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Disposal of Land – to be taxed or not to be taxed? Part two
My first article on the various land tax provisions contained within the Income Tax Act 2007 (“the Act”) focused on the potential application of section CB 6 – land acquired with a purpose or an intention of disposal. This second article, in a series of six, moves on to what I consider is second in the pecking order of what to think about for those who are dealing with land but are not themselves carrying on a business of land dealing, land development and/or subdivision, or of erecting buildings, and nor are they associated with any person carrying on one of these businesses.
That taxing provision is section CB 12, commonly referred to as the “minor subdivision” rule – although the reference to “commonly” does not reflect taxpayer awareness of its existence. I remember a few years back having arrived early for a touch rugby game and listening to a fellow teammate bragging to someone else about how he and his brother (both plumbers) had recently carved up a section of land and profited quite well from the project. I asked him if he had paid tax on that profit, and he stared at me blankly and responded that he wasn’t a developer, so of course not!
Lesson number one, therefore – section CB 12 has potential application to any Joe Bloggs on the street who develops and/or subdivides a piece of land. In other words, you do not have to be carrying on a business activity with respect to the land in question, to be caught by the taxing provision potentially.
So, let’s consider the nitty gritty details first.
Section CB 12 can apply where any scheme or undertaking to develop and/or subdivide the land into lots is commenced within 10 years of the date the land was acquired, and the scheme or undertaking is to involve work of “more than a minor nature”.
The following checklist could be a useful starting point, therefore, to provide you with an initial “gut feeling” as to whether you may have a section CB 12 issue:
- Within 10 years of the land in question being acquired, have you commenced a scheme or undertaking to develop and/or subdivide the land?
- If the answer to 1 is yes, then would the work involved in completing the project be “of more than a minor nature”?
- If the answer to 2 is yes, would you be entitled to claim one of the four available exclusions that would negate taxation under section CB 12 – residential land, business premises, farmland, or investment land?
- If the answer to 3 is no, then it might be time to give me a call.
Within questions 1 to 3, I have used a number of phrases, which now warrant further discussion.
Firstly, “commencement within 10 years”.
Time for lesson number two. It is important to note that the scheme or undertaking does not need to have been completed before section CB 12 can have an application to the disposal event – it simply needs to have been commenced within the requisite 10-year period. So, if you commence your scheme and then abandon it, you may still have triggered section CB 12 and potentially have now tainted the land to the extent that any future disposal of the land will be subject to tax.
There is also the difference between undertaking certain activities to simply explore what options you have available with respect to developing a piece of land versus committing yourself to a particular idea and putting that plan into action. “Commencement”, therefore, will often be deemed to have occurred when you undertake the first “overt” act of getting underway. Quite often, this will be filing a resource consent application with the local authority; however, each case must be judged on its own facts, so “commencement” could be triggered by something entirely different.
Additionally, the purpose of undertaking the development or division work should be to attain an end goal of disposing of the land. If you are undertaking a subdivision with no intention of disposing of the land, then section CB 12 is unlikely to have an application.
Finally, suppose you acquired the land from someone closely related to you (an “associated person”, which is a concept legislatively defined). In that case, you may be able to use their original purchase date of the land (as opposed to your own), for determining whether or not you have commenced the scheme within the requisite 10 year period.
Secondly, “of more than a minor nature”.
Whether the work undertaken to complete the development or subdivision project has involved work “of more than a minor nature” naturally requires consideration of both the physical and non-physical work that has occurred in carrying on the scheme.
The “work of a minor nature” issue has been discussed in numerous cases before the Courts over the years, with Inland Revenue eventually issuing an interpretation statement (IG0010) titled “Work of a Minor Nature, in January 2005” to share its views on the issue in an attempt to provide some clarity for the taxpayer.
For some 15 years, IG0010 was essentially the go-to guidance document to give you some flavour of how Inland Revenue was likely to view the particular undertaking. It was, however, still a very grey issue, with the only real appreciation by those who read it that the commentary suggested that not a lot would be required to breach the “minor work” threshold.
On 13th August 2020, a ray of sunlight suddenly appeared through the clouds; however, when Inland Revenue issued IS 20/08 – “Income tax – when is development or division work “minor”?”. The new Interpretation Statement is stated to update and replace IG0010. While it does commence with a comment that the main conclusions reached in the earlier document remain unchanged, its one silver lining over its predecessor is the inclusion of ‘safe harbour’ figures for absolute cost and relative cost, to assist taxpayers with compliance with section CB 12.
So, if the absolute cost of your project is $50,000 or less, and on a relative basis, absolute costs are less than 5% of the value of the land at the commencement of your project, then you may be ok. Exceed either one threshold; then equally you could be in a spot of bother.
Finally, you should also consider the following 3 factors:
- the significance of the changes to the physical nature and character of the land – if I walked past your land before you commenced your project and then again once you had completed it, how much would I notice what you had done;
- The extent of the physical work required – what was the actual level of physical work involved; and,
- the nature of the professional services used, including the number and complexity of legal steps and professional work required to achieve the purpose – how simple actually was the project.
Thirdly, and finally, “the exclusions”.
I do not plan to go into any great detail here, instead just providing some key comments for you to be aware of.
Lesson number 3 is very important. Unless you own the land in your own names, you cannot claim the residential land exclusion – so family trust ownership is out. However, if you do own the land personally and have occupied the land as your personal residence immediately prior to undertaking a subdivision, and the original land area is less than 4,500 sqm, then you may be in luck.
The business premises exclusion only applies if you have an active trading business occupying the land. So simply leasing the land to someone else to trade their business from or having a number of dwellings upon the land which you have tenanted (and argue, therefore, you are in business as a landlord), will not be sufficient to claim the exclusion.
Finally, if you are undertaking the development or subdivision with the purpose of deriving future investment income from the land post the completion of your project (so erecting dwellings to then rent out, for example), then you are likely to be able to negate a section CB 12 application.
I appreciate that having read this article, you may be just as uncertain as to the correct taxing treatment with respect to your project as you were when you read the title. That being the case, or, if there is any doubt, please call out, and I will be more than happy to provide an opinion for you.