Even though recommended by the Tax Working Group (TWG) in 2019, the political polls at the time saw a complete about-turn by the Labour Government (having previously stated it would act on the TWG recommendations), which had the resultant consequence that New Zealand still does not have a capital gains tax when it comes to a disposal of land that was acquired for investment purposes.
That being said however, there are still a number of ways in which a person who does not carry on a business of dealing in land (land dealer, land developer / subdivider, builder), can still be subjected to an income tax imposition upon the disposal of that land.
This is due to the inclusion of specific rules relating to the taxation of land transactions, included within subpart CB of the Income Tax Act 2007 (“the Act”). In effect, there are 10 main taxing sections, closely followed by several exclusion provisions, whose criteria which if satisfied, will negate the otherwise taxation of the disposal gain.
There is also a ‘pecking order’ in terms of the various taxing provisions, some only having potential application, if others do not.
This article will be the first in a series, where I will endeavour to provide a high level overview of when the various legislative provisions can be triggered, and some traps to be aware of with respect to both the taxing provisions themselves, and the potential available exclusions.
The bright-line rules
To commence the discussion therefore, it is acknowledged that in recent years, all the talk has been surrounding the bright-line rules – acquire a piece of residential land, dispose of it within five years, and unless you can show it was your main home, then pay tax on any disposal gain. At the time of its introduction, bright-line was promoted by the Government, as a tool to deal with property speculators, whose consistent buying and selling behaviours, were having a detrimental effect on Auckland housing prices. Some like myself however, would suggest that the introduction of the bright-line rule was a political overreaction, to a problem that in my mind was one of the age old economic concept of supply versus demand (we just didn’t have enough houses available to satisfy demand), as opposed to having anything to do with so called ‘speculators’.
I base my simple view of the world, on the fact that in reality, Inland Revenue have always had the ability (well for my tax lifetime at least) to assess any disposal of land for tax, where the land in question was deemed to have been acquired for a purpose or with an intention of disposal. In this regard, a disposal intention or purpose did not even have to be the taxpayers’ primary acquisition intention or purpose, it simply had to be one purpose or intention of acquiring the land at the time.
While the onus of proof rested with the taxpayer in terms of substantiating what their subjective mindset was at the date of acquisition, surprisingly it almost appeared to be in ‘the too hard basket’ for Inland Revenue to pursue the taxpayer, unless there was clear evidence of the requisite disposal intention or purpose. Now admittedly, back in the day when I commenced advising on land tax issues, the land transfer register was not electronic, which often meant that you really were unlucky if your land disposal was actually identified and then progressed to any sort of review by Inland Revenue.
So, in essence, the bright-line rule introduction simplified life for the Inland Revenue dramatically – sell within the five year timeframe – pay tax – black and white. More on bright-line later however in a subsequent article, because in terms of pecking order, the bright-line rule only comes into play when a number of other taxing provisions do not have application.
Original intention or purpose
The starting point in the pecking order in my view, and the focus for the remainder of this article, is the intention or purpose of disposal provision, because if this legislative test is satisfied, the land in question is effectively within the taxing net whenever sold, regardless of what happens next with the land, and any subsequent changes in the taxpayers original intention or purpose.
In this regard however, a key element to understand with the intention or purpose of disposal provision, is that it is the taxpayers intention or purpose on a single day, that will ultimately determine the taxing outcome for the land in question. This is because the Courts have interpreted the meaning of the wording used in the legislation, to be the intention or purpose of the taxpayer on the date the land was acquired, which itself has been deemed in most cases, to be the date upon which the relevant parties have entered into a binding sale and purchase agreement.
Consequently, if the taxpayer intended to subsequently dispose of the land on the day they signed the sale and purchase agreement, but then changed their mind a week later to now hold the land long-term, the land is effectively still ‘tainted’ by the acquisition date intention and will still be taxable upon disposal, whenever that may be. Equally however, if the taxpayer acquired the land with a long-term investment purpose in mind, and a month later received an unsolicited offer from someone who wanted to buy the land which was simply too good to refuse, arguably they should not be subject to tax on any gain arising upon the unintended sale, under the intention or purpose of disposal taxing provision. I say ‘arguably’, because one should still expect some fairly pointed questions from the Revenue due to the quick turnaround in ownership by the taxpayer, and naturally with the onus of proof on the taxpayer to rebut any taxable assertion by Inland Revenue, sufficient evidence will need to be retained to show that the offer was indeed unsolicited as claimed.
While an acquisition intention or purpose of disposal will effectively taint the land forever, it may however not taint all of the land in question. This position was recently espoused by Inland Revenue in its QB 16/06, which is titled ‘Income Tax – Land Acquired With A Purpose Or With An Intention Of Disposal’.
In this regard, one question raised during the QB 16/06 commentary, was ‘What if I buy some land intending to subdivide it and sell some and keep some?’
Inland Revenue’s response was – ‘If you acquire land intending to sell some and keep some, you will only be taxed on the disposal of the part you acquired to sell. You would need to have satisfactory evidence to show how much of the land or what part of the land you did not acquire for a purpose or with an intention of disposal.’
Two available exclusions
Finally, if you do find yourself in a position that you may have triggered the taxing provision due to clear evidence of an acquisition intention or purpose of disposal for the land, the next question is whether or not one of the legislative exclusions may be available to you, to negate otherwise taxation of the disposal gain. There are two available exclusions in this regard, one related to residential land, the other to land used for business premises of the taxpayer.
With respect to the latter, I personally have seen little use of the exclusion in relation to the intention or purpose of disposal taxing provision, as it requires that the taxpayer has used the land as their business premises, which itself has been shown to require an active trading business activity to be carried on from the land. It is not sufficient therefore to simply lease the land to another party who then operates their business activity from the land. It is also not available to a person who may consider that they are carrying on a business of renting from the land, due perhaps to a number of residential dwellings that exist upon the land and the taxpayers level of involvement in the rental activity satisfying a ‘business test’ analysis. The residential dwellings in this regard, are not considered ‘business premises’ of the taxpayer.
The residential land exclusion on the other hand, is widely used. It can be claimed where the taxpayer acquires the land, and then resides upon the land as their personal residence in a dwelling on the land (either acquired with the land or subsequently erected). The exclusion extends to both natural person owners and land owned by trusts. It is however limited in its scope usually to land that has an area of less than 4,500 square metres, although there is discretion provided for larger areas of land which can be shown to be required for the reasonable occupation and enjoyment of the family home.
Naturally to ensure the rules are not abused by the taxpayer simply residing on the land each time to claim the exclusion where there is in fact an ulterior motive in play (renovation projects for resale for example), there is a limitation to claiming the exclusion where the taxpayer has exhibited a regular pattern of acquiring and disposing of residential dwellings. In this regard, Inland Revenue has also espoused a view, that three prior transactions would usually negate the claiming of the exclusion for the fourth transaction.
Two final comments
Firstly, while the bright-line rules will now in essence capture any disposal of residential land within five years of acquisition date, the original intention and purpose of disposal taxing provision should not be forgotten about, as it could still come into play when the particular disposal is post five years of ownership.
Secondly, proposals are underway to widen the exclusion limitation for a ‘regular pattern’, from a present single taxpayer, to a group of persons test. This extension of the test is to limit the existing potential to structure ownership of the land slightly different each time, to avoid the application of the limitation.
Should you wish to discuss any of the content of this article further, please get in touch.