QUESTION
Word Limit: 2000 words
In 1982 Graham Jones purchased eight hectares of land for a strawberry farm at a cost of $320,000. By 1989 the plantation was well established and producing strawberries of good quality and deriving reasonable profits. As a result, on 1 October 1989 Graham bought another two hectares of land for $40,000. Costs associated with the purchase included stamp duty of $800 and legal fees of $1,600.
In 1997 the crop was exceptionally poor, coupled with this, customs restrictions were altered, allowing greater quantities of strawberries to be imported. These conditions precipitated financial difficulties and Graham decided to sell the land. Attempts to sell the land as a whole were unsuccessful, although one agent did offer $400,000. Graham therefore decided to sell the land by subdivision.
After re-zoning and gaining council approval in June 1999, Graham spent $160,000 on the subdivision in October and November 1999 and finally sold the land for $700,000 in July 2011 to a local builder. Although the contract of sale was dated 1 July 2011, settlement was not effected until 12 October 2011.
The contract provided that half of the purchase money would be payable upon settlement and the balance on 31 March 2012. The outstanding balance would accrue interest at 10% pa. Costs of disposal including agent’s commission of $12,000 and legal fees of $2,400.
Advise Graham Jones on the tax implications on the above transaction for the 2011/12 tax year
SOLUTION
Introduction:
The following essay clearly depicts the tax implications of selling sub divided land and the special concessions, if any, provided as per Australian Tax Laws for land that is used for farming. The associated costs for purchasing the land and the cost related to sale are also taken into consideration to understand the impact on taxation in Australia. It studies the nuances of capital gains taxation norms prevalent in Australia and the exemption categories. The case also gives lot of intricate details about the way the tax payer can claim exemption on age old property and amidst the capital gains there also arose the other income category in the form of interest which also is accountable.
Tax Implications:
The capital gain tax as per the taxation laws of Australia refers to the gains that are made out of the sale of any kind of capital assets. The capital gains tax are charged and included in the income tax statement and are not a separate form of tax. The capital gains are calculated by reducing the so called Cost base from the actual sale proceeds. If the sale proceeds are more than the cost base then it’s a capital gains and it attracts taxability norms. (Eddie, 2008)
In this context subdivision of land is also a major part that needs to be analysed. As such subdivision of land does not amount to any kind of taxation but when such subdivided land is sold then it does attract taxation that can be either capital or revenue in nature. After subdivision of land the new blocks that are formed subsequently is treated as the same old land and their date of purchase and other Cost base does not change. The cost of the original land can then be apportioned to the new blocks formed after subdivision. Also, the rule depicts that if there is a pre CGT land that has been subdivided it will not lose its pre CGT status even after subdivision. (Subdivide and conquer,2011).
Many people involve in subdivision of land for the sake of commercial sale and they include real estate agents. When the subdivision of land is done and sale is made thereafter its necessary to understand if the sale proceeds can be treated as revenue or capital. In case of real estate agents, the subdivision is done primarily for business sake and this becomes his revenue and is treated as such in the taxable income category.
In the given case of Graham, he had been using the land for farming strawberries and when the sale depleted too much and he had to suffer loss, he then decided to sell off the land. He initially attempted to sell the land before subdivision but did not get any prospective and profitable buyers. As a result of this he decided to sub divide the land for facilitating the sale of the large area of land which proved to be helpful for him as he got a buyer who was able to pay higher price. These points are relevant to decide if the sale will be considered as revenue or capital. The following paragraphs will give a detailed insight about the tax implications on Graham and his sale of land
Revenue or Capital on subdivision:
Graham had subdivided the land for selling it to make profit. In case of subdivision, it’s essential to understand if the loss or profit needs to be treated as revenue or capital. The simple test is that if the land has been purchased and held for a longer years and then sold with the motive of making a profit then it amount to capital asset sale. There are several factors that need to be considered in order to determine if the sale of an asset amounts to revenge or capital income under subdivision:
- The intention for subdivision –if to facilitate the realisation of property then it’s a capital income ( Chung, 2011)
- Is the subdivision done as a routine part of the business – if not commercial then it’s a capital nature
- Repeated subdivision and sale of assets can amount to revenue
- If the sub division process is taken care by the seller and is actively involved in them then it may be a routine business and so revenue nature
The above mentioned points when applied to the case of Graham it clearly suggests that the sale of land after subdivision is purely of capital nature. So, the Capital gains tax implications have to be analysed in detail to understand the nature of transactions and the exemptions, if any that can reduce the taxable value.
When subdividing the land, the cost associated with the land has to be apportioned according to the actual percentage of sale of land. If for example, out of the total land area there is residential house contracted and if this is sold then the residential house is fully exempt from taxation. So, the sale proceeds only for the adjacent land that attracts CGT must be considered and the cost base must be calculated accordingly. ( Chung, 2011)
The cost of the new blocks that has been purchased must be apportioned after the subdivision and the net sale proceeds must also be segregated accordingly.
The new block of land purchased by Graham in 1989 is not exempted from CGT as it’s not a pre CGT transaction. Also, there has been no house constructed on the land. If there had been house then Graham is eligible for claiming exemption for the sale of house as residence and also the adjacent land up to an area of 2 hectares. In the given case the rest of the two hectares bought by graham in the year 1989 is fully subjected to Capital gain taxation laws of Australia.
Exemptions
Land that is used for farming when sold will also attract capital gains tax under the tax laws of Australia. However there are few exemptions provided under the CGT of Australia. The following transactions do not attract CGT under Australian tax laws:
- Sale of Assets that has been purchased before 20 September 1985
- Sale of House that has been used as residence by the tax payer
- Collectables up to the tone of $500that are items like jewellery, stamps and lot more
- Winnings from gambling
- Shares held in pool of development fund
- Payments from government schemes
The case of Graham, the first land was purchased in the year 1982 and so it clearly is exempted as given in the above mentioned points. (Eddie,2008)
Graham had purchased 8 hectares of land in the year 1982 for strawberry farm at the cost of $320000. This part of land is also included under the sale contract and it’s necessary to identify this portion and exempt them from the CGT calculations. The taxation laws have clearly described that such land is termed as pre CGT and so no tax liability on them.
Cost Base:
The cost base refers to the total expenses and cost spent for purchasing the land. This has to be calculated to find out the capital gains for a transaction of sale of assets. However, there are two other methods that are applied for assets purchased before 21st September 1999. In the given case of Graham all the assets has been purchased before 1999 and so this can be applicable.(Eddie,2008 )
Graham can apply the discount method wherein the sale proceeds are reduced from the cost base. And in case the purchased asset in 1999 has been held for more than a year, which is true in this case, then a discounting factor of 50% for individuals can be applied on the capital gains before applying the Capital gain tax.
Another method that can be used is the indexation method. The indexed cost base is calculated for the land and the difference between the indexed cost base and the actual sale proceeds is known as the capital gains or loss. Here there is no further discounting allowed as the indexation is in itself a form of discounting. So, its always better to apply the discounting method if the sale proceeds of for a small area of land.
The tax laws of Australia gives the tax payer complete freedom to adopt either of the methods whichever yields the least tax. (Common Wealth of Australia, 2011)
The total area that has been sold is 10 Hectares. Out of these 8 hectares has been purchased before 1982 and so fully exempt from CGT. So only the remaining 2 hectares is subject to taxation. After subdivision, Graham has to apportion the sale proceeds in percentage only for the taxable area.
So, its 20% of sale proceeds that is 20% on $700000 that is considered for calculating the Capital gains. Sale proceeds on 2 hectares of land = $140000. 20% is applied because out of the total 10 hectares of land only 2 hectares are subject to taxation.
The subdivision expenses include $160000 plus cost of disposal: agents commission $12000 plus legal fees $2400 so total of $174400 (total expenses) Out of this 20% is applicable to the taxable area of land and so its $34880.
Calculation of Cost base can be done as follows:
Land purchased on 1 October, 1989 $40000
Stamp Duty $800
Legal Fees $1600
Subdivision expenses n cost of disposal $34880
Total $77280
Capital Gains:
The capital gains refer to the excess of sale value over the Cost base and are subject to taxation. So the capital gains can be calculated as:
Sale value (20% on $700000) $140000
Less: Cost Base $77280
Capital Gains $62720
However, since Graham has held the new block of land for more than a year he can discount 50% of the capital gains. So the actual taxable capital gains would be 50% of 62720 = $31360
Other income:
Besides the Capital Gains, there is also another source of income that pops out of this case of Graham. It’s necessary to take a look at the sale contract and its agreement terms and conditions.
Graham had entered into the sale agreement on the conditions that the settlement of money would be made on October 12, 2011, the date on which the sale deed became effective. The remaining instalment was to be paid by March 31, 2012. The balance outstanding attracts interest @10% p.a. The interest amount that is received on such a transaction must be shown under other income of Graham. It’s completely taxable and must not be shown under the capital gains head but shown as ordinary income and is taxable in the same financial year as the entire amount is received in the same year.(Loan Market,2012)
So as per the case, the total proceeds is $700000, half of this amount must have been paid on October 12, 2011. Though the sale date was July 2011, the sale was effective only on October, 12 2011 and so the amount outstanding till then does not accrue interest as it’s clearly given in the sale deed. So the first instalment of $350000 is received on October, 12, 2011.
The second instalment of $350000 which is payable on March 31, 2012 accrues interest @10% p.a. for a period of 5 months and 19 days(from October,12,2011 till march,31,2012)14600+1847=16447
Total number of days that accrues interest = 171(19+30+31+31+29+31)
Total number of days =365
So Interest @10%p.a. on $350000=35000 for a year
So taxable interest = 35000/365 * 171 = $16400
Conclusion:
Since Graham had purchased a part of the land before the year 1982 he was able to evade capital gains tax on that land sale. However, capital gains on the other area attract tax under the Capital gains rules of Australia. In the meanwhile, graham must not forget to make a note of the interest that he is accruing over the outstanding balance of sale proceeds and this must be included in his taxable income under the other income without fail.
References:
Eddie Chung, Storman, 2011 viewed on 1st june 2012, http://ssn.storman.com/pages/newsblogs/the-taxing-issues-of-subdivision/
Common Wealth of Australia 2011 Capital Gains tax, viewed on 1st june 2012,http://www.ato.gov.au/corporate/pathway.aspx?pc=001/001/038
Chung Eddie 2008,Tax implications, land subdivision, viewed on 1st june 2012, http://www.bdo.com.au/media-centre/media-releases/national/tax-implications-of-land-subdivision
Subdivision of land, 2009 viewed on 1st june 2012, http://wealthruproperty.com/Blog/2009/12/subdividing-land-calculating-capital-gains-tax/
Loan Market 2012, Subdivide and conquer retrieved from http://www.loanmarket.com.au/subdivide-and-conquer/
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