Is your client considering subdividing their property?
With the rezoning of land on the urban growth zones and the move towards higher density living, it is becoming increasingly common to see property subdivided before being sold. For these transactions, the question that arises is whether the profit is treated as the mere realisation of a capital asset (with potential access to the CGT discount or if acquired pre 20 September 1985 a CGT exemption) or assessable as ordinary income under section 6-5 of the ITAA 1997.
From the often cited cases of Casimaty v FC of T 97 ATC 5135 and Statham & Anor v. FC of T 89 ATC 4070, a list of factors have emerged that are to be taken into account in determining whether the activities are the mere realisation of a capital asset. Some of these major factors are:
- Whether the subdivision is being undertaken for not-profit related reasons (i.e. increasing age, health reasons, etc.);
- The size and scale of the subdivision;
- Whether the taxpayer originally tried selling the land as one parcel;
- The level of personal involvement by the taxpayer in the subdivision;
- Whether borrowed funds are used to finance the subdivision; and
- Whether the subdivisional works undertaken are limited to that required by the council.
While each case needs to be considered on its own specific facts, where the taxpayer limits their borrowings, has little or no personal involvement in the subdivision (e.g. simply appoints the relevant contractors to complete the works and engages a real estate agent to sell the newly created lots) and the subdivision is completed in a relatively straight forward manner (e.g. one stage and less than approximately 10-20 lots), a mere realisation of a capital asset outcome is likely.
A case where the activities went beyond the mere realisation of a capital asset was McCurry & Anor v FC of T 98 ATC 4487 where two brothers purchased land, demolished an old house and constructed three townhouses. After being unsuccessful in their bid to sell the units prior to their completion, they lived in two of the units with various family members before successfully selling the units a year and a half later.
Relevant factors in the conclusion that the activities went beyond the mere realisation of a capital asset were that the taxpayers put the properties on the market shortly prior to their completion, took no steps to acquire tenants, and it was likely that they would need to sell the properties at some stage to repay the substantial bank loan. In the words of the Court: “Profit-making by the sale of the units always remained an option for the brothers, notwithstanding that, for some period, when it was convenient to do so, the units were used for another purpose”.
Will the subdivision amount to an enterprise for GST purposes?
Even if the Commissioner of Taxation was of the view that the profits from an isolated transaction amounted to the mere realisation of a capital asset and therefore on capital account for income tax purposes, it did not necessarily follow that the same activity would not amount to an enterprise for GST purposes.
This was always a bone of contention for many tax agents and their clients as the same list of factors was supposedly referred to by the Commissioner in establishing whether an “enterprise” exists (see paragraphs 262 to 267 of MT 2006/1).
Our recent communications with the ATO suggest a more consistent approach and a better alignment of the concepts for income tax and GST purposes.
Given the amount of money at stake for property developments are usually significant and the inherent uncertainty in the law, taxpayers often prefer obtaining a private ruling to confirm their position prior to committing to the subdivision.
Webb Martin Consulting has recently obtained a number of successful private rulings in this area and can provide assistance on such transactions.
This article was prepared by Webb Martin Consulting. If you have any questions, or wish to seek advice on matters referred to in this article, we can be contacted on (03) 8662 3200 or firstname.lastname@example.org.