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Disposal of Land – to be taxed or not to be taxed? Part 1
In 2020, I published a series of articles that provide guidance on the potential application of the land taxing provisions contained within subpart CB of the Income Tax Act 2007 (“the Act”). Three years later, the most common questions I still receive from the outside world are related to land, and whether certain transactions or projects will trigger taxation implications for the landowner. Coupled with the residential land bright-line changes which came into effect in 2021, I thought it would be timely to issue updated versions of the earlier articles.
New Zealand still does not have a capital gains tax regarding the disposal of land acquired for investment purposes. Although arguably, extending the residential land bright-line period to ten years is a capital gains tax in disguise, which has been stealthily slipped in by the government.
However, there are still a number of ways in which a person who does not carry on a business of dealing in land (land dealer, land developer/subdivider, builder), can still be subjected to an income tax imposition upon the disposal of that land.
This is due to the inclusion of specific rules relating to the taxation of land transactions, which, as I mentioned at the commencement of my article, are included within subpart CB of the Act. In effect, there are ten main taxing sections, closely followed by a number of exclusion provisions, whose criteria, if satisfied, will negate the otherwise taxation of the disposal gain.
There is also a “pecking order” regarding the various taxing provisions, some only having a potential application and others not.
So this article, for those of you who have not read them previously, will be the first in a series, where I will endeavour to provide a high-level overview of when the various legislative provisions can be triggered and some traps to be aware of with respect to both the taxing provisions themselves, and the potential available exclusions.
To commence the discussion, therefore, it is acknowledged that in recent years, all the talk has been surrounding the bright-line rules – acquire a piece of residential land, dispose of it within ten years (although reduced to five years for “new build” land), and unless you can show it was your main home, then pay tax on any disposal gain. At the time of its introduction, bright-line was promoted by the Government as a tool to deal with property speculators, whose consistent buying and selling behaviours were having a detrimental effect on Auckland housing prices. Some, like myself, however, would suggest that the introduction of the bright-line rule was a political overreaction to a problem that, in my simple mind, was one of the age-old economic concepts of supply versus demand (we just didn’t have enough houses available to satisfy demand), as opposed to having anything to do with so-called “speculators”.
base my simple view of the world on the fact that, in reality, Inland Revenue has always had the ability (well, for my tax lifetime at least) to assess any disposal of land for tax, where the land in question was deemed to have been acquired for a purpose or with an intention of disposal. In this regard, a disposal intention or purpose did not have to be the taxpayers’ primary acquisition intention or purpose, it simply had to be one purpose or intention of acquiring the land at the time.
While the onus of proof rested with the taxpayer in terms of substantiating what their subjective mindset was at the date of acquisition, surprisingly, it almost appeared to be in “the too hard basket” for Inland Revenue to pursue the taxpayer, unless there was clear evidence of the requisite disposal intention or purpose. Now admittedly, back in the day when I began advising on land tax issues, the land transfer register was not electronic, which often meant that you really were unlucky if your land disposal was identified and then progressed to any review by Inland Revenue.
So, in essence, the bright-line rule introduction simplified life for the Inland Revenue dramatically – sell within the applicable bright-line period timeframe and pay tax – it’s black and white. More on bright-line later, however, in a subsequent article, because in terms of pecking order, the bright-line rule only comes into play when a number of other taxing provisions do not have application.
The starting point in the pecking order, in my view, and the focus for the remainder of this article, is the intention or purpose of disposal provision. Because if this legislative test is satisfied, the land in question is effectively within the taxing net whenever sold, regardless of what happens next with the land and any subsequent changes in the taxpayers original intention or purpose.
In this regard, however, a key element to understand with the intention or purpose of disposal provision is that it is the taxpayer’s intention or purpose on a single day that will ultimately determine the taxing outcome for the land in question. This is because the Courts have interpreted the meaning of the wording used in the legislation to be the intention or purpose of the taxpayer on the date the land was acquired. Which itself has been deemed, in most cases, to be the date upon which the relevant parties have entered into a binding sale and purchase agreement.
Consequently, if the taxpayer intended to dispose of the land on the day subsequently, they signed the sale and purchase agreement but then changed their mind a week later to hold the land long-term, the land is effectively still “tainted” by the acquisition date intention and will still be taxable upon disposal (whenever that may be). Equally, however, if the taxpayer acquired the land with a long-term investment purpose in mind and a month later received an unsolicited offer from someone who wanted to buy the land, which was simply too good to refuse, arguably, they should not be subject to tax on any gain arising upon the unintended sale, under the intention or purpose of disposal taxing provision. I say “arguably” because one should still expect some pointed questions from the Revenue due to the quick turnaround in ownership by the taxpayer. Naturally, with the onus of proof on the taxpayer to rebut any taxable assertion by Inland Revenue, sufficient evidence must be retained to show that the offer was indeed unsolicited as claimed.
While an acquisition intention or purpose of disposal will effectively taint the land forever, it may, however, not taint all of the land in question. This position was recently espoused by Inland Revenue in its QB 16/06, which is titled ‘Income Tax – Land Acquired With A Purpose Or With An Intention Of Disposal’. In this regard, one question raised within the QB 16/06 commentary was, “What if I buy some land intending to subdivide it and sell some and keep some?”
Inland Revenue’s response was – “If you acquire land intending to sell some and keep some, you will only be taxed on the disposal of the part you acquired to sell. You would need to have satisfactory evidence to show how much of the land or what part you did not acquire for a purpose or with an intention of disposal.”
Finally, if you do find yourself in a position where you may have triggered the taxing provision due to clear evidence of an acquisition intention or purpose of disposal for the land, the next question is whether one of the legislative exclusions may be available to you, to negate taxation of the disposal gain otherwise. There are two available exclusions in this regard, one related to residential land, and the other to land used for business premises of the taxpayer.
With respect to the latter, I personally have seen little use of the exclusion in relation to the intention or purpose of the disposal taxing provision. It requires that the taxpayer has used the land as their business premises, which itself has been shown to require an active trading business activity to be carried on from the land. It is not sufficient, therefore, to simply lease the land to another party who then operates their business activity from the land. It is also not available to a person who may consider that they are carrying on a business of renting from the land, due perhaps to the number of residential dwellings upon the land and the taxpayers’ level of involvement in the rental activity satisfying a “business test” analysis. The residential dwellings, in this regard, are not considered “business premises” of the taxpayer.
The residential land exclusion, on the other hand, is widely used. It can be claimed where the taxpayer acquires the land and then resides upon the land as their personal residence in a dwelling on the land (either acquired with the land or subsequently erected). The exclusion extends to both natural person owners and land owned by trusts. It is, however, limited in its scope, usually to land that has an area of less than 4,500 square metres. Although there is discretion provided for larger areas of land which can be shown to be required for the reasonable occupation and enjoyment of the family home.
Naturally, to ensure the rules are not abused by the taxpayer simply residing on the land each time to claim the exclusion where there is an ulterior motive in play (renovation projects for resale, for example), there is a limitation to claiming the exclusion where the taxpayer has exhibited a regular pattern of acquiring and disposing of residential dwellings. In this regard, Inland Revenue has also espoused a view that three prior transactions would usually negate the claiming of the exclusion for the fourth transaction.
To conclude this article, I have two final comments to make.
Firstly, while the bright-line rules will now, in essence, capture any disposal of residential land within the applicable bright-line period, the original intention and purpose of disposal taxing provision should not be forgotten about, as it could still come into play when the particular disposal is post the expiry of the applicable bright-line period.
Secondly, the exclusion limitation for a “regular pattern” was widened from 30th March 2021 from a single taxpayer to a group of persons test. The extension of the test was to limit the potential to structure ownership of the land slightly differently each time to avoid the application of the limitation.
Should you wish to discuss any of the content of this article further, please contact me.