Inland Revenue’s land sales guidance needs clarification

The article is relevant to members in New Zealand and was current at the time of publication.

New Zealand’s Inland Revenue (IR) has released a draft Interpretation Statement that signals a notable shift in how profit making undertakings or schemes involving land disposals may be treated for income tax purposes.

A key part of IR’s updated reasoning concerns the relationship between section CB 3 of the Income Tax Act 2007 and the tax provisions contained in sections CB 12 and CB 13.

These sections do not require a dominant profit making intention and apply only to development or division work, not to building activity.

IR’s draft Interpretation Statement states that the application of income tax under CB 3 remains fully applicable to land transactions, including residential subdivisions, even where the specific land taxing provisions under CB 12 and CB 13 do not apply.

Undertakings designed for profit

Under the specific requirements for CB 3, IR notes that the disposal of land must be deemed to be part of an undertaking or scheme where there is a plan, design or programme of action devised to attain an end result.

“The focus is on the taxpayer’s subjective purpose at the start of the undertaking or scheme,” IR states. “But this is assessed objectively based on the facts.

“The key consideration is whether the taxpayer is merely disposing of the asset in a way that maximises returns or makes it more attractive to buyers, or whether something new is created or the character of the asset is changed significantly.”

IR states that in the context of land, an undertaking or scheme will likely go beyond mere realisation if it involves extensive subdivision with infrastructure, building new dwellings, or significant transformation of the property’s character, such as extensions to a dwelling.

Greater clarity required

In a submission lodged with IR in August, CPA Australia notes: “While the draft provides useful conceptual guidance, we are concerned that applying section CB 3 as a residual taxing provision may undermine the certainty intended by the specific land-taxing rules and their statutory exclusions.

“In particular, greater clarity is needed on the boundary between mere realisation and a profit-making undertaking or scheme, the interaction with the bright-line test, and the evidentiary requirements for identifying when a scheme commences.

“Section CB 3 should not operate as a residual or default taxing provision where a land transaction is not captured by the specific land-taxing rules. The finalised interpretation statement should make clear that section CB 3 requires a distinct factual and legal basis.”

The bright-line test under section CB 6A is a separate rule from CB 3, which taxes gains from the sale of residential investment property if it is sold within a set period after purchase, even if the owner did not originally buy it with a clear profit-making purpose.

The bright-line period has shifted over time – from two years to five years, then 10 years, and now back to two years – which has contributed to uncertainty for taxpayers and advisers.

Confusion for taxpayers and advisers

CPA Australia’s Regulations and Standards Lead, Belinda Zohrab, says IR’s position is guidance, not law, and should more effectively reflect the certainty intended by the specific land provisions and their statutory exclusions, particularly for long-held residential land, business premises and farmland.

“Many New Zealanders own investment properties, inherited land, farmland or subdividable land, and without clear guidance, they may be confused or exposed to penalties despite trying to comply,” she says.

“New Zealand’s lack of a comprehensive capital gains tax regime creates complexity. Because New Zealand relies on a patchwork of specific land rules and broader provisions like CB 3, clearer guidance is needed to help ordinary people and advisers understand where they stand.”

Zohrab says IR’s finalised Interpretation Statement should provide more practical commentary on the distinction between mere realisation of a capital asset and a profit-making undertaking or scheme, supported by realistic taxable and non-taxable examples.

The onus on taxpayers

Richard Ashby CPA, Tax Partner at accounting firm Gilligan Shepherd, says that in the case of a residential land subdivision, one of his concerns is that IR employees may over-focus on the fact that a profit was made, even though most rational people would only undertake a subdivision if it were expected to be profitable.

He is also concerned that IR may apply thresholds too rigidly, such as treating the NZ$50,000 subdivision cost threshold published in IS 20/08 as determinative, even though official guidance says it is only a guide.

Ashby agrees that the law should be clarified through legislation, for example, by stating whether CB 3 does or does not apply to land.

“If Inland Revenue releases the interpretation statement, CB 3 may be raised in many more land tax disputes as a fallback argument,” he says.

“Once Inland Revenue takes a position, the onus shifts to the taxpayer to prove it wrong, which can take years and cost significant amounts, often making disputes impractical for ordinary taxpayers.”