GST AND “ENTERPRISE” IN THE CONTEXT OF THE SUB-DIVISION AND SALE OF REAL PROPERTY
30 March 2012
CHRIS SIEVERS, AICKIN CHAMBERS
Presented at Russell Cocks’ Property Law Seminar
If you trawl through the ATO’s register of Private Rulings, you will see that a number of them involve the question of whether the applicant is carrying on an “enterprise” for the purposes of the GST Act when they are looking to subdivide and to sell real property. The issue may be as simple as the subdivision of the family home into two lots, so that the vacant lot can be sold, ranging to a large-scale subdivision of land.
What a review of the register shows is that the views of the Commissioner do appear to be somewhat inconsistent and arbitrary. This is probably a reflection on the nature of the material provided by taxpayers in support of the private ruling but also shows the difficulty in establishing where the line between the non-taxable activity of simply selling land in a profitable way ends, and conducting an “enterprise” begins. Also, it is likely that within the ATO itself, officers have different views on where to draw this line. Unfortunately, that makes life very difficult for practitioners who are asked to give advice in this problematic area.
This paper will look at the following matters:
(a) The relevant provisions of the GST Act, with a focus on the concepts of “enterprise” and “registration”;
(b) The Commissioner’s public Rulings on the concept of “carrying on an enterprise”; and
(c) A consideration of some of the recent ATO private rulings dealing with the question of whether an entity is carrying on an enterprise when it undertakes the subdivision and sale of property.
This paper does not consider the cases handed down on the issue of “enterprise” and seeks to focus more on how the ATO looks at the issue and applies its views in the making of private rulings. That does not mean that the ATO’s views should be seen to be correct (they are often proved wrong), but this does provide an insight into how the ATO may look at a particular arrangement.
GST is charged on “taxable supplies”, which are defined in s 9-5 of the GST Act. The elements of taxable supply are:
(a) You make the supply for consideration; and
(b) The supply is made in the course or furtherance of an enterprise that you carry on; and
(c) The supply is connected with Australia; and
(d) You are registered or required to be registered.
In the context of the subdivision and sale of real property, (a) will be satisfied as the sale is for consideration, and (c) will be satisfied as the supply of real property located in Australia will always be connected with Australia: s 9-25(4). The relevant questions are therefore whether (b) and (d) are satisfied. Each of which is considered below.
Of course, it should be noted that there will not be a taxable supply if the supply is input taxed or GST-free. Those concepts are particular important for real property, given the input taxed treatment of the sale of existing residential premises and the lease of residential premises, and the GST-free treatment of supplies such as the sale of a going concern and the supply of farmland.
The “flip-side” to taxable supply is the concept of “creditable acquisition”. This allows registered enterprises to claim back the GST embedded in the price of inputs acquired, to the extent that those acquisitions are used to make taxable or GST-free supplies.
The concept of “creditable acquisition” is found at s 11-5 of the GST Act which provides as follows:
You make a creditable acquisition if:
(a) you acquire anything solely or partly for a creditable purpose; and
(b) the supply of the thing to you is a taxable supply;
(c) you provide, or are liable to provide, consideration for the supply; and
(d) you are registered or required to be registered.
The concept of “creditable purpose” is found at s 11-15 of the GST Act which provides as follows:
(1) You acquire a thing for a creditable purpose to the extent that you acquire it in *carrying on your *enterprise.
(2) However, you do not acquire the thing for a creditable purpose to the extent that:
(a) The acquisition relates to making supplies hat would be *input taxed; or
(b) The acquisition is of a private or domestic nature.
The aim of the GST/input tax regime is for GST to effectively flow through the value added business stages, where it will ultimately “bite” on the unregistered consumer, who cannot claim credits, or on a registered entity who is acquiring the thing to make input taxed supplies (for example a lessor of a residential lease) or the acquisition is of a private or domestic nature.
Section 195-1 relevantly states that:
(a) “carrying on an *enterprise includes doing anything in the course of the commencement or termination of the enterprise.”
(b) “enterprise has the meaning given by section 9-20”.
Section 9-20 relevantly provides that:
(1) An enterprise is an activity, or series of activities, done:
(a) In the form of a *business;
(b) In the form of an adventure or concern in the nature of trade; or
(c) On a regular or continuous basis, in the form of a lease, licence or other grant of an interest in property;
(2) However, enterprise does not include an activity, or series of activities, done:
(b) as a private recreational pursuit or hobby; or
(c) by an individual (other than a trustee of a charitable fund) or a *partnership (all or most of which are individuals), without a reasonable expectation of profit or gain…
When regard is had to the above provisions, the following conclusions may be drawn:
(a) The definition of “enterprise” in the GST Act is very wide, and it appears to be broader than “business”. This is because an “enterprise” includes activities done “in the form of” a business and activities done “in the form of” an adventure or concern in the nature of trade. In this regard, the focus would appear to be less on the substance of the activities but on the form in which the activities are carried on.
(b) An enterprise includes “an activity” – therefore it will extend to a single activity (as well as a series of activities). “One-off” transactions may therefore fall within the definition of “enterprise”.
(c) The exclusion in s 9-20(2) extends to individuals and partners, but not to corporations. Therefore, it would appear that where corporations carry on activities in the form of a business, or an adventure or concern in the nature of trade, those corporations carry on an enterprise regardless of whether they have a reasonable expectation of profit or gain.
The breadth of “enterprise” is shown by the Explanatory Memorandum to the Bill introducing the GST Act, which states as follows:
Enterprise is defined widely because the GST is intended to have a broad base. Certain things are included as enterprises so that input tax credits are available to them. Enterprise includes:
- A business, trade or profession;
- A lease, licence or other grant of interest in property;
- Certain activities of gift deductible funds, authorities or institution;
- Certain activities of charitable institutions;
- Certain activities of religious institutions; and
- Certain activities of governments and government corporations.
Certain things are excluded from being an enterprise. For example, hobbies, private recreational pursuits and employee wages are not subject to GST. For individuals and partnerships there must also be a reasonable expectation of profit or gain.
A broad approach to the concept of “enterprise” is also supported by the following aspects of the GST Act:
(a) Unlike income tax, where deductions are limited to items on revenue account, and capital expenses may be depreciated over time, a registered enterprise is entitled to claim up-front input tax credits on all expenses (regardless of whether those items may be regarded as being on “income” or “capital” account).
(b) Entities carrying on an enterprise must register for GST if their annual turnover is above the threshold. However, entities with an annual turnover below that threshold can elect to register for GST. This will entitle small-scale enterprises (including ones which may not strictly be regarded as a business, but are carried out in in that way) the opportunity to claim input tax credits (but of course expose them to a GST liability on taxable outputs).
In addition to determining whether you are carrying on an “enterprise”, it is also necessary to determine whether you are required to be registered for GST. In the context of proposed subdivision and sale of real property, this is an important consideration because the sale of subdivided land, or land upon which new premises are built, will generally be a taxable supply.
Registration for GST is dealt with in Division 25 of the GST Act. There are two types of registration, mandatory and voluntary.
You will be “required to register” if you are carrying on an enterprise and your GST turnover meets the “turnover threshold” (currently $75,000). If you do not register when you are required to, the Commissioner must register you (even if you have not applied for registration) and the date of effect of the registration will be the date you became required to be registered (which may be a much earlier date). The consequences of this “retrospective registration” include:
(a) You will be liable for GST on all taxable supplies from that date, and be exposed to penalties and interest on any unpaid GST. Of course, you will be entitled to input tax credits on acquisitions.
(b) You may not be able to take advantage of concessional taxing treatment under GST Act, including:
i) The margin scheme in Division 75, as the parties need to agree in writing that the margin scheme applies;
ii) The going concern exemption, as the parties need to agree in writing that the sale is of a going concern.
If you are not required to register, you can nevertheless choose to register for GST if you are carrying on an enterprise. However, if you cease to carry on an enterprise (and you do not apply for cancellation of the enterprise), the Commissioner must cancel your registration if he believes on reasonable grounds that you re not likely to carry on the enterprise for at least 12 months.
One of the more complex areas of the GST Act is the concept of “turnover threshold”. The basis rule is that you will satisfy the test where:
(a) Your “current GST turnover” is at or above the threshold and the Commissioner is not satisfied that your “projected GST turnover” is below the threshold; or
(b) Your “projected GST turnover” is at or above the turnover threshold.
Section 188-15 defines “current GST turnover” as:
Your current GST turnover at a time during a particular month is the sum of the *values of all the supplies that you have made, or are likely to make, during the 12 months ending at the end of that month, other than:
(a) supplies that are *input taxed; or
(b) supplies that are not for *consideration (and are not *taxable supplies under section 72-5) or
(c) supplies that are not made in connection with an *enterprise that you *carry on.
This looks at your activity over the previous 12 months, ending with the current month.
Section 188-20 defines “projected GST turnover” as follows:
Your projected GST turnover at a time during a particular month is the same as the values of all the supplies that you have made, or are likely to make, during that month and the next 11 months, other than:
(a) supplies that are input taxed; or
(b) supplies that are not for *consideration (and are not *taxable supplies under section 72-5) or
(c) supplies that are not made in connection with an *enterprise that you *carry on.
This test looks at the current month and the future 11 months.
The above two tests show that to work out if you satisfy the registration threshold, you need to look at the value of supplies (that would be taxable) in the previous 12 months (including the current month) and also the next 12 months (including the current month). They are separate tests.
Division 188 has a number matters which are exclude from the tests (eg, supplies not connected with Australia). However, in the context of the subdivision and sale of property, s 188-25 provides a potentially important exclusion from “projected GST turnover”. Section 188-25 provides as follows:
In working out your *projected GST turnover, disregard:
(a) any supply made, or likely to be made, by you by way of transfer of ownership of a capital asset of yours; and
(b) any supply made, or likely to be made, by you solely as a consequence of:
(i) ceasing to carry on an enterprise; or
(ii) substantially and permanently reducing the size or scale of an enterprise.
The scope of this exclusion is unclear.
It is clear that the exclusion would apply where, for example, an entity owned a single shop which was rented out for $36,000 per annum and the shop was sold for $500,000. In that case, the entity’s “current GST turnover” is $36,000 (ie, below the threshold). Further in calculating the entity’s “projected GST turnover”, the proceeds of the sale would be excluded as that sale is both the sale of a capital asset and a sale done in the course of ceasing to carry on the enterprise. Accordingly, the entity would fail the turnover tests and is not required to be registered for GST.
What is unclear is how this exclusion will apply in the context of an isolated subdivision of real property. Two issues arise:
(i) Given that the concept of “enterprise” appears to be broader than “business”, it may be that the activity of subdivision and sale of real property may fall within the definition of enterprise, but, the lots sold may still be held on “capital account” (ie, the taxpayer would be liable for CGT on the sale, not income tax). Those sales would arguably fall within the exclusion as the sale of capital assets.
(j) The sale of the lots in a one-off subdivision would arguably be made solely as a consequence of ceasing (or partially ceasing) to carry on an enterprise, and be excluded.
Not surprisingly, in GSTR 2001/7 “Goods and services tax: meaning of GST turnover, including the effect of section 188-25 on projected turnover” the ATO takes a different view. At -, the Ruling states:
An enterprise may consist of an isolated transaction or a dealing with a single asset. For example, an enterprise may consist solely of the acquisition and refurbishment of a suburban shop for resale at a profit. Where an entity engages in acquiring a single asset for resale at a profit, the activity will be an enterprise under paragraph 9-20(1)(b), because it is an activity in the form of an adventure in the nature of trade. As discussed in paragraph 35 of this Ruling, the disposal of that single asset is not the transfer of a capital asset. Consequently, that supply is not excluded from your projected GST turnover.
The disposal of that single asset, or the completion of that isolated transaction, is also not a transfer solely as a consequence of ceasing to carry on an enterprise. In such circumstances the enterprise ceases as a consequence of the disposal of the single asset, rather than the single asset being disposed of in consequence of the ceasing to carry on the enterprise.
In the private rulings that I have reviewed, in the context of property sub-divisions, the ATO effectively resolves the issue by treating the subdivided lots as “trading stock”. From my perspective, it is difficult to see how a two-lot subdivision can be seen as trading stock.
Resolution of this issue is beyond the scope of this paper, save to say that a “purposive” construction of the word “capital asset” may support the Commissioner’s view and a “literal” construction of those words may support the alternate view. I am sure that a Court will be asked to resolve this question at some time in the future.
ATO Rulings on the meaning of “carrying on an enterprise”
The central ATO publication is MT 2006/1 “A New Tax System: the meaning of entity carrying on an enterprise for the purposes of entitlement to an Australian Business Number”. While this Ruling relates to the issue of whether an entity is entitled to an ABN, in GSTR 2006/6 the Commissioner confirms that his views in MT 2006/1 have equal application to the meaning of “enterprise” for the purposes of the GST Act.
The Ruling is very extensive and contains a number of example. In the context of property sub-division, the relevant parts of the Ruling are discussed below.
In the form of a business
When considering this issue, the focus of the Ruling is very much on looking at the factors which indicate that the activity is being on in the form of a business. At paragraph 178, reference is made to ATO Ruling TR 97/11 which outlines the following main indicators of carrying on a business:
(a) A significant commercial activity;
(b) A purpose and intention of the taxpayer to engage in commercial activity;
(c) An intention to make a profit from the activity;
(d) The activity is or will be profitable;
(e) The recurrent or regular nature of the activity;
(f) The activity is carried out in a similar manner to that of other businesses in the same or similar trade;
(g) Activity is systematic, organized and carried on in a businesslike manner and records are kept;
(h) The activities are of a reasonable size and scale;
(i) A business plan exists;
(j) Commercial sales of product; and
(k) The entity has relevant knowledge or skill.
None of these factors will be determinative and in each case the factors need to be considered in light of the particular facts and circumstances.
In the form of an adventure or concern in the nature of trade
This part of the definition if “enterprise” is fundamental when considering whether a “one-off” subdivision and sale of land is an enterprise. As noted at paragraph 234 the Ruling:
Ordinarily, the term “business” would encompass trade engaged in, on a regular or continuous basis. However, an adventure or concern in the nature of trade may be an isolated or one-off transaction that does not amount to a business but which as the characteristics of a business deal.
The Commissioner considers that while this concept may apply to isolated transaction, the activity must still have the features of a business deal. In this regard, the sale of the family home, car and other private assets are not, in the absence of other factors, adventures or concerns in the nature of trade.
Further, the fact that the asset is sold at a profit does not, of itself, result in the activity being commercial in nature. However, improving property beyond preparing an asset for sale, to bring it into a more marketable condition and gain a better price, suggests and element of trade
Isolated transactions and sales of real property
The Ruling considers, in detail, the question of whether an entity is carrying on an enterprise where there are ‘one-offs’ or ‘isolated real property transactions’: see paragraphs 262-302. In practice, the ATO (at the audit level and when making private rulings) will pay regard to the matters in this ruling (as opposed to decisions of the AAT and even the Federal Court) in considering whether an enterprise is carried on. In this regard, these paragraphs are probably the first place to go when looking to advise clients on this issue. For ease of reference, these paragraphs are attached at the end of this paper.
The Ruling correctly notes that the issue is whether the activity is of a revenue nature or whether it is simply the realisation of a capital asset in a profitable way. The Ruling refers to a number of income tax cases dealing with this question. Those cases disclose the following factors which indicate that a business or an adventure in the nature of trade is carried on (at paragraph 265):
(a) There is a change in purpose for which the land is held;
(b) Additional land is acquired to be added to the original parcel of land;
(c) The parcel of land is brought into account as a business asset;
(d) There is a coherent plan for the subdivision of the land;
(e) There is a business organisation – for example a manager, office and letterhead;
(f) Borrowed funds financed the acquisition or subdivision;
(g) Interest on money borrowed to defray subdivisional costs were claimed as a business expense;
(h) There is a level of development of the land beyond that necessary to secure council approval for the subdivision; and
(i) Buildings have been erected on the land.
The Ruling notes that each of these factors (and potentially other factors) need to be weighed in the context of the facts and circumstances of each particular case. No single factor will be determinative, but rather it will be a combination of factors which leads to a conclusion as to the character of the activities.
The Ruling states that where land is bought with the intention of resale at a profit, this would amount to an enterprise. Further, the Commissioner considers that this is the case whether the land is sold as it was when purchased or whether it was subdivided before sale. Such a blanket statement is unhelpful, and bound to cause difficulty, because all purchases of property (albeit to varying degrees) carry an intention of re-sale at a profit. Also, such a statement would arguably mean that the activity of “land banking” (ie, where a party purchases land for the sole purpose of holding it for the eventual sale at a profit, albeit that the sale may be some time well into the future) would arguably be an enterprise.
The Ruling refers to a number of examples of subdivision activities that are enterprises. These example include:
(a) A discovers that their local council has recently changed its laws to allow for smaller lot subdivisions. A purchases a block of land with the intention to subdivide into two lots and sell the blocks at a profit. A is carrying on an enterprise because their activities are an adventure or concern in the nature of trade, their activities are planned and carried out in a business like manner.
It may be that A falls within the definition of “enterprise”. However, that is only half the story. The question is also whether A is required to register for GST. As discussed above, that will depend on whether A satisfies the turnover test. On the assumption that A carries on no other activities, the question is whether the sale of the two lots is to be included in the “Projected GST turnover”. As discussed above, that turnover does not include the sale of capital assets or supplies made solely as a consequence of ceasing to carry on the enterprise. It is arguable that both are satisfied here, although the Commissioner does not agree. Further, contrary to the Commissioner’s view, it is difficult to see how the two subdivided lots would properly be regarded as “trading stock”.
(b) T purchases an ocean block with the intention of building a duplex whereby he would live in one and the other would be sold, with the sale proceeds funding the cost of the purchase and construction of his residence. T is carrying on an enterprise because his intentions and activities have the appearance of a business deal, and there is a reasonable expectation of profit or gain.
Again, it is hard to see how that single lot and dwelling could be seen as trading stock.
(c) S buys a 100 hectare property with the intention of developing a resort. He subsequently decides that it would be more profitable to subdivide and sell the property. For the subdivision to be approved, S must satisfy various council conditions. S approaches his advisers who prepare a comprehensive business plan. S approaches a commercial lender for a loan secured by the property. S is carrying on an enterprise.
I think it would be very difficult for anyone to argue that S was not carrying on an enterprise.
(d) P has lived in the same house on a large block for a number of years. P decides that he wants to move from the area and develops a plan to maximise the sale proceeds from the land by demolishing the house, subdividing the land into two blocks and building a new house on each block. S is carrying on an enterprise because the activities go beyond the minimal activities necessary to sell the subdivided land.
This example is getting closer to the line. A more difficult question would be whether P would still be carrying on an enterprise if he simply determined to demolish the house and subdivide the land and sell the vacant blocks.
The Ruling refers to a number of examples of subdivision activities that are not enterprises. These example include:
(a) A lives on a large suburban block. The council has recently changed its law to allow smaller blocks. A decides to subdivide the land to allow their only child to build a house in which to live. The land is subdivided and a lot is transferred to the daughter who pays for the construction of the house. A is not carrying on an enterprise because it is a private or domestic arrangement.
(b) U lives on a 2.5 hectare lot that they have owned for 30 years. They decide to subdivide the land into two equal blocks and to sell one, retaining the block with the house on it. U is not carrying on an enterprise as the sale is a way of disposing some of the land on which their home is situated and it is the mere realisation of a capital asset.
(c) E purchased some acreage a number of years ago on which to keep their horses. E has accepted a job overseas and has decided to sell the land. The land was put on the market with little success and the local real estate agent advised that it would be easier if the land was subdivided and sold as smaller blocks. Only minimal activity is required to subdivide the land. E is not carrying on an enterprise as it is the mere realisation of a capital asset.
A question after reading this example is what would the result have been if E had initially decided to subdivide and sell the land (ie, there was no initial attempt to sell the land as a single lot). In this regard, one may question the relevance of the fact that there was an initial attempt to sell the property as a single parcel.
(d) O has lived on a rural property for 30 years. Due to a number of factors, including their advancing years, declining health, growing debt and drought conditions, O decides to sell. O puts the property on the market and is unable to sell. O is then advised by a real estate agent that they may be able to sell smaller portions of the land. O arranges for council approval to subdivide part of the land into 13 lots and they continue to live on the remaining part of the property. A few years later, O decides to subdivide and sell some more land to meet increasing debt. Three years after that, more land is subdivided and sold. In each case, the minimal work required to subdivide the land is done. No enterprise is carried on as O is merely realising a capital asset.
Again, one questions the relevance of the initial attempt to sell the whole of the land, and whether there would be a different result if O initially subdivided part of the land for sale.
The application of the Commissioner’s view in practice – the ATO rulings register
The ATO Private Rulings Register contains redacted versions of the private rulings issued by the ATO. A review of the register discloses that a number of the rulings relate to subdivision of land and whether an enterprise is carried on and whether registration is required.
I propose to consider four ATO private rulings. One published in later 2009 and three published in late 2011.
Ruling 1 – no enterprise carried on
The facts of this ruling were as follows:
(a) The applicant owns 52 acres of residential land. The applicant has owned the land for 30 years. At the time of purchase, the land was vacant and a house was built on the property. Since that time the land has been used as a private residence.
(b) It is intended to subdivide the land into 22 lots for sale as vacant land. One of the lots will contain the house, which the applicant will continue to use as a private residence.
(c) The subdivision will be financed entirely by borrowed funds, which will be repaid in full by the proceeds of the sale of vacant lots.
(d) The property is not treated as a business asset and no deductions will be claimed for income tax purposes in relation to any of the costs associated with the development (including interest costs).
(e) The applicant has not previously undertaken any business or enterprise activities.
The ATO applied the facts as outlined above against the Ruling MT 2006/1 and formed the view that the proposed subdivision would not amount to the carrying on of an enterprise and that the subdivision and sale of the vacant lots will be the mere realisation of a capital asset. Further, the sales would not be included in the applicant’s annual turnover as they involved the transfer or sales of capital assets.
Rather unhelpfully, the ruling provides no detail of the reasoning behind the ruing and how the ATO balanced the respective considerations in forming its view. One may think that this was a very good result for the applicant, given the size and scope of the proposed subdivision, the high level of funding required, and the potential to make a significant gain.
Ruling No.2 – enterprise carried on
The facts of this ruling were as follows:
(a) The applicant acquired the property pre-2000 for the purposes of constructing a family home and since then has used it as the principal place of residence. Improvements were made to the property, including a family home, tennis court, swimming pool, and barn.
(b) The applicant is approaching retirement and is finding the broadacre lifestyle tiring.
(c) The local council has recently rezoned the area from rural to residential.
(d) The applicant has been approached at various times to sell the property and recent activity by neighbours has been the catalyst for the decision to sell the property.
(e) The applicant engaged a consultant to advise on how to sell the property and to realize the value of the property and how a subdivision could proceed.
(f) The proposed subdivision will occur in stages, this is so that the lots with frontages to the road can be sold as they have access to both the road and essential services. To achieve the subsequent staged subdivision, it will be necessary to construct an access road and connect services to those lots.
(g) The applicant does not intend to undertake any more work than the minimum required by council to register the subdivision. No houses will be constructed on the lots and the applicant will not be involved in the marketing or sale of the subdivided lots.
(h) The applicant has no history of property subdivision or property investment and does not intend to undertake such activities in the future.
(i) The applicant has engaged a project manager to oversee the subdivision process, liaise with appropriate authorities and negotiate with contractors.
(j) The applicant has engaged a real estate agent to sell the lots.
(k) The applicant will need to borrow funds to fund the subdivision.
(l) The applicant intends to preserve the family home within the boundary of one of the subdivided lots and to continue to live there.
In finding that the entity was carrying on an enterprise, the Commissioner adopted the approach of looking at “the overall impression gained” after examining the activities as a whole and the intention of the taxpayer undertaking the activity. The Commissioner found that the following matters were relevant:
(a) The subdivision is developed in a businesslike manner as a project manager has been engaged to oversee the subdivision process and had employed an agent to undertake the sale of the subdivided lots.
(b) The notice of determination from the council requires that certain things be done. Those things indicate that more than minimum council requirements have to be met in relation to the subdivision.
(c) There is a comprehensive plan for the development of the property.
(d) The applicant will borrow and risk a large amount for a considerable return.
(e) There is a change of purpose for which the whole land is held.
Looking at the facts of Rulings 1 and 2, it is difficult to distil any real difference between the two. The answer may be found in the nature of the factual material lodged in support of the respective rulings, but looking at the facts as described in the documents, I would make the following observations:
(a) Both rulings involved large-scale subdivisions using borrowed funds and would appear to involve potentially large gains.
(b) Both rulings involved the undertaking of the “minimum” development works required by council for planning approval. Having regard to Ruling 2, the relevance of the council imposing greater obligations than may otherwise be required must be of questionable relevance.
(c) Both rulings involved the subdivision of land which had been used by the applicant as private residences for a significant period of time.
(d) Having regard to Ruling 2, the relevance of the applicant engaging a real estate agent to sell the land must be of questionable relevance. Similarly, in circumstances where the owner of the land knows little of the subdivision process, engaging a project manager to assist with the process could also be seen to be of little relevance. Without engaging those services, the subdivision and sale would likely not proceed, or certainly not proceed as effectively.
Ruling No.3 – enterprise carried on
The facts here are very similar to those in the first two rulings:
(a) The applicant purchased land pre-July 2000, built a house on the land and has lived in it since.
(b) The applicant has submitted a development application to subdivide the property into several lots. One lot will comprise the existing house.
(c) Certain development works will be needed to be completed, but the applicant will not carry out activities beyond what is required by council.
(d) The applicant has engaged a project manager to manage the subdivision process.
(e) The applicant has engaged a real estate agent to sell the lots.
(f) The applicant will need to borrow money for the subdivision costs.
(g) The applicant has not previously been involved in land development and has no plans to subdivide any other properties.
In finding that the applicant was carrying on an enterprise, the ATO found the following factors to be relevant:
(a) The subdivision is developed in a businesslike manner, as the applicant has engaged a project manager to oversee the sub-division process
(b) All the lots are to be sold by a real estate agent at auction
(c) The estimated total net proceeds will exceed the current value of the property, as such the activity will be profitable.
Comparing this ruling to Rulings 1 and 2, I make the same comments as in paragraph 41 above. Also, one would expect that the ATO’s reliance on the fact the proceeds of the sale will exceed the current value of the property should also have been a relevant factor in the consideration of Ruling 1 (which involved a 22 lot subdivision).
Also, in Ruling 2 there was a rezoning of the land which may have let to the ATO’s view that there was a “change of purpose” with the land. There was no such re-zoning in Ruling 3.
Ruling No.4 – no enterprise carried on
Again, the facts here are similar to each of the previous three rulings.
(a) The applicant purchased the land at an unspecified time and was used as the applicant’s main residence until 2008.
(b) In 2008 the applicant’s children left home and a decision was made to vacate the premises and move to a smaller house. From that time the property has been rented to tenants.
(c) The applicant intends to submit a development approval application to council seeking to subdivide the property into eight lots and to sell the lots as vacant land.
(d) The applicant has not previously subdivided land.
(e) The applicant will not build on the land and will not perform development works beyond the minimum requirements necessary to satisfy the development application conditions.
(f) The applicant intends to maintain a passive role in the subdivision activities.
(g) It is intended to demolish the existing house and carport.
The Ruling found that, on balance, the applicant was not carrying on an enterprise because it did not have the characteristics of an adventure or concern in the nature of trade, but rather was the merely realisation of a capital asset. Unhelpfully, no further explanation was made for the decision, although the references to the words “on balance” imply that the Commissioner saw this matter as being close to the line.
The Ruling does appear to conflict with Rulings 2 and 3 (which were all published within the same month). Importantly, the fact that the applicant was taking a passive role (ie, engaging consultants to do the work) did not appear to carry much weight.
Conclusions to be drawn from the Rulings
The rulings considered above show that determining whether an enterprise is being carried on where a landowner decides to subdivide land is often far from easy. They also show that even within the ATO, different officers may take different views to what appear to be very similar facts.
On the whole, a review of the rulings register shows that the Commissioner draws the line as to where capital realisation stops and enterprise begins at an earlier stage than the law may suggest. That is not really surprising. Now that taxpayers have the right to object to private rulings, we may well see a greater number of these decisions being tested in the Tribunal.
What is also striking (but again not surprising) is that the rulings themselves generally make no reference to the law, or to cases, but essentially rely on MT 2006/1. In that regard, if a private ruling is to be prepared, it should be drafted in a way which utilises that ruling. It is often a waste of energy to refer to cases, or even to the legislation or Explanatory Memorandum to support a private ruling – of course, that material will be of much greater relevance if an objection is lodged against the ruling and the matter proceeds to the Tribunal on review.
30 March 2012
APPENDIX – MT 2006/1 PARAGRAPHS 262-302
Isolated transactions and sales of real property
262. The question of whether an entity is carrying on an enterprise often arises where there are ‘one-offs’ or isolated real property transactions.
263. The issue to be decided is whether the activities are an enterprise in that they are of a revenue nature as they are considered to be activities of carrying on a business or an adventure or concern in the nature of trade (profit making undertaking or scheme) as opposed to the mere realisation of a capital asset. (In an income tax context a number of public rulings have issued outlining relevant factors and principles from judicial decisions. See, for example, TR 92/3, TD 92/124, TD 92/125, TD 92/126, TD 92/127 and TD 92/128.)
264. The cases of Statham & Anor v. Federal Commissioner of Taxation 105 ( Statham ) and Casimaty v. FC of T 106 ( Casimaty ) provide some guidance on when activities to subdivide land amount to a business or a profit-making undertaking or scheme. In these cases, farm land was subdivided and sold. Minimal development work was undertaken to meet council requirements and to improve the presentation of certain allotments. On the particular facts of these cases the courts held that the sales were a mere realisation of a capital asset.
265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). If several of these 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:107
- 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.
266. In determining whether activities relating to isolated transactions are an enterprise or are the mere realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above, however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative rather it will be a combination of factors that will lead to a conclusion as to the character of the activities.
267. No two cases are likely to be exactly the same. For instance, while the conclusions reached in the Statham and Casimaty cases were similar, different facts and factors were considered to reach the respective conclusions.
268. The case of Marson (H M Inspector of Taxes) v. Morton and Others 108 describes the process of reaching a conclusion in cases involving isolated transactions. After listing the factors that have been taken into account by courts in other cases, including the badges of trade, Sir Nicolas Browne-Wilkinson V-C stated:109
I emphasise again that the matters I have mentioned are not a comprehensive list and no single item is in any way decisive. I believe that in order to reach a proper factual assessment in each case it is necessary to stand back, having looked at those matters, and look at the whole picture and ask the question – and for this purpose it is no bad thing to go back to the words of the statute – was this an adventure in the nature of trade?
Similarly, Foster J in AB v. FC of T observed:110
It is clear in my view, that before the label ‘adventure in the nature of trade’ can be applied it is necessary to isolate with clarity the particular matters which are the subject of its application…Accepting as I do, that the phrase means ‘an isolated business venture’ questions must be asked as to what was the venture and what gave it its commercial character.
269. The Commissioner recognises that in some cases practical difficulties may arise in deciding whether the activities involved in a particular subdivision amount to an enterprise. The question is necessarily one of fact and degree. As outlined above, it requires a careful weighing of the various factors and exercising judgment in the light of decided case law and commercial experience. If an entity is experiencing practical difficulty reaching a decision they can seek guidance from the Tax Office.
Land bought with the intention of resale
270. In isolated transactions, where land is sold that was purchased with the intention of resale at a profit (which would be ordinary income) the Commissioner considers these activities to be an enterprise. This would be so whether the land was sold as it was when it was purchased or whether it was subdivided before sale. An enterprise would be carried on in this situation because the activities are business activities or activities in the conduct of a profit making undertaking or scheme and therefore an adventure or concern in the nature of trade.111
Examples of subdivisions of land that are enterprises
271. Stefan and Krysia discover that the local council has recently changed its by-laws to allow for smaller lots in the area. They decide to take advantage of the by-law change. They purchase a block of land with the intention to subdivide it into two lots and to sell the lots at a profit. They carry out their plan and sell both lots of land at a profit.
272. Stefan and Krysia are entitled to an ABN in respect of the subdivision on the basis that their activities are an enterprise being an adventure or concern in the nature of trade. Their activities are planned and carried out in a businesslike manner.
273. Tobias finds an ocean front block of land for sale in a popular beachside town. He devises a plan to enable him to afford to live there. He decides to purchase the land and to build a duplex. He plans to sell one of the units and retain and live in the other. The object of his plan is to enable him to obtain private residential premises in an area that would otherwise be unaffordable for him.
274. Tobias carries out his plan. He purchases the land, and lodges the necessary development application with the local council. The development application is approved by the council, Tobias engages a builder and has the duplex built. He sells one unit, and lives in the other.
275. Tobias is entitled to an ABN. His intentions and activities have the appearance of a business deal. They are an enterprise.
276. Further, there is a reasonable expectation of profit or gain (see paragraphs 378 to 405 of this Ruling) as his plan has enabled him to be able to keep and live in one of the units.
277. Steven buys a 100 hectare property. He believes that the property may be suitable to be developed as a resort. After investigation he decides that it would be more profitable to subdivide and sell the property. He decides to subdivide the property into one hectare lots and sell these.
278. He engages a town planner and a surveyor to survey the 100 hectare property and to establish how many hectare lots it can be subdivided into. Steven then approaches the local shire council and is advised that he may subdivide his property into 65 one hectare lots.
279. However, Steven must satisfy various shire council conditions if he wishes to obtain development approval. They are:
- the making of new sealed roads with kerbing and channelling within the subdivision;
- the provision of water, electricity and telephone services to the new lots;
- the provision of culverts and other storm water drainage works ; and
- the transfer of certain areas of land to the shire council for parks, environmental and other public purposes.
280. Steven consults his accountant and legal advisers. Together they prepare a comprehensive business plan for the project. They approach a commercial lender to arrange a substantial loan, secured by the property, to cover all development costs and related expenses.
281. After gaining development approval from the council, Steven then engages a project manager who arranges for all the survey and subdivisional works to be carried out. Contractors are engaged to put in the roads, complete all the necessary drainage works and install the water, electricity and telephone services.
282. Steven also investigates a marketing strategy that will provide the best return for his project. Sales agents are retained to carry out the marketing program which involves a comprehensive advertising campaign using a promotional estate name , ‘ Bush Turkey Hill’.
283. Steven is entitled to an ABN on the basis that the subdivision is an enterprise and it is more than a mere realisation of a capital asset. Significant factors that are relevant which lead to this conclusion are as follows :
- there is a change of purpose for which the whole property is held;
- there is a comprehensive plan for the development of the property;
- the subdivision is developed in a businesslike manner for example there is a project manager, significant development costs, a comprehensive marketing campaign including an estate name for the land; and
- a substantial loan has been taken out to finance the development.
284. Prakash and Indira have lived in the same house on a large block of land for a number of years. They decide that they would like to move from the area and develop a plan to maximise the sale proceeds from their land.
285. They consider their best course of action is to demolish their house, subdivide their land into two blocks and to build a new house on each block.
286. Prakash and Indira lodge the necessary development application with the local council and receive approval for their plan. They arrange for:
- their house to be demolished;
- the land to be subdivided;
- a builder to be engaged;
- two houses to be built;
- water meters, telephone and electricity to be supplied to the new houses ; and
- a real estate agent to market and sell the houses.
287. Prakash and Indira carry out their plan and make a profit. They are entitled to an ABN in respect of the subdivision on the basis that their activities go beyond the minimal activities needed to sell the subdivided land. The activities are an enterprise as a number of activities have been undertaken which involved the demolition of their house, subdivision of the land and the building of new houses.
Examples of subdivisions of land that are not enterprises
288. Astrid and Bruno live on a large suburban block. The council has recently changed their by-laws to allow for smaller lots in their area. They decide to subdivide their land to allow their only child, Greta, to build a house in which to live.
289. They arrange for the approval of the subdivision through the council, for the land to be surveyed and for the title of the new block to be transferred to Greta. She pays for all the costs of the subdivision and the cost of her new house.
290. Astrid and Bruno have not carried on an enterprise and are not entitled to an ABN in respect of the subdivision. It is a subdivision without any commercial aspects and is part of a private or domestic arrangement to provide a house for their daughter.
291. Ursula and Gerald live on a 2.5 hectare lot that they have owned for 30 years.
292. They decide to sell part of the land and apply to subdivide the land into two 1.25 hectare lots. The survey and subdivision are approved. They retain the subdivided lot containing their house and the other is sold.
293. Ursula and Gerald are not carrying on an enterprise and are not entitled to an ABN in respect of the subdivision as the subdivision and sale are a way of disposing of some of the land on which their home is situated. It is the mere realisation of a capital asset.
294. A number of years ago Elsie and Karin purchased some acreage on which to keep their horses, which they rode on weekends. Karin now accepts a job overseas and they decide to sell the land.
295. They put the land on the market with little success. The local real estate agent then advises that it would be easier to sell the land if it was subdivided into smaller lots. They arrange for a development application to be lodged with the local council and obtain approval to subdivide the land into nine lots. Elsie and Karin arrange for the land to be surveyed. The land has a road running along its boundary and has some existing services such as electricity. Only minimal activity is required to subdivide the land.
296. Elsie and Karin are not entitled to an ABN. The sale is not considered to be an enterprise and is the mere realisation of a capital asset.
297. Oliver and Eloise have lived on a rural property, Flat Out for the last 30 years. They live a self-sufficient lifestyle. As a result of a number of circumstances including their advancing years, Oliver’s deteriorating health, growing debt and drought conditions they decide to sell.
298. Oliver and Eloise put Flat Out on the market and are unable to find any buyers. They then receive advice from the real estate agent that they may be able to sell smaller portions of it. They initially arrange for council approval to subdivide part of Flat Out into 13 lots. They undertake the minimal amount of work necessary and sell the lots. They continue to live on the remaining part of their property.
299. A few years later Oliver and Eloise decide to sell some more land to meet their increasing debt obligations. They arrange for council approval to subdivide another part of Flat Out into four lots. Again they undertake the minimal amount of work necessary to enable the lots to be subdivided and arrange for the real estate agent to sell these lots.
300. Three years later Oliver’s and Eloise’s personal and financial circumstances are such that they again decide to sell some more land. They arrange for further council approval to subdivide part of their remaining property into three lots. Again they undertake the minimal amount of work necessary to enable the lots to be sold and arrange for the real estate agent to sell the lots.
301. Over the years involved Oliver and Eloise have subdivided 30 % of Flat Out. They continue to live on the remaining part of their property.
302. Oliver and Eloise are not entitled to an ABN as they are not carrying on an enterprise. They are merely realising a capital asset. In this example the following factors are relevant:
- There is no change of purpose or object with which the land is held – it has remained their home.
- There is no coherent plan for the subdivision of the land – the subdivision has been undertaken in a piecemeal fashion as circumstances change.
- A minimal amount of work has been undertaken in order to prepare the land for sale. There has been no building on the subdivided land. The only work undertaken was that necessary to secure approval by the council for the subdivision.
 A New Tax System (Goods and Services Tax) Act 1999
 For example, Touram Pty Ltd ATF the GKA Family Trust and Commissioner of Taxation  AATA 1167; D’Arcy and Commissioner of Taxation  AATA 709; Commissioner of Taxation v Swansea Services Pty Ltd  FCA 402; Russell v Commissioner of Taxation  FCAFC 10; A & C Sliwa Pty Ltd and Commissioner of Taxation  AATA 390; Educational Pty Ltd and Commissioner of Taxation  AATA 445.
 S 40-65.
 S 40.35.
 S 38-325.
 Subdivision 38-O.
 Explanatory Memorandum to the A New Tax System (Goods and Services Tax) Bill 1998
 Subject to the other requirements of s 11-15 of the GST Act as to what constitutes a “creditable acquisition”.
 As the sale of “new residential premises”: para 40-65(2)(b).
 Reg 23.15.01 of the A New Tax System (Goods and Services Tax) Regulation.
 S 25-5(2)
 S 25-55(2)