Recently, in Budget 2024, Inland Revenue (IR) was allocated $116m to tackle tax debt and compliance. The latter focus areas, for at least the 2024 – 2025 financial year, will be:
- the hidden economy and organised crime;
- electronic sales suppression tools;
- GST integrity;
- student loan overseas-based borrowers; and,
- increased audit activity.
Personally, the last of these five focus areas will potentially have the greatest impact on my daily workflow, particularly if the Revenue becomes more aggressive in its approach to risk reviews. This, in turn, will result in increased referrals for more specialised tax advice from my internal business services team and the external accounting firms that often reach out to me for help.
Therefore, I thought it might be timely to share some of my recent experiences with the Revenue, which are simply a reminder that the Commissioner’s representatives are not ‘tax advisers’. While there are certainly some very good, technically sound people within the walls of IR, unfortunately, at the entrance level (perhaps some of those undertaking the initial risk review enquiries), it is sometimes a case of pushing back on comments made and not always believing what you hear.
Possibly the worst case I have experienced recently was concerning a client of ours who had acquired a home for herself and her son’s family in East Auckland. With a growing family (the approaching arrival of a new baby), Mum decided to undertake a project of extending the dwelling either upwards or outwards. During the initial consultation phase, however, Mum was informed that the existing dwelling had a number of structural issues, and the better plan would be to demolish the existing house and start again. In this regard, the architect recommended that the land could, in fact, be divided into two, with two new dwellings constructed: one to be occupied as the new, larger family home, while the second could be retained as a residential investment property, or sold to assist in the finance of the new family home. Our client decided on the latter option and sold the front lot once the development was completed.
To set the scene…
There is a taxing provision which states that any person who commences a subdivision scheme within ten years of acquiring their land is subject to taxation on the disposal of any of that land, where the work involved in undertaking the scheme is more than minor. Clearly, demolishing an existing structure on the land exceeds the ‘more than minor’ threshold.
However, even if the taxing provision is triggered, there is a legislative exclusion that states if you occupy the land as your personal residence before undertaking the subdivision scheme, the subsequent disposal of any of the subdivided land is not taxed under this specific taxing provision (provided the original area of land did not exceed 4,500sqm). Eventually, our client received a risk review letter of a ‘please explain’ nature. Her income tax return relating to the year of disposal of the newly developed lot had been checked, and the Revenue wanted to know why no income had been returned from a sale of land.
Whenever I advise my clients, which is more often than not (hopefully!) before a subdivision project has commenced, their number one question is always, ‘What are the chances of the Revenue reviewing my tax return?’. My usual response is that it is a roll of the dice, dramatically increased now from the days of old due to the size of their property compliance team. Regardless, however, 99% of the time, the first contact is a ‘please explain’ letter, and drafting that initial response is critical in this regard. Say slightly the wrong thing, and the first impressions created can be very difficult to change later on!
So, my internal team referred the ‘please explain’ letter to me, appreciating the need to dampen the Revenue’s ‘spark’ and eliminate any chance of flames taking hold. I proceeded to carefully craft a response letter, acknowledging that, yes, our client had triggered the specific taxing provision. Still, the specific exclusion then covered her, which was why no income had been declared in the income tax return. Feeling good about myself and the masterpiece I had created to snub out all possible sparks, I was somewhat surprised to receive a response—and not one that thanked me for my masterpiece and advised me that the file was now closed.
Reading through the response, a feeling of doom came over me, and I knew that we were in trouble.
The response from the Commissioner’s representative said that we could not claim the legislative exclusion because Mum had never lived in the brand-new house as her personal residence before it was sold. Now, while I consider myself well-versed in reading and applying income tax legislation, I’d respectfully suggest that even my 10-year-old son could read the exclusion wording and note that there is no reference to any requirement to occupy the new dwelling at any time. What it does say is, ‘The land is a lot that came out of a larger area of land that the person divided into two or more lots, and the larger area of land was 4,500 square metres or less immediately before it was divided and was occupied mainly as residential land for the person.’ So, do reach out to me if you feel I’m being a little unkind. However, I think the wording leaves little doubt that you simply had to occupy the land as your personal residence before it was subdivided.
Anyway, I quickly wrote back with my second masterpiece, this time expecting a short response containing a brief apology for the misinterpretation and confirmation that the file had now been closed. Without boring you further with all the details, it took another six months of correspondence before the legal team finally agreed with my assertions on the residential exclusion available to my client. However, by that stage, a bushfire was raging, and numerous other potential taxing provisions were now being thrown at my client, including that she should have paid GST on the one-off sale. Ultimately, it took nearly four years before the Revenue’s Tax Counsel Office (an ‘independent’ arm of the Revenue) finally ruled in my client’s favour on all counts. How different things may have been had the Commissioner’s representative correctly interpreted the legislative exclusion and had agreed with my conclusion at the outset.
Claiming GST
More recently, a client of mine purchased a farm in coastal Auckland. The farm was in a run-down state, and since the vendor was not GST registered, my client made a second-hand goods GST claim in relation to the total purchase price. The land contained a farmhouse and secondary accommodation facilities (a converted stable), but both were empty at the time of sale. Not surprisingly, we received a GST risk review letter with all the standard questions. Having decided it was a relatively straightforward scenario, my client decided to interact directly with the Commissioner’s representative (although she asked for my input on a few more tricky questions).
I then received a call from my client. She had been told that the GST refund would not be released until an adjustment had been made to the claim to account for the portion of land occupied by the farmhouse. I helped her draft an appropriate email response, but to no avail – the Commissioner’s representative was insistent. So, I jumped on the phone and had a 40-minute call with the reviewer, but I could not convince him that no adjustment was required. He argued that as a farmhouse existed, an adjustment was required. I responded that his view was incorrect (I was very respectful in my approach); the legislative reference requiring an adjustment was to a ‘dwelling’, which the farmhouse was not at the time of purchase. I tried to tell him that conceptually, there was no difference between an empty farmhouse and an empty barn – both structures on the land not being used for their intended purposes, but equally, neither being used for private or exempt purposes, which would trigger the adjustment requirement. Somewhat frustratingly to me (as this was the coalface of the Revenue, after all), he could not get his head around the concept, admitted that the issue was above his paygrade and that he would have to refer to the property compliance team. Within two days, I received a message from the property compliance team that they completely agreed with my view and that the full GST refund had been released.
Always remember…
As I said at the commencement of my article, there are some very good people at the Revenue, and the purpose of this article is not to undertake a witch-hunt of the not-so-good. I only wish to demonstrate the need not to take everything you hear from the Commissioner’s representatives as gospel. It certainly pays to push back if you feel uneasy about what you are being told. And while they may be seen as being ‘free’, never use the Revenue to obtain any tax advice – it could eventually cost you so much more.
Finally, a plug from me. If you would actually like some specialist tax advice, please do not hesitate to reach out.
