 September 1985. Therefore, any capital gain made in relation to the dwelling component of each of the Subdivided Lots cannot be disregarded. A separate CGT calculation will need to be done to calculate any capital gain arising in relation to the sale of the dwelling component of each of the Subdivided Lots, which can be reduced by the 50% CGT discount as the conditions contained in Division 115 of the ITAA 1997 have been met.