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Disposal of Land – to be taxed or not to be taxed? Part six
This final 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 the associated persons’ rules to those taxing provisions.
However, this article will be somewhat different to those that have come before, because, firstly I will not just be focusing on a single taxing provision, and secondly, not only will the narrative apply to “non-business” landowners but equally to those who may be carrying on a business of land dealing, land development and/or subdivision, or of erecting buildings.
As a starting point, I would suggest that the associated persons provisions could be viewed from three different perspectives:
- Those scenarios where the relevant land taxing provision itself actually refers to associated persons – sections CB 7, CB 8, CB 9, CB 10 and CB 11;
- The anti-avoidance provision contained within section CB 15(1); and,
- What I’d like to call the “ownership concession” contained within section CB 15(2).
So how do the associated persons’ provisions work?
Well, firstly, you will not find the associated person’s definitions within the land taxing provisions themselves. Instead, they have their own little cubbyhole in the legislation, contained within subpart YB of the Act. And then once you have located them there, you will note that sections YB 1 to YB 14 contain the general associated persons definitions, which have application more globally throughout the income tax legislation, with certain individual provisions then narrowing their application when considering land transactions – for example, section YB 9 which deems a settlor of a trust and a beneficiary of the same trust to be associated persons, does not apply for the purposes of the land provisions (s.YB 9(2)).
Lesson number one – even with these legislative carve-outs, which narrow the definition of associated persons somewhat when you are considering the land taxing provisions, a word of warning that their reach is still very wide, and it is therefore quite tricky (but not impossible) to structure legitimately in order to prevent their application.
As I alluded to earlier, the first perspective of the application of the associated persons’ rules is where they are referenced within the taxing provision itself. People often refer to this as “tainting”, and the majority of the aforementioned taxing provisions, in respect of this perspective, are targeted towards persons who have an association with someone else (in the wider sense, including other individuals, partnerships, trusts and companies) who at the time the person acquired the land, was carrying on a business of land dealing, land development and/or subdivision, or of erecting buildings (although in the case of erecting buildings, the timing issue is somewhat different) – let’s refer to them as a “tainted person”.
Lesson number two – if you are deemed to be associated with a tainted person, then usually there will be a 10-year timeframe (date of acquisition to date of disposal), where if you dispose of your land within this period, your disposal gain will be subject to income tax, regardless of your original intention when you bought the land. This will be unless a legislative exclusion applies.
The second perspective of the associated person’s rules when considering their application to land transactions, is what I will refer to as the avoidance provision, which is contained within section CB 15(1).
Section CB 15(1) applies whenever there has been a transfer of land between associated persons, and I would suggest that the easiest way to appreciate how it works when the associated purchaser subsequently sells the land is to ask the question – if the transfer between the associated persons had never occurred and therefore it was the associated seller who was now disposing of the land and not the associated purchaser, would that associated seller have been subject to taxation on the disposal gain, via application of any of the land tax provisions? If the answer to your question is yes, your associated purchaser is also subject to taxation on their disposal gain.
So, take the simple example of a person who wholly owns a development company and is also the settlor of their family trust – the development company and the family trust would be deemed to be associated persons under the associated person rules. The development company bought a piece of land for the purpose of its business (so taxable whenever disposed of). Still, the person thinks the completed product would now actually be a good long-term rental property investment. The person wants to transfer the land out of the development company to crystalise both the income tax and GST liabilities and consequently arrange for the land to be transferred to the family trust for market value.
Twelve years later, the person experiences financial difficulties, and consequently, the family trust sells the rental property to free up cash. Under this scenario, while the GST exposures were certainly crystalised at the time of the historic associated person transfer, the person still needs to consider the potential application of section CB 15(1). In this regard, clearly if the development company still owned the land and was undertaking the disposal now, section CB 7 would have application to tax the disposal gain, since the land was originally acquired for the purpose of the development business. Consequently, section CB 15(1) will now require the family trust to account for income tax on its disposal gain.
Lesson number three – if you are subject to tax via application of section CB 15(1), because you are being taxed under this anti-avoidance section instead of the relevant land tax provision itself (section CB 7 in the above example), there are no legislative exclusions available to you – so neither section CB 16 nor section CB 19 in the case of a section CB 7 application will provide you with a get out of jail free card when you are subject to paying income tax due to section CB 15(1).
Lesson number four – section CB 15(1) does not have a daisy chain effect, however. So, the vendor transfers land to associated purchaser one, who transfers to associated purchaser two – associated purchaser two, when disposing the land, needs to consider its own exposures to the land tax provisions in the first instance (CB 6 – intention of disposal or CB 6A – bright-line for example), and then subsequently whether section CB 15(1) might apply due to associated purchaser one’s disposal status. So, in the above example, the family trust would not be taxed directly under the land tax provisions (instead only due to the avoidance provision application), so section CB 15(1) would not be of application to associated person two.
The final perspective of the potential application of the associated person rules to land transactions is what I referred to earlier as the ownership concession, which is contained in section CB 15(2). The application of this provision has certainly saved a number of clients’ bacon over the years and is always up for consideration where my client has done something within what I will refer to as the “trigger period” – common examples being where they have commenced a minor subdivision within ten years of the date of acquiring the land, or their land had a zoning change which increased its value by more than 20%, and they’ve sold the land within ten years of acquiring it.
In both above scenarios (ignoring any legislative exclusions that may be available), the client is potentially going to now be taxed on their disposal gain. However, if my client has bought the land from an associated person when considering the trigger period, my client is permitted to also take into account the ownership period of the associated vendor.
In one real-life scenario I had, my client’s investment company (with which he was associated) had commenced a subdivision of land within the 10-year trigger period (5 years post-acquisition date). The land had, however, been acquired from a family trust which had been settled by his father, of which my client was a beneficiary. Now initially my client was not deemed to be associated with the family trust (under the more narrower application of the associated person rules to the land tax provisions), however upon the death of his father (which had occurred not long before the land was transferred to the investment company), my client had been given the trust powers of appointment – which then had the consequence that the trust and the investment company were now deemed to be associated persons. Since the family trust had owned the land for some 20 years, and because the family trust and the investment company were associated at the time of transfer, the investment company was deemed to have owned the land for 25 years (instead of 5) and consequently section CB 12 was no longer of application.
Lesson number five – as for section CB 15(1), section CB 15(2) does not work on a daisy chain basis, so you only obtain the ownership period concession of the associated vendor and not any associated vendor of that person.
Final lesson for today – it has been a trap for many unsuspecting residential landowner that section CB 15(2) does not have an application to the bright-line rules, and this is certainly still the case – it only applies for the purpose of sections CB 7 to CB 12 and CB 14. So if an individual owned residential land (that was not their main home) and decided to transfer that land to their family trust that they had just settled for future asset protection reasons, not only were they potentially subject to bright-line taxation if that land had been owned for less than 5 years, but the family trust would also obtain no ownership concession for the period of time the person had already owned the land, and consequently the bright-line clock would restart for the family trust. Thankfully however, the Government acknowledged this inequity of the bright-line rules with the other land tax provisions where associated person ownership is recognised, and legislated for specific so-called roll-over relief provisions to be inserted directly within the bright-line provisions themselves (new sections CB 6AB, CB 6AC and CB 6AE), which dictate the bright-line acquisition date for the residential land for the transferee, when certain conditions are satisfied. These new provisions apply to transfers of residential land occurring post 1st April 2022.
Well, that’s it in this series, I hope you enjoyed the articles, 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.