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Subdividing & Partitioning Land: Key Tax and Duty Issues
Rajan Verma and Andrew HenshawDirectors, Velocity Legal
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DisclaimerThis is not advice. You should not act solely on the basis of the
material contained in this presentation as it is of a general nature.
Formal advice should be sought before acting in any of the areas
covered in this presentation.
Presented by:
RAJAN VERMA
Director, Velocity Legal
M: 0402 811 298
ANDREW HENSHAW
Director, Velocity Legal
M: 0421 219 553
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Agenda
Part 1• Revenue vs Capital: ‘One-off Developments
Part 2• Partitioning Land: CGT and Duty Implications
Part 3• Retaining Subdivided Land: Tax Issues
Part 4 • Development Agreements:
Duty on ‘Economic Entitlements’
Part 1Revenue vs Capital
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HOW CAN DEVELOPMENT PROFITS BE TAXED?
The landowner’s profits from a development will fall within one of the following categories:
1. REVENUE ACCOUNT (i.e. income): where the development project is a business in and of itself;
2. REVENUE ACCOUNT (i.e. income): where the development project is an isolated profit-making scheme; OR
3. CAPITAL ACCOUNT (i.e. not income): where the development project is a mere realisation of a capital asset.
• Sometimes, a development project will exhibit the factors of a business in and of itself.
• Land is, or becomes, trading stock when the owner begins to hold it for purposes of manufacture, sale, or exchange in the ordinary course of a business.
• Taxation Ruling TR 97/11 sets out factors indicative of a business:
• the activity has a significant commercial purpose;
• an intention to make a profit from the activity;
• repetition and regularity of the activity;
• the activity is carried on in a similar manner to that of the ordinary trade in that line of business;
• the activity is organised and carried on in a businesslike manner directed at making a profit; and
• the size and scale of the activity.
• If land held as a capital asset becomes trading stock, CGT event K4 will occur (section 104-220 of the Income Tax Assessment Act 1997). Advantageous triggering a capital gain if relying on main residence exemption or small business CGT concessions.
• Generally, a ‘once off’ development will not be a business. However, this depends entirely on the facts and circumstances.
CATEGORY 1: DEVELOPMENT PROJECT IS A BUSINESS
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• Can apply to:• transactions outside the ‘ordinary course’ of business; and• transactions entered into by non-business taxpayers.
• Taxation Ruling TR 92/3 states that a profit from an isolated transaction is generally assessable income when:• the intention or purpose of the 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 or carrying out a business operation or commercial transaction.• Paragraph 7, TR 92/3: 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.
• Profits are taxed as income (just like a business). However, the taxing points are slightly different from businesses. In some circumstances this is advantageous, and in other circumstances, a disadvantage.
CATEGORY 2: ISOLATED PROFIT-MAKING SCHEME
• Paragraph 41, TR 92/3:The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. However, as the High Court decisions in White v. FC of T (1968) 120 CLR 191; 15 ATD 173 and Whitfords Beach demonstrate, that is not always the case.
• Paragraph 42, TR 92/3:For example, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either:(a) as the capital of a business; or(b) into a profit-making undertaking or scheme with the characteristics of a business operation or
commercial transaction,the activity of the taxpayer constitutes the carrying on of a business or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset.
When is the ‘Requisite Purpose’ required?
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• Federal Commissioner of Taxation v WhitfordsBeach Pty Ltd (1982) 150 CLR 355
• In 1954, company acquired 1,584 acres of land for non-commercial purposes.
• In 1967, the original shareholders sold their shares to three development companies.
• Company adopted new articles, re-zoned and subdivided the land.
• Full High Court held that the taxpayer had gone beyond merely realising a capital asset and its activities constituted carrying on a business of land development = REVENUE
CASE EXAMPLE 1 CHANGE OF PURPOSE
• Less than a business or an isolated transaction.• Realisation of a capital asset in an ‘enterprising way’.• Generally the best treatment. Benefits:
• not ‘ordinary income’;• capital gain may arise (unless pre-CGT land);• access to CGT benefits (general 50% discount, small business
CGT concessions, main residence exemption); and• ability to use capital losses.
CATEGORY 3:MERE REALISATION OF CAPITAL ASSET
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• Landowner’s purpose when they acquired the land;• Length of time of ownership of the property;• Size and scale of the development;• Purpose of selling the land;• Landowner has prior experience in subdividing and developing;• Number of development stages;• Construction of site office or buildings;• Extent of landowners’ personal involvement; and• Terms of any land development agreement.
WHERE DOES MY DEVELOPMENT FALL?FACTS RELEVANT IN DISTINGUISHING BETWEEN THE CATEGORIES
• The GST implications of a development will generally follow the income tax consequences.
• If the development is a mere realisation (capital) then GST will not apply on the sale of the lots (because no enterprise).
• However if the development is an isolated profit-making scheme then GST will be payable on the ultimate sale of the lots.• In this scenario the landowner can register for GST and claim input
tax credits in relation to the development expenses.• There may also be scope to claim the margin scheme.
WHAT ABOUT GST?
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• Certain property developments will be considered a ‘mere realisation’ of property and remain on capital account if the development involves only the bare minimum work required to comply with council requirements – e.g. construction of service roads, connection of essential services.
• However, if the development goes any further from the bare minimum and moves into the construction of new buildings or residences then such developments will likely be treated as an isolated profit-making scheme. However, in certain situations, construction activity may be okay.
• In extreme circumstances, the level and scale of development activity may be so significant that the development itself is treated as a business endeavor.
• Many cases will fall within the grey zone between a mere realisation and an isolated scheme. In those cases, it may be prudent to seek expert advice or a private ruling from the ATO.
SUMMARY: CAPITAL V REVENUE
• https://lets-talk.ato.gov.au/PropDev• Released on 9 July 2018 for consultation. Consultation closed on 17 August
2018. • Guidance provides 12 examples of fact scenarios in property development
and construction contexts. • Certain level of divergence between ‘ATO views’ and views based on case
law. • Guidance has now been removed from ATO website.
The ATO’s Current View:Draft Property and Construction Website Guidance
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Part 2Partitioning Land:
CGT, GST and Duty Implications
What is a partition? • Transfer of divided parts of the land between co-owners.• Land held by co-owners is physically divided among them so
that each co-owner is entitled in severalty to a separate part of the physically divided property.
• Should not be confused with subdivision of land.Why partition the land?• Common examples: dispute between the co-owners or
conclusion of a venture to subdivide and share the products of subdivision.
How is partitioning of land effected?• Effected by either an agreement between the co-owners (i.e.
Partition Agreement) or as a result of a court order.• Under a Partition Agreement, the land may be divided and
each co-owner agrees to contemporaneously transfer their respective interest in the part of the land being taken by the other.
• When agreement between co-owners is not possible, a partition may be sought as a remedy in court.
Partition of Land
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Facts • On 1 January 2017, Bart and Homer purchased a parcel of land in
Springfield as tenants in common in equal shares (Springfield Land). • From 1 January 2017 to 31 December 2017, Bart and Homer subdivided
the land to create Lot A and Lot B (each lot of equal value). • On 1 January 2018, Bart and Homer enter into a Partition Agreement.
Bart wants to take Lot A and Homer wants to take Lot B. • The Partition Agreement is effected by:
o Bart transferring his undivided interests in Lot B to Homer; and contemporaneously
o Homer transferring his undivided interest in Lot A to Bart. Effect of the partition• Before: Bart and Homer each had a 50% undivided interest in the entire
Springfield Land (and following the subdivision, in both Lot A and Lot B).• After: Bart has a 100% interest in Lot A and Homer has a 100% interest in
Lot B
Example: Bart and Homer
The following tax implications should be considered in partitions of land:
• Transfer duty (Duty) o Duty exemption for partition
arrangements• Capital gains tax (CGT)
o No exemption other than for strata titles
o CGT withholding • Goods and services tax (GST)
o Where carrying on an enterprise o GST withholding
Tax Implications
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Duty implications in Victoria • Duty exemption under section 27 of the Duties Act 2000 (Vic)• Need to prepare a transfer duty exemption application to the SRO
(including statutory declaration, partition agreement, plan of subdivision etc.)
• Does not apply when determining the duty chargeable under section 18A and 28A (regarding foreign purchasers)
• Revenue Ruling DA-017: o If the transferee is receiving property of a value that does not
exceed the value of the transferee’s interest in the whole of the property, the transaction is not liable to duty.
o If the transferee is receiving property of a value that exceeds the value of the transferee’s interest in the whole of the property, duty will be assessed on the difference between the value of the transferee's prior interest in the real property and the value of the transferee's interest after the partition or division of the real property.
Tax implications – Duty
• If the land was previously jointly acquired on or after 20 September 1985 and is held on capital account, the partition of that land may have CGT consequences.
• CGT event A1: Section 104-10 Income Tax Assessment Act 1997 (Cth) (ITAA97)
• Johnson v FCT [2007] ATC 2161
Dividing the parcel in two for the purposes of a transfer to each joint owner effectively requires those owners to relinquishownership of the CGT assets in the shares in the other parcel in return for clear title to the shares in the parcel they are acquiring. It is as if the CGT assets contained in each share have to be unpacked and redistributed so that the taxpayer endsup holding half the number of shares in his or her own right – and those shares do not contain any CGT assets belonging to the other (former) joint owner. This rearrangement and reallocation of the ownership of CGT assets constitutes a disposition of the CGT asset, and is therefore a CGT event: s 104-10.
Market value
• In the example, Bart will acquire his new interest in Lot A (being the interest disposed of by Homer) for market value.
Separate CGT Assets
• The new interest in Lot A will be a separate CGT asset than the initial interest in the Springfield Land (Tax Determination TD 2000/31)
• Examples of relevance: application of small business CGT concessions and general 50% CGT discount will apply separately for eachof Lot A and Lot B.
CGT clearance certificate
Tax implications – CGT
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CGT exemptions for Strata
• Limited application. No other CGT exemptions available.
• Section 118-42: transfer of units in a building that are not held by way of strata title into a strata titled ownership structure.
• Section 124-190: rollover relief where ownership arrangement for a home unit or apartment is converted into a strata title.
• Taxation Ruling TR 97/4: Income tax: capital gains: roll-over relief for buildings subdivided under strata title law into stratum units and common property.
Bare trust structure?
• Enter into a deed that the land is held on bare trust for the benefit of each other in accordance with the proposed plan of subdivision (i.e. land registered in the names of all co-owners as tenants in common in equal share but each co-owner holds interest in one post-partition lot absolutely and balance is held for the benefit on bare trust by the other co-owner.
• Section 106-50: If you are absolutely entitled to a CGT asset as against the trustee of a trust (disregarding any legal disability), this Part and Part 3-3 apply to an act done by the trustee in relation to the asset as if you had done it.
• Treated as owner of the CGT asset from the time the property was acquired.
Possible CGT exemptions?
• Partition of land may have GST implications where the interest in the land that is transferred by one co-owner to the other is a ‘supply’ made in the course or furtherance of carrying on an ‘enterprise’ (section 9-5 A New Tax System (Goods and Services Tax) Act 1999 (Cth) (GST Act))
• If GST is imposed, GST withholding rules may apply• Commissioner’s views on the GST implications of partitions of land is set out in GST Ruling 2009/2
Goods and Services Tax: Partitioning of Land:o the supply by each co-owner will normally be made as part of carrying on an ‘enterprise’, if
the land was applied or intended to be applied as part of an enterprise carried on by that co-owner. This is so even if the partition results in the termination of the enterprise;
o however, if the co-owners do not carry on any enterprise, or the partition has nothing to do with the enterprise conducted by the co-owner, the supply under the partition will not be made in the course or furtherance of an enterprise and therefore will not be subject to GST;
• GST margin scheme can apply to reduce the GST payable on a supply of land by a co-owner under a partition agreement if Division 75 of the GST Act is met.
Tax implications – GST
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• Transfer duty• No transfer duty if partitioned interests are of
the same value.• Capital gains tax
• CGT is likely to apply. Each of Bart and Homer will make a capital gain on the interest which they have disposed of, equal to the difference between the market value of that interest, less a portion of their cost base.
• Goods and services tax• GST possible if either Bart or Homer was
carrying on an enterprise or intending to carry on an enterprise on the partitioned land. However, if properties are being retained for use as a main residence or long term rental of residential premises, GST is unlikely to apply.
Application to Bart and Homer
Part 3Retaining subdivided
land
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• In certain circumstances, subdivided land might be retained by the landowner(s). This could occur where:• the landowner is a single individual, company or a trust; or• where the landowners are related to one another and/or are happy to
maintain their co-ownership.• Tax issues may appear straight forward:
• Duty – no transfer of land, therefore no duty;• CGT – subdivision of land is not a CGT event (see subsection 112-25(2)).
Accordingly, no CGT;• GST – not considered by the ATO to be a ‘supply’ for GST purposes (see
GSTR 2009/2).• However, issues can arise where:
• the pre-subdivided land was a main residence;• the pre-subdivided land was held as trading stock, but ceases to be
trading stock post-subdivision; or• one landowner wishes to sell while the other does not.
RETAINING SUBDIVIDED LAND
• Main residence issues• Scenario - Pre-subdivided land is used as a main
residence. The landowner subdivides out the back yard and sells it to a third party. The front block retains the family home;
• Each new block is treated as a new asset for CGT purposes (see section 112-25);
• Main residence exemption is not available on the sale of the back yard;
• What about the front block with the house?
Retaining subdivided land
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• Trading stock issues• Scenario - Pre-subdivided land was held as trading stock by
a developer. However, the developer decides to subdivide the land into two lots, keeping one as her main residence and the other as a long term residential investment property;
• Section 70-110 ITAA97 – the developer is treated as having sold the land to herself for its cost and is taken to have acquired the land at its cost;
• The disposal at cost is treated as assessable income under the trading stock rules. However, the acquisition at cost is not deductible as the land is now being used for personal / private purposes.
• Increasing adjustments for GST purposes will arise as the land is no longer being used for a creditable purpose.
Retaining subdivided land
• Dispute between landowners• Where there are two or more landowners, disagreement
can arise in relation to the joint-ownership of the land. For example, one may wish to sell while the other wishes to retain the land due to financial pressures or divorce.
• Options to resolve the dispute include:• Partitioning the land – but tax implications will arise
for all owners (see part 2);• One co-owner buys out the other one – there may be
funding issues which prevent this;• Litigation / lawyers – expensive and protracted and
likely to lead to a court ordered partition or sale.• It is critical to have an exit strategy / dispute resolution
mechanism for the parties in case a dispute arises.
Retaining subdivided land
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Part 4Development Agreements:
Duty on ‘Economic Entitlements’
• Development agreements between a land owning entity and a development entity are used to govern developments from small scale residential subdivisions to large scale development projects.
• No standard development agreements. • Examples:
• ‘Joint venture’ between landowner and developer, with landowner maintaining control of development: with or without profit sharing component; and
• Service development agreement: engaged to develop only, developer assumes development risk
• Structuring of development agreements: duty and tax consequences • Risk allocation• Commercial terms matter
WHAT IS A DEVELOPMENT AGREEMENT?
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1. Previously contained in landholder provisions (Section 81, Part 2 of Chapter 3) • the person acquires shares or units in a private landholder or enters an
arrangement in relation to a private landholder under which the person has certain entitlements: o to participate in the income, rents or profits derived from the
landholder;o to participate in the capital growth of the landholdings of the
landholder;o to participate in the proceeds of sale of the landholdings of the
landholder;o to receive any amount determined by reference to any of the above; o to acquire any entitlement described above.
2. BPG Caulfield Village Pty Ltd v Commissioner of State Revenue (2016) VSC 172:• Economic entitlement provisions could only apply if a person acquired a
certain level of entitlements to all the land of the landholder• For example, if the landholder held multiple parcels of land, and the property
development agreement covers a single parcel of land = rules do not apply
Economic Entitlement Provisions
1. Background: • Budget announcement (27 May 2019) and New Bill (29 May 2019)• Now Law: State Taxation Acts Amendment Act 2019 (received royal assent 18
June 2019) – introduce new Part 4B in the Duties Act (separated from landholder rules)
2. New rules: what is ‘Economic Entitlement’ now? (Sections 32XC and 32XD)• an arrangement is made in relation to relevant land that has an unencumbered
value that exceeds $1 000 000; and• under that arrangement the person is or will be entitled, whether directly or
through another person, to any one or more of the following: o to participate in the income, rents or profits derived from the relevant
land;o to participate in the capital growth of the relevant land;o to participate in the proceeds of sale of the relevant land;o to receive any amount determined by reference to any of the above; o to acquire any entitlement described above.
Economic Entitlement Provisions
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1. 100% deeming rules: • a person may be deemed to have
acquired 100% of the land in certain circumstances (e.g. entitlement in multiple categories)
2. Commissioner’s discretion: • where the 100% deeming rule applies,
the Commissioner of State Revenue is provided with a discretion to determine a lesser percentage if appropriate in the circumstances; and
• submissions will need to be made to the Commissioner
Economic Entitlement Provisions
• (Continued) New rules what is ‘Economic Entitlement’ now?o It is immaterial whether or not the person who acquires
the economic entitlement is a party to the arrangement by which it is acquired
o Economic entitlement taken to be beneficial ownership of relevant land
• When do the rules apply?o Effective date: date of Royal Assent (18 June 2019)
• What is the effect in practice?o impose duty on arrangements where a person (e.g.
developer) obtains economic benefits in relation to the land (without acquiring ownership interest)
o many property development agreements will be affectedo many property developers will be subject to duty
immediately on entering into a property development agreement for land in Victoria
• Worked example (next slide)
Economic Entitlement Provisions
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Let’s go through an Example!• Bill owns a parcel of land in Doncaster with an unencumbered
value of $4 million (Doncaster Land).• Bill entered into a Land Development Agreement with a
developer to undertake land development activities on the Doncaster Land.
• The Land Development Agreement provides that the developer’s fee will be calculated on the following basis:o the developer’s cost plus a margin; pluso a percentage of the proceeds from the sale of the
Doncaster Land.Questions to discuss• Will this type of arrangement be caught under the new rules? • What percentage duty would need to be paid if the developer
had the following entitlements under the Land Development Agreement:o a right to receive 40% of the sale proceeds; pluso a further 10% on any capital growth on the remaining
60% of the property?• What if the Doncaster Land was valued at $1.5 million?
Economic Entitlement Provisions
A NEW BREED OF LAW.
RAJAN VERMA
Director
Velocity Legal
M: 0402 811 298
ANDREW HENSHAW
Director
Velocity Legal
M: 0421 219 553
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