Consultation on the land development and subdivision provisions
Tax Alert - February 2015
By Phil Stevenson and Aran Bailey
Late last year, Inland Revenue released two exposure drafts relating to land subdivisions and developments. These were
- QWB0100: Income Tax – Major development or division – what is ‘significant expenditure’ for section CB 13 purposes, and
- QWB0040: Income Tax – Whether it is possible that the disposal of land that is part of an undertaking or scheme involving development or division will not give rise to income, even if no exclusion applies
What is significant expenditure for major subdivisions?
The draft statement QWB0100 provides some much needed guidance on what type and what level of expenditure could trigger the land taxing provision applying for major subdivisions, section CB 13 of the Income Tax Act 2007 (“the Act”).
Section CB 13 applies in circumstances where the disposal of land is not otherwise taxable under the Act, and there is an undertaking or scheme involving development or division of land where the work “involves significant expenditure on channelling, contouring, drainage, earthworks, kerbing, levelling, roading or any other amenity, services or work customarily undertaken” in major projects involving the development of land (emphasis added).
The primary conclusion in the exposure draft is that the relevant expenditure relating to “any other amenity, service, or work customarily undertaken or provided in major projects” should be interpreted in a limited manner so that only physical development work is included. Expenditure that relates only to division activities (rather than physical development) is not relevant for assessing whether the level of expenditure is significant expenditure for the purposes of section CB 13. An example of this type of expenditure is surveying costs relating to the division (preparation and deposit of plans) as opposed to surveying for the development of the land.
Some other useful conclusions reached by the Department in the exposure draft include:
- Whether expenditure on the undertaking or scheme is significant will be a matter of fact and degree in the circumstances of any given case. The relevant factors listed in the draft are the amount of the expenditure in absolute terms, the amount of the expenditure relative to the pre and post development value of the land, and the context of the project.
- Proceeds from a disposal of land in a major subdivision will only become taxable under section CB 13 once there has been significant expenditure incurred. This will have relevance in situations where a development project is undertaken in a staged manner (i.e. where some lots are able to be divided and sold off prior to the significant expenditure on earthworks occurring).
- Confirmation that section CB 13 is intended to only cover major, large scale, subdivision projects. It is possible to incur significant expenditure, in both absolute and relative terms, and not trigger the provision. An example of this could be where major retaining and drainage work is required due to the technical difficulty of the work or unique circumstances of a particular development. However, where the number of lots in the project is limited, the proceeds from the sale of land should not be taxable under section CB 13 of the Act.
- The use of a person’s time, effort and their own machinery does not need to be taken into account in assessing the level of expenditure for the purposes of section CB 13.
The statement attempts to provide some guidance on the level of expenditure that could trigger the application of section CB 13. However, as is common with examples provided by Inland Revenue, the factual situations presented in the example lead to answers that are clearly on one side or the other. Usually when practitioners are advising on these situations the facts are not as “neat” as those presented in the limited examples, resulting in more border line positions. To complicate matters even more there is limited guidance available for advisors and taxpayers from court decisions.
Section CB 12 of the Act applies to schemes at the other end of the subdivision scale, being those commenced within 10 years of acquiring the land where the work is work that is more than minor in nature.
All of the cases that have been decided by the courts in relation to the predecessors to sections CB 12 or CB 13 are at least 20 to 30 years old and the minimum resource consent standards and requirements have changed significantly over this time. In order to get any value from these cases and try to pin-point the relevant expenditure boundary it is necessary to adjust the amounts incurred in those cases into present day dollars and apply some judgement over the complexity of the development or division work completed.
What would be of greater assistance to taxpayers in determining their liabilities, rather than the limited examples presented in the exposure draft, is for the (appropriately redacted) decisions of Inland Revenue’s Disputes Review (previously Adjudication) Unit to be made available to the public and/or tax agents.
In disputes with Inland Revenue relating to subdivisions, it is common for taxpayers to have strong arguments but be unable to fully test those arguments due to the costs of proceeding with a dispute compared to the potential tax payable. Where a dispute does make it to the adjudication phase of the disputes process the outcome is not made available to other taxpayers to help them assess their own tax positions.
It would not be difficult to remove any identifying comments from the Disputes Review Unit’s decisions and make these available whilst still protecting individual taxpayer’s privacy. Any internal costs for the Department would be outweighed by the benefits to taxpayers generally from the greater transparency.
Is it possible that the disposal of land that is part of an undertaking or scheme involving development or division will not give rise to income, even if no exclusion applies?
QWB0040 is a re-released draft of an earlier draft item issued by the Department in 2012. The Department is seeking further consultation given the length of time since the original draft item and because the Commissioner’s analysis has changed slightly.
The situations where this statement will be relevant are where a division or development is carried on and the disposal of land would be taxable under section CB 12 or CB 13 of the Act. For example, a block of land is purchased and immediately divided into four lots with two lots being sold and two lots being retained for the taxpayer’s own use.
Where the retained lots are subsequently sold it is necessary to determine if the sale proceeds will be taxable. The lot is part of an undertaking or scheme of division, commenced within 10 years of acquiring it. Assuming the work was more than work of a minor nature the disposal proceeds would prima facie be taxable. In practice, there are a number of residential, investment, farming and business exclusions that are often available where land is retained. However, there are often situations where these exclusions cannot be applied.
The exposure draft concludes that where part of the land (the lot now being disposed of) was not part of an undertaking or scheme of development or division carried on with a view to the disposal of that part of the land, the disposal proceeds will not be taxable. Inland Revenue will expect to see evidence that there was some other plan for that land and the draft provides some comments on the type of evidence they will be looking for.
This exposure draft is a vast improvement on the earlier 2012 draft item. The analysis and reasoning is more logical. In our opinion, some of the interpretations in the earlier draft “drew a long bow” and were focused on achieving a desired outcome rather than being a logical interpretation of the Act.
The conclusions reached in the current draft do however argubly strain the interpretation of the actual words in sections CB 12 and CB 13 of the Act. On the words alone, a subsequent disposal of a portion of land retained from an undertaking or scheme caught by these provisions will be taxable regardless of when the disposal takes place or what the retained land was used for (subject of course to any available exclusions). The Commissioner has sought to determine the intended scope of the original land taxing provisions for developments and divisions and, having determined that the intent was to focus only on development and division schemes where disposal of the land was in mind, the Commissioner has effectively inserted an additional requirement into sections CB 12 and CB 13 which is not present in the legislation.
The conclusion is of course taxpayer-friendly and, despite our comments above, is unlikely to draw much criticism during the consultation process. Arguably it presents a purposive interpretation of the relevant rules and could be acceptable on that basis.
There is however a need for some caution. Some of the analysis is not so beneficial for taxpayers. The Department expresses the view that it is only necessary that an undertaking or scheme be carried on to trigger section CB 12 or CB 13. It is not necessary for the undertaking or scheme to have been carried out (i.e. completed). This could lead to a situation where the sale of land forming part of an abandoned project could potentially be subject to taxation. This is the case even if no development work is actually undertaken and no ultimate division of the land occurs. The question will then be, did an undertaking or scheme commence? This is a difficult question in its own right.
February 2015 Tax Alert contents