Tax Updates: 19 August 2024

Welcome to this week’s review of tax issues where Richard comments on what’s been happening in the world of tax over the past week. If you have a question or would like a second opinion on any national or international tax issues, please contact Richard via email at [email protected].

Look-through companies and bright-line IS

Inland Revenue (IR) has issued a draft interpretation statement titled ‘Look-through companies and disposal of residential land under the bright-line test.’ It is a 50-page document and is referenced PUB00455.

The Interpretation Statement (IS) covers 5 specific scenarios, which involve Look-through companies (LTC) and residential land, and endeavours to explain how the bright-line rules (including the main home exclusion and rollover relief) apply in the various situations. Notably, the IS only applies to transfers of residential land on or after 1^st July 2024 – the date on which the bright-line period was reduced to 2 years, and the roll-over relief provisions were expanded.

Each scenario discusses whether there is a disposal of land, whether the main home exclusion could apply, and the potential taxing outcomes where roll-over relief either does or does not have application.

The 5 scenarios are:

• Where a person transfers residential land to an LTC;

• Where an LTC transfers residential land to the LTC owners;

• Where a company that owns residential land becomes an LTC;

• Where a company that owns residential land ceases to be an LTC; and,

• Where a person disposes of some or all of their owner’s interests in an LTC that owns residential land.

Of the above 5 scenarios, only in the 3^rd does the IS consider that there is no disposal of residential land, with the consequence that neither the main home exclusion (at the time of commencement of LTC status at least) nor the roll-over relief provisions require further consideration.

Pages 6 to 8 of the IS contain a quick table form summary of the tax treatment for all 5 scenarios, which is also included in a 7-page fact sheet that accompanies the IS. The remainder of the IS is then dedicated to explaining each of the 5 scenarios in more detail.

Within the draft IS, the topic of most interest to me, was the discussion on the new roll-over relief provisions, which are now contained in section FD 1 of the Income Tax Act 2007 (ITA07). Roll-over relief can apply in two situations:

• If residential land is transferred within the bright-line period between persons associated under any of sections (ss) YB 2 to YB 13 at the date of transfer and for at least two years before that date; or,

• If residential land is transferred within the bright-line period, to a trustee of a trust in which all beneficiaries, other than the transferor in their capacity as a beneficiary, are associated with the transferor at the date of transfer and for at least 2 years before that date (with a couple of exceptions) or the beneficiary is a charity (or similar).

Now at first glance (well to me anyway), the relief provision appears as if it only applies to transfers of residential land that occur within 2 years of the transferor’s acquisition date, because you (well me at least) automatically think of the reference to the bright-line period as being the 2-year period, which triggers a taxable event in accordance with section CB 6A. However, the bright-line period is, in fact, an undefined period. It commences on the bright-line start date (often, but not always, the date of title transfer being registered in the transferee’s name) and ends on the bright-line end date (usually the date a binding agreement to sell the land is entered into by the transferor).

So land that the transferor has owned for 20 years, simply has a bright-line period of 20 years. And, consequently, a transfer of the residential land to any associated person of the transferor at the end of the 20-year period, will qualify for roll-over relief (so no reset of the bright-line clock). Provided the association has existed for the requisite 2-year period pre-transfer. It is only where the bright-line period is less than 2 years, that section CB 6A potentially jumps in, to tax the disposal.

Some important takeaways from the draft IS then:

• Roll-over relief can only apply where the association at the time of transfer has existed for at least 2 years. So establishing a new LTC to own your residential land which you have personally owned for only 6 months, will not qualify for roll-over relief. And, therefore, unless the residential land has been used as your main home prior to the transfer, will potentially subject you to taxation under section CB 6A;

• When a company that owns residential land ceases to be an LTC, take note that the bright-line clock will restart at the date of cessation of LTC status;

• When an LTC owner disposes of their interest in the LTC, the first consideration is the safe harbour rule contained in section HB 5(1) – made less than $50k gain (gross tax value of assets minus liabilities). Only if the safe harbour rule does not apply, do you then need to consider both roll-over relief (transferee has been associated to the transferor for at least two years) or the main home exclusion; and,

• Do not overlook the anti-avoidance rule contained within section GC 1. Land that is subject to taxation under the land taxing provisions (CB 6 to CB 15), is defined as ‘trading stock’ for the purposes of section GC 1. And, consequently, a market value is imputed for the transfer consideration, if the transferor/transferee are associated and have used a less-than market value consideration for the transfer value to perhaps mitigate the impact of taxation under the bright-line rules.

 Should you wish to make a submission on PUB00455, the closing date is 23^rd September 2024.  

This article was originally published through the ‘A Week In Review’ newsletter. If you would like to receive Richard’s tax updates every Monday morning, you can subscribe here.