Market Impacts Of New Rules
Mark Withers urges new developers to seek tax advice early on developing or dividing land with profit in mind.
1 December 2021
The new tax rules around interest deductibility and the 10-year bright-line for existing stock residential purchasers, combined with revamped planning rules allowing for intensification, has investors considering their options to develop land they might already own – or even make a move to property development rather than sticking with investment.
As with anything new, there is much to learn before taking a leap of faith. It’s no different on the tax front. This article seeks to offer some of the important things new developers need to understand before developing or dividing land with the purpose of profiting.
Land held by a property development entity is said to be held on “revenue account” for resale and becomes the stock in trade of any development entity. Investment land is held on “capital account”, held for the purpose of deriving rental income.
They are chalk and cheese with regards to tax.
Whenever a developer sells revenue account land there is tax payable on any profit derived regardless of where that property may sit on a bright-line timeline.
In Section CB15, the Income Tax Act contains an anti-avoidance provision designed to remove the motivation a developer may have to transfer land to associated parties at less than full saleable market value. This provision requires anyone associated with the developer acquiring revenue account land to be perpetually liable for income tax should that land be onsold, regardless of whether the associate has acquired it on capital account.
This provision makes it difficult to effect tax efficient structuring if the developer’s agenda is to keep some of the revenue account property as investments and sell some down for profit. All the revenue account land held in the development entity is subject to CB15 and as such any property sold to an associated party will be perpetually taxable, rather than subject to the five-year bright-line status it may have had as a new build bought by a nonassociated party.
The Question Of GST
There are strategies to mitigate this, but careful planning is required. Seek advice early on a development with a split keep/sell agenda.
Most developments involving the subdivision of land into lots and/or the construction of dwellings for resale will constitute a taxable activity for GST.
An important issue when considering the development of land you might already own is how the sale to a development entity might have a GST impact. When land is acquired by an associate GST can only be claimed to the extent it was originally charged. So if you paid no GST when the land was originally acquired and you want to transfer the property to a new associated development entity, no GST second good tax credit can be recovered. Despite no GST being claimable, there is still GST payable when the developments are sold down. Often, the decision on whether to transfer land to a new associated development company will require a careful trade-off between achieving capital gain on sale to the vendor entity and relinquishing a GST input tax claim in the purchasing entity.
Zero Rating Rules
Even if the development land is being acquired from an arm’s length party a purchaser will need to have a clear understanding of the compulsory zero rating rules that impact all land sales between GST registered parties.
If buyer and seller are GST registered and the buyer gives an undertaking they will use the land in their taxable development activity and won’t be living at the property, the transaction must be dealt with on a zero-rated basis. A contract inclusive of GST in this context is inclusive of GST at the rate of zero offering no 15% claim to the purchaser. There is a long line of novice developers who have purchased assuming they could claim 15% GST only to discover the compulsory zero rating rules prevent this.
It is only property acquired from nonassociated unregistered parties for use in a taxable activity that now gives rise to a GST second-hand good claim.
Entering property development taints future acquisitions of investment properties with a 10-year hold requirement if these investments are to be sold at capital gain. While this may be less important now that existing residential stock has a 10-year bright-line period anyway, new build residential investments might otherwise offer a five-year brightline and commercial investments no bright-line at all.
Property development is not an easy game.
Take tax and GST advice prior to committing yourself.
Mark and his team specialise in advising on property-related transactions, valuation and restructure services, and tax planning. Withers Tsang & Co Phone 09 376 8860, www.wt.co.nz