Disposal of land – to be taxed or not to be taxed? That is the question – part 5

This fifth 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 13 – Disposal: amount from major development or division 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 focus on a single taxing provision (so others may still have application), and I am only writing with respect to those land owners who are doing something with a piece of 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 13 is in essence the last in the pecking order of the land taxing provisions, and it can only be of potential application where sections CB 6A to CB 12 and section CB 14 do not apply to the land transaction under consideration.

So how does section CB 13 work?

Section CB 13 has potential application to any disposal of land, where there has been an undertaking or scheme (does not have to be of a business nature) to develop the land and/or to divide the land into lots, and the project involves significant expenditure on work of the kind usually seen in major projects developing land for commercial, industrial or residential purposes.

For those of you who have read my previous articles in this series, particularly the second article which referred to section CB 12, you will immediately note that while sections CB 12 and CB 13 both deal with the development and/or division of land into lots, there are two key differences between these two taxing provisions.

The first key difference surrounds the level of work required in the particular undertaking or scheme to trigger potential application of the taxing provision. Section CB 12 simply requires that the work involved in the undertaking or scheme is ‘more than minor’, a phrase in relation to which the Revenue have recently provided some safe-harbour guidance thresholds for taxpayers (absolute cost <$50k and/or absolute cost <5% of commencement date market value of the land). Section CB 13 however requires that ‘significant expenditure’ of the type usually seen in major commercial, industrial or residential land development projects is involved.

Lesson number one – therefore if your project does not involve ‘significant expenditure’ of the type usually seen in major commercial, industrial or residential land development projects, then you are unlikely to be subject to taxation via the application of section CB 13.

Now what is similar between the minor (CB 12) and major (CB 13) land development and/or division of land taxing provisions, is the uncertainty created by the need for the taxpayer and/or their advisor, to attempt to interpret the meaning of the wording used in the relevant taxing provision, in the latter case, what is ‘significant expenditure’?

Useful in this regard, although certainly not as helpful as IS 20/08 which has provided some safe-harbour thresholds, is the Revenue’s 2015 guidance document QB 15/02. The narrative of QB 15/02, has as its purpose, answering the questions of ‘what expenditure should be considered?’ when interpreting section CB 13, and then ‘what is significant expenditure?’.

In answering the first question, the Revenue’s view is that:

  • Both physical and non-physical development work should be included in the analysis, however non-development expenditure should not. So, any expenditure incurred in preparing the land for its intended use is considered development expenditure, whereas that expenditure either related to dividing the land into lots or in making improvements to the land once it is ready for its intended use (so erecting buildings) is not.
  • Only that expenditure actually incurred at the time there is a disposal of any of the land in question should be considered. So, there is no deemed imputed cost relating to either the value of the taxpayers’ time spent on the project, nor that related to the use of their own machinery. What is interesting here is the Commissioner’s view, that it is possible to sell some sections in the project early on free from taxation under section CB 13, due to the fact that the ‘significant expenditure’ threshold may not yet have been crossed at the time of those disposals.

And in relation to the second question, QB 15/02 suggests:

  • You need to consider the absolute expenditure – note that of the three examples provided in QB 15/02, one example is suggestive that absolute development expenditure of $60,000 was considered ‘significant’.
  • You need to consider the relativity of the absolute development expenditure against both the pre and post development value of the land. In this regard, I would suggest any calculation results above 5% should put you on notice, and any above 10% you should be nervous.
  • Each case needs to be judged on its own merits, and even in cases where both the absolute cost and relative value assessments are indicative of a ‘significant expenditure’ conclusion, the context of the project could actually lead to a different conclusion. For example, one of the three scenarios provided in QB 15/02 involved a one lot subdivision into two, where the expenditure incurred was considered to be ‘significant’ in both the absolute and relative value assessments. However, putting the project into its context, a one lot into two lots undertaking was not considered to be ‘major project’ – a legislative requisite of any section CB 13 application.

The second key difference between sections CB 12 and CB 13, is that a section CB 13 application is not time limited – it can apply to any project commenced that satisfies the requirements of the taxing provision, regardless of how long the land has been owned by the taxpayer. This is unlike section CB 12, which only has application to projects commenced within ten years of the land being acquired.

Lesson number two – since the ‘minor work’ threshold which will trigger the potential application of section CB 12 is very low, and since in the legislative pecking order section CB 13 only has potential application if section CB 12 does not, you are likely to only need to consider the potential application of section CB 13, where at the time you commence the project, you have owned the land in question for more than ten years.

Ok, so let’s move on to the scenario where you’ve potentially triggered the application of section CB 13, due to having incurred the requisite ‘significant expenditure’ in the context of a ‘major project’.

Can you claim an exclusion?

In this regard, section CB 12 and section CB 13 again join hands, with the fact that their legislative exclusions are identical – being the residential exclusion, the business premises exclusion, the farmland exclusion and the investment income exclusion.

At this time, as I did with my second article in this series, I do not propose to go into any great detail on each of the exclusions, as their application is very much case specific. Instead, I will simply restate the key comments that I made in my earlier article:

  • Unless you own the land in your own names, the residential land exclusion cannot be claimed by you – so family trust ownership is out. However, if you do own the land personally and you have occupied the land as your personal residence immediately prior to undertaking a subdivision project, and the original land area is less than 4,500sqm, 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 a 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 13 application. However, due care must be taken in this regard, particularly if the land was already being rented prior to subdivision

Finally, if all else has failed and you have reached the point that section CB 13 will apply to your disposal, a somewhat favourable difference from section CB 12 this time, is that your cost base for calculating the disposal gain that is subject to tax, is based on the market value of the relevant land at the time of commencement of your project. Consequently, you, in essence, get to keep any appreciation in the value of the land, between the date it was originally acquired, and the date you commenced your taxable project. Section CB 12 uses the original cost of the land for the purpose of calculating your taxable gain.

Lesson number three – obtain a market value assessment of your land prior to commencing your project. It removes the stress of needing to find a valuer who is prepared to perform a back-dated valuation when you eventually determine that your project will be subject to taxation under section CB 13, plus it will also be beneficial for the purpose of performing your relative value assessment calculations, additionally so if you also request a post completion valuation at the same time.

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.

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