Two almost identical scenarios in the past few weeks, were a stark reminder to me, of the importance of stressing to others to seek good advice prior to commencing any project, so you are at least fully informed with respect to all of the potential taxation implications that may arise as a result of completing your proposed plans. And in the present cases, the failure of both individuals to get the right advice at the outset, was unfortunately going to be a very expensive learning lesson for them.
The two scenarios were so similar in fact, that I actually asked the person who called in respect of the second situation (who was supposedly calling on behalf of his ‘friend’), what his friend’s name was, because the background to the case was in essence a perfect match to a guy who had emailed me out of the blue, a week or two earlier. However it was simply coincidence, the first guy having just proceeded on the basis of people having told him it was the right way to go, whereas the second guy, and perhaps more concerning in this instance, had relied on the advice of his accountant!
So why were the lessons going to be so costly to the two individuals concerned? The answer, because both scenarios were with respect to land, and to Auckland land in that regard, so clearly the numbers involved were going to be large, and the tax implications of getting things wrong, material.
In both cases, the individuals were living on the land as their personal residences, and had done so for over 20 years. The new Auckland unitary plan however, now permitted both owners to subdivide their land into four lots, and each was planning to demolish the existing dwelling, construct four new townhouses, and then sell the completed development.
“Don’t be afraid to ask questions. Don’t be afraid to ask for help when you need it. I do that every day. Asking for help isn’t a sign of weakness, it’s a sign of strength. It shows you have the courage to admit when you don’t know something, and to learn something new.” ~ Barack Obama
Good advice would have informed them, that from an income tax perspective, because the land had been owned for more than 10 years (and neither of the owners had any connections to building, land development/subdivision or land dealing businesses, either carried on by themselves or by associated parties), the only income tax taxing provision that may have application to a disposal of the completed lots, was that which related to major development or subdivision schemes – clearly not the case in this instance. Consequently they could have completed their projects and pocketed any gains derived from the subsequent disposal of the newly developed lots, as tax free capital gains.
From a GST perspective, if a taxable activity was deemed to be carried on (which was debatable due to the one off nature of the schemes and the number of lots to be created), requiring the owner to register for GST and account for GST on the eventual sale prices obtained for each section, at least they may have been entitled to claim a GST input tax deduction, in respect of a change of the land’s use from non-taxable to taxable.
Sadly for these two land owners, for one reason or another which I was not privy to, they had both transferred their land to a company, had registered the company for GST with respect to their subdivision schemes on the basis the companies were in the business of property development, and in one of the cases at least, had filed a GST refund claim with Inland Revenue in relation to the land being used, which had been rejected.
So what now were the consequences of not receiving good advice?
- The land was now effectively tainted by the
development activity of the company (from the perspective of the nature of
business activity stated on their GST registration application). Any subsequent
disposal of the land was now taxable, whenever sold, including a subsequent
disposal by any associated party the company may have tried to transfer the
land to (in an effort to break the tainting chain), if the owner decided to
instead keep any of the newly developed lots longer term. The only saving grace
would be the ability to have transferred the land to the company at its present
market value, thereby effectively retaining the tax-free capital gain arising
from the increase in the value of the land over its original cost at the date
of transfer. However this factor alone should not distract us from the fact,
that there would still be income tax payable on the disposal of the land, where
under the alternative scenario there would not have been.
- Even if the development tainting issue could
be navigated around in some way, for example by being able to convince Inland
Revenue that the GST registration was in fact a mistake because the company was
actually a property investor, the transfer of the land to the company had now
reset the bright-line clock, with the consequence that any disposal of the land
within five years by the company would be automatically subject to tax.
- From a GST perspective, because the
individual owner had paid no GST when they had originally acquired the land,
the quantum of the GST second-hand goods claim the company could recover upon
acquiring the land, was now zero. GST however was now fully payable on the
disposals. This was essentially the reason the Inland Revenue had rejected the
earlier mentioned GST refund claim.
- Finally, both taxpayers were now fully on the Inland Revenue radar, with the one whose company’s GST refund claim had been rejected, also now potentially exposed to shortfall penalties on the basis of taking an unaccepted tax positon when the company had filed its GST return.
Certainly a hard lesson for both individuals to swallow, and hopefully a timely reminder to you all, that no matter how knowledgeable the guy in the pub sounds when you are discussing your proposed project, always seek advice from a suitably qualified person, and be prepared to pay for that advice.
If we can be of assistance in any way, please just call one of our tax team members.