Capital vs Revenue? Reflections on Morton (Full Federal Court)

Background

Dave’s Block formed part of Morton Farm, a family farming property at Tarneit. Mr Morton acquired Dave’s Block from his father in 1980 for $13,500 (making it a pre-CGT asset) and farmed it until 2015. In 2010, the land was brought within the Urban Growth Boundary and rezoned, increasing rates and land tax and making continued farming commercially unviable.

After negotiations with property developer Dacland, a development agreement was executed on 23 November 2012. Under the development agreement:

1. Mr Morton was entitled to a fixed percentage of lot sale proceeds, did not borrow or guarantee development finance, would not allow the land to be used as security; and
2. the developer carried out the development in its own right and assumed the relevant risks.

The terms of the development agreement were that the overwhelming majority of the ‘risk/reward’ lay with the developer, rather than with Mr Morton.

The Commissioner later issued amended assessments for the 2019 and 2021 income years, treating proceeds from the sale of subdivided lots as assessable income.

Mr Morton succeeded before the primary judge and the Commissioner appealed (see our previous article on the Federal Court decision).

Key Issues

The Full Court noted that the Commissioner’s grounds of appeal narrowed significantly at the hearing.

The Commissioner’s principal contention became that, on the proper construction of the development agreement and related sale contracts, the developer’s acts in carrying out the development were acts done by or on behalf of Mr Morton and should therefore be treated as his activities for income tax characterisation purposes.

Key Findings

The Full Court held that the primary judge was correct to conclude that Mr Morton merely realised a capital asset and that the proceeds were not assessable as income from business or profit-making activity.

The Full Court placed substantial weight on the unchallenged factual findings that:

1. Mr Morton acquired Dave’s Block for farming, not resale at a profit;
2. that the move toward development was prompted by rezoning, increased rates and land tax, and the declining viability of continued farming;
3. that he would not allow the land to be used as security;
4. that he did not borrow to fund the development; and
5. that he was unwilling to be actively involved in the project.

The Court also accepted that Mr Morton’s practical involvement was limited. Mr Morton did not oversee the project, contribute in substance to planning applications, organise project finance, manage construction works, or meaningfully engage with the monthly reports he received. Those facts told strongly against characterising the development as Mr Morton’s own business activity.

Importantly, the Court accepted that the agreement created a limited agency. The developer could perform acts necessary to undertake Mr Morton’s obligations under the agreement, including executing sale contracts or lodging planning and regulatory documents. But that did not mean the developer’s property development business became Mr Morton’s business. The agreement also confined the relationship between Mr Morton and the developer, whereby the developer acted as an independent party, assumed the risks, and conducted the development in its own right.

The Court cautioned against moving too quickly from the fact that a landowner engages a professional developer to the conclusion that the developer’s business-like conduct should be attributed wholesale to the owner.

The Commissioner also placed reliance on the massive scale of the subdivision. In relation to this point, after referring to Scottish Australian Mining Company Limited v Federal Commissioner of Taxation (1950) 81 CLR 188 (a High Court authority involving a massive subdivision), the Full Court stated that the scale of activities alone does not have the consequence that the activities are properly to be characterised as the carrying on of a business.

Accordingly, Mr Morton had not embarked on a business of development or entered into a profit-making undertaking. Rather, Mr Morton had engaged a developer to obtain the best price on realisation of a capital asset.

Takeaways

• Morton confirms that mere rezoning, subdivision and sophisticated development activity do not, by themselves, place long-held land on revenue account. The question remains one of overall characterisation.
• Practically, landowners should look closely at who is really taking the development upside and downside. Mr Morton’s case involved an unusual allocation which will not be present in many development agreements. It would be expected that the ATO would make that distinction in any Decision Impact Statement.
• The mere realisation argument becomes harder where the landowner takes on more financial or operational exposure, for example, by funding works, guaranteeing debt, exposing the land to development finance, or taking a more active role in approvals, works or sales. That is an inference from the factors the Court treated as significant in Mr Morton’s favour.
• Even so, long-held ownership, an original non-profit-making purpose, external pressures leading to sale, and limited personal involvement remain strong indicators of mere realisation.
• Morton is not a green light for all subdivisions and disposals. These cases remain intensely fact specific, and landowners should still examine acquisition history, development structure, financing, risk/reward allocation, and practical role before assuming a capital outcome.

To discuss whether your subdivision or development project is likely to be taxed on revenue or capital account, please contact Velocity Legal’s tax team.