Tax Alert November 2017


When does new building fit-out make the building sale taxable?

Tax Alert - November 2017

By Emma Marr and Brendan Ng

Building owners who undertake a re-fit of the interior of a building might be surprised to find that, in some circumstances, the whole profit made on selling the building is taxable, not just any depreciation recovered on the fit-out. 

A building owner who is in the business of erecting buildings, or associated with anyone who is, should make sure they are aware of Inland Revenue’s draft QWBA PUB00286: Can a fit-out of an existing building be “improvements” for the purposes of s CB 11? (“draft QWBA”, available here).

The short answer to the question posed by the draft QWBA is yes: if a person who fits out an existing building is in the business of erecting buildings (or is associated with such a person), and later sells that building within 10 years of completing the fit-out, they may be required to pay tax on the net proceeds of the sale.

In our view the QWBA could have been more clearly drafted to emphasise that only fit-out which becomes a fixture because it is actually permanently attached to the building would qualify as an improvement.  It may also have been helpful if the draft QWBA had discussed how section CB 11 sits alongside the depreciation regime.  Many items of building fit-out will be depreciable, and any recovery of depreciation deductions on sale would be taxable.  Presumably, Inland Revenue does not expect the proceeds of a building sale to be taxed twice, as both depreciation recovery and an improvement to land under section CB 11.

Section CB 11 of the Income Tax Act 2007 taxes the profit made on the sale of land (which includes buildings) when the land is sold within 10 years of the owner making improvements to the land, if the owner is in the business of constructing buildings, or is associated with someone who is.  If someone falls under section CB 11, the main question to consider is whether the fit-out constitutes the level of “improvements” required under that section. That is to say, the improvements must be:

  • Improvements to land;
  • That are not minor; and
  • Are made by a person erecting a building or otherwise.

These factors are commented on further below.

Improvements to land made by a person erecting a building or otherwise

There can be many improvements made to land that would trigger section CB 11, however this draft QWBA focusses specifically on building fit-outs.  As an aside, not all taxpayers would necessarily realise that land includes buildings – for legal purposes, land includes anything attached to the land, such as a building.  Therefore, building fit-out can be considered an improvement to land depending on its nature.

The draft QWBA does note that fit-out which is not permanently attached to a building would not trigger section CB 11. However this point is not overtly included in the commentary and is only drawn out by way of example. As it stands, building owners who are in the business of constructing buildings and who therefore fall under section CB 11 should evaluate and consider any fit-out work being undertaken, especially where the work involves fit-out that toes the line of being a fixture, as this may be captured by the rules.

Note that improvements may also involve the removal of something previously attached to land (such as the removal of something unsafe to enhance the value of the land), not just additions.

Improvements are not minor

The improvements to land will only be improvements so long as they are “not minor”. This will involve an assessment of the particular circumstances which will include consideration of the following four factors:

  • The importance of the improvements in relation to the physical nature and character of the land;
  • The total cost of the improvements done, in both absolute and relative terms;
  • The nature of the professional services required; and
  • The nature of the work required for the improvements (if any).

These factors are discussed in detail in Interpretation Guideline IG0010 “Work of a Minor nature”.

Taxpayers should be aware that section CB 11 applies whether or not the building in question is part of the building owner’s business of erecting buildings.  For example, the person might also hold an investment property. Generally section CB 11 has a relatively narrow application and in many cases an exemption for the sale of business premises may apply. However, section CB 11 applies to a sale within 10 years of the building fit-out, and  given many commercial leases fall within the range of 6-12 years and fit-outs generally occur with new leases (which usually involve some element of fixtures), the draft QWBA could apply reasonably often, depending on where in the lease cycle the property is disposed of.

Comments on the draft QWBA are due on 17 November 2017. If you would like to make a submission or would like more information on the draft QWBA, please contact your Deloitte advisor.

November 2017 Tax Alert
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