Practical Tax Issues in the Development of Property
The rapid intensity of development of urban areas in both capital and regional areas is giving rise to significant issues not just from a planning and infrastructure perspective.
In regional centres, what was yesterday a rural land package, will tomorrow be a new thriving residential sub-division. Closer to the City Centres, the traditional ½ or ¼ acre block held in the family for generations is now being developed to hold multi story dwellings close to the major transport hubs. Often we hear about a group of neighbours banding together and selling as a group to property developers to maximise their collective and individual returns.
This transformation of historically held properties is also giving rise to a number of taxation issues, with the primary issue being the characterisation of the activities undertaken, are they “capital” or “revenue” in nature - or in non-tax terms “yesterday I was a chicken farmer, why am I now suddenly a property developer?”
The tax characterisation of a property development for the landowner is complex and involves considering the intention of the landowner when the property was acquired, whether that intention changed during the course of the ownership, and the extent of the activities undertaken on the “development” of the property sold.
All these factors lead into the question of whether a gain on the transfer of the property is taxable as:
1. A disposal of trading stock of a property development business;
2. A profit making scheme because it was acquired with the intention of making a profit on disposal; or
3. A taxable gain on the disposal of a CGT asset - because it was a “mere realisation of a capital asset.”
These threshold questions turn on the nature of the undertaking and historical guidance of the tax treatment. Such undertakings goes back to a case decided in 1982 FCof T v Whitfords Beach Pty Limited.
In that case, the taxpayer company ‘Whitfords’ purchased land so that the shareholders, who were fishermen, could access fishing shacks on a beach. Some years later, three development companies sought to acquire the land for subdivision and sale at a profit. An outright purchase of the land by the developers and subsequent subdivision and sale at a profit would clearly have been assessable as revenue in nature. To avoid being assessable under the ordinary income provisions, the developers decided instead to buy shares in Whitfords and then, once in control of the company, subdivide and sell the land. The property developers in due course bought shares in Whitfords, altered the constitution of the company, and subsequently embarked on a large scale re-zoning and development of the land. The subdivided land was eventually sold at a significant profit.
The High Court held that once the developers took over Whitfords, the company transformed from one which held land for the “domestic purposes” of its shareholders to one that was purely driven to engage in a commercial venture to make a profit. In the Court’s view it was this transformation that turned the development from a “mere realisation” to an assessable transaction.
The practical question for our chicken farmer mentioned earlier is, how far can I go in “developing” the property before the property ceases to be a capital asset, and becomes either trading stock of a development business or is part of a profit making undertaking or scheme?
For example, take our chicken farmer;
- If the property was acquired for use in a business as a chicken farm, that business ceased and the farmer sold the farm to a developer then it is strongly arguable that any gain is assessable under the capital gains tax rules and potentially subject to the 50% discount treatment. This may still be the case where minimal activities were undertaken, such as successfully applying for development approval without actually undertaking any development works.
- Where subdivision into lots was approved and infrastructure (roads) undertaken yet the land was sold as one parcel, this may lead to a conclusion that this was no longer the realisation of a capital asset but the undertaking of a profit making scheme.
- Where the land is further developed into lots that are sold with dwellings constructed upon them, then our chicken farmer would now have made his or her transition to “property developer.”
To address these issues the emergence of “joint ventures” between landholders and property developers is becoming more common. Under such an arrangement there is no transfer of the property to the developer. The developer undertakes the development of the land and the owner continues to hold the land until the properties are sold. Under these arrangements it is argued that the landholder merely “realised its asset” in the most effective way, yet remains in the CGT regime with the potential discounts still applying.