There is a large amount of case law that surrounds property subdivisions and whether they are on capital or revenue account.
Often the desire is to have the subdivision income assessed on capital account, as this could mean the 50% general CGT discount may be available, or could mean that sale proceeds of pre-CGT assets remain tax free.
Where the landowner is merely maximising the value of the realisation of a capital asset it is generally found that the subdivision income is on capital account.
Each case is determined on its own merits with consideration given to various factors, including but not limited to:
• How long the land has been held
• What was the primary use of the land before subdivision
• What was the intent of the landowner at the time the property was acquired
• How involved was the landowner in the subdivision
• Was the subdivision carried out in a businesslike manner
A recent decision by the Federal Court has provided some guidance in the capital vs revenue debate.
The case involved Morton, a retired farmer, who held pre-CGT land sold to him by his father, known as “Dave’s block”. Dave’s block sat surrounded by other blocks of land held by various Morton family members and entities. Dave’s block had been used for farming by his father, and then solely by Morton from 1996 until 2015.
In 2010 Dave’s block was rezoned which resulted in higher rates and charges being levied on the block and Morton’s decision that farming it would become unviable in the future. After approaches from and discussions with property developers Morton signed a development agreement in 2012. The same developer entered into agreements for the other family blocks.
The development of Dave’s block was stage 15 of the developer’s 31 stage development of the properties into 1,632 lots, which started in 2016. Dave’s block was subdivided into 48 lots with sales starting in 2016.
The developer would finance the development, was responsible for all operations, marketing, setting sale prices and dealing with regulatory requirements. Upon the sale of each subdivided lots the developer would charge a development fee to Morton based on a percentage of sale proceeds.
Morton did have some contractual obligations, such as authorising the stage budget. The developer was also required to provide Morton with monthly progress reports, but it appears Morton never read them.
The ATO issued Morton with amended assessments to include $3,813,938 of assessable income in relation to the sale of subdivided lots. In court the ATO tried to argue that Morton carried out the development in a business-like manner or was undertaking a profit-making scheme, giving weight to the scale of the development.
The Federal Court found that Morton was not conducting the development in a business-like manner, was not involved in the decision and development activity of the development, and that all commercial risks lied with the developer. It was the developer acting in a business-like manner in its own capacity, not on Morton’s behalf. Morton played an inactive role in the development.
In addition, Morton acquired the land for farming, used it as such and continued to do so well after the rezoning. The decision to sell the land was made as a result of the rezoning – a rezoning that Morton did not seek.
The court found that the fact the total development was of a massive scale, did not mean that the development should be considered as being a business activity. The scale of the development was merely commensurate with the size of the blocks being developed.
As a result of the above the Federal Court found that the sales were on capital account and the amended assessments were reversed.
Where someone is looking to develop long-held land it would be prudent to seek early advice. There are various pathways to subdivision and Morton’s case has provided good guidance in how it may be treated on capital account.
If you would like to discuss these matters, please contact Ross Prosper.