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Disposal of Land – to be taxed or not to be taxed? Part four
This fourth article in a series of six, on the various land tax provisions contained within the Income Tax Act 2007 (“the Act”), will focus on the potential application of section CB 14 – Disposal: amount from land affected by change and not already in income.
As a starting comment, and as a consequence of some responses from readers to previous articles, just a reminder that each of these articles only focuses on a single taxing provision (so others may still have application), and I am only writing with respect to 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.
Section CB 14 is often referred to as the rezoning taxing provision, and its potential application to gains arising upon the disposal of land has arguably increased in recent times, due to the adoption by Auckland Council in 2016 of the Auckland Unitary Plan (“AUP”). In fact, a colleague of mine was attending a seminar on the land tax provisions a couple of years back, and overheard an Inland Revenue investigator make the comment, with reference to the Unitary Plan release – “Don’t worry, we’re just going to tax everyone in Auckland undertaking any sort of subdivision activity now, under section CB 14”.
So, how does section CB 14 work, and why would the Inland Revenue employee make such a comment with confidence?
Well, section CB 14 has potential application to any disposal of land within ten years of the land’s acquisition date, where a gain is realised upon disposal, and 20% or more of that gain has arisen due to one of the factors listed in section CB 14. One of those factors, and the one providing the basis for the aforementioned comment, is any change to the rules of an operative district plan under the Resource Management Act 1991.
In this regard, the AUP released by Auckland Council was to discharge its function of achieving the purpose of the Resource Management Act 1991. It was drafted with a view to assisting Auckland in meeting its economic and housing needs by determining how to create a higher quality and more compact Auckland, by what could be built and where. Landowners all over Auckland, post-adoption of the AUP, woke up to find they were now able to carve up their land into smaller lots – something they could not have done the previous day. Consequently, a change in land use rules had occurred, and the taxpayer could now do something because of that change (that they were not already permitted to do before the change), and they were able to make a disposal gain in doing so, then they needed to consider whether more than 20% of that gain had been because of the land use change.
In terms of the pecking order, section CB 14 only has potential application if sections CB 6, CB 12 and CB 6A do not apply in the first instance. When it comes to a subdivision of land, therefore, due to the increase in the bright-line period to ten years effective from 27th March 2021, section CB 14 will potentially never be a relevant consideration. This is because you are likely to get caught under the bright-line test, unless you can claim the main home exclusion, which could be the case where you have decided as a result of the AUP to carve a lot off the back of your existing residence.
If, however, your land is classified as “new build” land for the purpose of the bright-line test, then again, unless you can claim the main home exclusion in relation to a disposal that occurs within the first five years of ownership, your disposal gain will be subject to taxation in accordance with section CB 6A.
Retain ownership post the reduced 5-year bright-line period however, in years six to ten, it’s then a question of whether you’ve breached the “minor work” threshold, to the extent that section CB 12 has application. However, should you manage to navigate yourself around these two provisions, as well as section CB 6 application (intention or purpose of disposal), then section CB 14 should be considered.
Lesson number one – if you are disposing of land within ten years of the date that you acquired it, and a land use change during the period of your ownership has permitted you to do something that you could not have done when you acquired the land, and you have taken advantage of that land use change accordingly which has resulted in a gain upon disposal of your land (basically sale price exceeds costs of your project including the original cost of the land being disposed of), then you need to consider whether at least 20% of the gain you have made is due to the land use change. If the answer is yes, then section CB 14 may apply to tax your gain. Note that where section CB 14 is triggered, the whole disposal gain is subject to taxation, not just the amount assessed relating to the land use change.
I mentioned earlier in this article that section CB 14 is commonly referred to as the rezoning provision. Well before the AUP release, it was common practice for taxpayers to acquire land on the fringe of existing residential zones, and then either apply for a specific rezoning with the local Council or simply sit and wait with the hope that the usual urban expansion would eventually force the Council’s hand to rezone the fringe land itself. Clearly, with reference to the previous discussion on the AUP release, any actual change in zoning triggered section CB 14 considerations for a landowner who sold during the requisite 10-year period and realised a disposal gain, even though they may have done nothing with their land.
Sometimes, however, the natural rezoning process by the Council would not occur during the taxpayer’s ownership period, but the likelihood of a future rezoning occurring had increased over the ownership period. In this regard, another of the listed factors in section CB 14, is the “likelihood of a change to the rules”. Consequently, even though the potential for the land to be rezoned existed when the land was acquired if the likelihood of a zoning change has increased over the ownership period to the extent that it could be shown that the increase in potential was sufficient to create at least 20% of the disposal gain, then section CB 14 can apply.
To ascertain the proportion of the excess caused by a zoning potential, the market value of the land without that potential at the time of disposal should be compared with the market value of the land with that potential at the time of disposal. Market value for the land should be used in each case as opposed to the actual sale price achieved, because the latter might be affected by factors peculiar to the purchaser, and not related to the zoning potential.
Lesson number two – knowledge by the taxpayer of any zoning changes or likely changes is not a pre-requisite to a section CB 14 application – the taxing provision will apply regardless of whether or not the taxpayer was aware of the zoning aspects related to their land. Therefore, always ask appropriate questions of your advisers.
So, you’ve potentially triggered the application of section CB 14, by determining that at least 20% of your disposal gain has arisen due to one of the listed factors. Can you claim an exclusion?
Well, there are two potential exclusions from taxation under section CB 14, the residential property exclusion and the farmland exclusion.
Lesson number three – if your land is neither farmland nor did you live on the land as your residence (or at least intend to), then your gain will be subject to taxation under section CB 14 without the need to consider the exclusions further.
The residential property exclusion can be applied, where you acquired the land and used it or intended to use it for residential purposes, and then you have sold the land to a purchaser who has acquired it for the same purpose. The meaning of “residential purposes” is defined in the exclusion clause itself, and means a purpose that the person has of using the land or intending to use the land mainly as a residence for the person, and if members of the person’s family live with them, the person and members of the person’s family living with them, and includes the purpose of erecting a dwellinghouse on the land to be occupied as such a residence.
Naturally, some knowledge of the purchaser’s intended use for the land would be prudent if you wanted to rely on the exclusion, as without a doubt, Inland Revenue will question you as to how you arrived at your conclusion.
On the other hand, the farmland exclusion can be claimed where you acquired the land, and you used it (along with any spouse, civil union partner or de facto partner) or intended to use the land mainly for the purposes of farming or agricultural business carried on by you, and you then sold the land to a purchaser mainly for the purposes of the continuing use of the land in a farming or agricultural business. Again, knowledge of the purchaser’s intentions that can be substantiated would be prudent to rebut any Inland Revenue challenge, although arguably, under both scenarios, Inland Revenue will be coming at you with the benefit of hindsight and may be able to ascertain for themselves what the purchaser subsequently used the residential/farmland for.
Finally, if all else has failed and you have reached the point that section CB 14 will apply to your disposal, there is a legislative concession to dictate how much of your disposal gain is subject to taxation. For each 12-month period that you have owned the land, the quantum of the disposal gain subject to taxation is reduced by 10%. So, if you have owned the land for four years, only 60% of the gain is taxable; for seven years, only 30% of the gain is taxable, and so on.
Final lesson – for the purpose of determining how long you are deemed to have owned the land for, and consequently what ownership discount you will be entitled to, you get to take advantage of the associated ownership concession contained in section CB 15(2). You may recall from earlier articles, that this concession can be applied in scenarios where you have acquired the land from an associated person (as that term is legislatively defined for the purpose of the land tax provisions). In these cases, your acquisition date will be deemed the date your associated vendor acquired the land and not your acquisition date. So, if a family trust of which you hold the power of appointment acquired the land on 1st April 2008, sold the land to you on 1st April 2014, and sold the land on 1st April 2020, then for the purpose of section CB 14, you are deemed to have acquired the land on 1st April 2008. As a consequence, being deemed to have owned the land for 12 years at the time of its disposal (as opposed to six years), section CB 14 is of no application to you as you have not disposed of the land during the requisite 10-year ownership period.
Well, until next time, I hope you enjoyed the article, and as always, if you have any questions or concerns, please reach out, and I will be more than happy to provide an opinion for you.