Weekly Comment 18 July 2012

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1. Earlier this year Inland Revenue released a draft Questions We’ve Been Asked on Income Tax – Whether residual land is part of an undertaking or scheme of development or division of land, on which comments closed on 11 May. This week I discuss:

• The question and answer in the draft QWBA;


• The issues that arise in connection with identifying the residual land (not considered in any detail in the draft QWBA); and


• The GST implications, which need to be carefully thought through (also not considered in the draft QWBA).

The draft QWBA

2. The question addressed is: 3. Sections CB 12 and CB 13 bring to tax income from disposing of land, where an undertaking or scheme, not necessarily in the nature of a business, involving the development of the land or the division of the land into lots, was commenced within 10 years of acquisition by or on behalf of the taxpayer, and:

• The development or division work is not minor (section CB 12): or


• The development or division work involves significant expenditure on channeling, contouring, drainage, earthworks, kerbing, leveling, roading, or any other amenity, services, or work customarily undertaken in major commercial or residential land development projects (section CB 13).

4. What constitutes work of a minor nature is covered in a previously issued Interpretation Guideline IG00010 Work of a Minor Nature subsequently published in Tax Information Bulletin: Vol 17, No.1 (February 2005).

5. The answer given is: 6. It is stated that this will be a question of fact and will require consideration of all of the circumstances, including, for example:

1. The subdivision plans;
2. Any contracts or agreements entered into;
3. Evidence as to the intended use of the retained land;
4. What ultimately happened to the retained land; and
5. The reasons for the ultimate sale of the land that was retained

7. If the retained lot is part of a subsequent undertaking or scheme falling within sections CB 12 or 13, the amount derived on disposal would be income.

8. It is stated that the Work of a Minor Nature IG should not be relied on to the extent that it suggests that the amount derived from the retained lot will be taxable.

What land?

9. The initial issue is what land the undertaking or scheme must have been carried out on:

• The particular part or lot that is disposed of; or


• A larger block of land of which the land disposed of formed only a part.

10. The answer given in the draft QWBA is that the particular land or lot disposed of need not have been itself developed or subdivided.

11. This answer relies on the existence of section CB 23B (which brings to tax an amount derived upon the sale of part of the land to which the a taxing section, including sections CB 12 and 13, applies) and on the decision in Lowe v CIR (1981) 5 NZTC 61,006 (CA) where the reference to “the land” was held to be reference to any part of the land on which an undertaking or scheme was carried out.

Residual land

12. The key issue in the draft QWBA is: what is “residual land”, and there are two aspects here:

• Whether it can it be part of the undertaking or scheme, or must be separate; and


• If it is part of an undertaking or scheme, how the residual land is to be identified.

The residual land can be part of the undertaking or scheme

13. It is stated in the draft QWBA that: 14. Reference is made to the following subdivision, where an original entire parcel of land is subdivided. Lots “B” to “I” were intended to be sold off. If it can be established that Lot “A” was never intended to be part of the scheme of development, it will be “residual land” and any amount derived on a subsequent sale of Lot “A” will not be taxable under sections CB 12 or CB 13.

LOT "A"

B	C	D	E
F	G	H	I

15. (Note: the proceeds from the sale of Lot “A” may be taxable under some other provision in the rules that tax gains from the sale of land, and that will have to be separately considered.)

16. In Church three subdivision plans lodged over some years were not taken together and regarded as part of a scheme of subdivision of the whole block. While it could be argued that a wider scheme of subdivision must have existed at the outset, the Court held that the scope of the undertaking or scheme only extended to that portion of the original block that is intended to be sold off as part of the undertaking or scheme.

17. In Cross the Court of Appeal rejected the taxpayers’ submission that there were three separate undertakings. However, it is noted in the draft QWBA that it may be inferred that the scope of the undertaking or scheme extends only to that portion of the original block that is intended to be sold off as part of the undertaking or scheme.

Boundary adjustments

18. The question of what happens when a boundary is adjusted so that one of two adjoining lots can be sold is also addressed in the draft QWBA.

19. The conclusion is that, unless the boundary adjustment was effected in order to sell both lots, only the amount derived from the lot to be sold will be within the ambit of sections CB 12 or 13. The remaining lot will be “residual land” and a subsequent sale will not be tainted by the boundary adjustment.

20. This conclusion differs from the one in the Work of a Minor Nature IG.

Identifying the residual land

21. It is stated in the draft QWBA that an amount derived upon the sale of residual land will not be taxable under sections CB 12 or 13 if it can be established that the retained land was always intended to be kept for the taxpayer’s own purposes. The type of supporting evidence referred to has been listed in paragraph 6 above. No further details are provided regarding how the separation of the residual land is to be established.

22. The Law Society has made a submission on this point: that the taxpayer may have no fixed preference at the time of acquisition as to which lot might be retained. The Law Society notes that: 23. In Morrow v CIR (1989) 11 NZTC 6,053, Doogue J had a great deal of difficulty identifying the separate intention. That case concerned whether property had been acquired for the purpose of sale. A key aspect was the sketch plan, which in the Judge’s view: 24. However, there was another major difficulty – that the area which might have been treated as “residual land” was not defined: 25. Whatever the case, it seems clear based on Morrow (and to some extent on Church and Cross) that it would be definitely more advisable to clearly identify the residual land at the outset, or as close to the outset as possible, and to document that fact with supporting evidence.

GST Implications

26. The GST implications are not covered in the draft QWBA. Case N59 (1991) 13 NZTC 3,457 concerned the GST on the sale of a home unit that was held to be part of an undertaking or scheme involving development or division of land into lots and was not work of a minor nature.

27. The facts in brief were that a husband and wife acquired a section of land and erected two home units. One of the units was to be sold to the wife’s mother at cost, and the other was to be retained as a long-term investment. Soon after the project commenced the wife’s mother decided not to buy the unit, which was put up for sale and sold on 11 September 1986. Due to financial difficulties the second unit was also put up for sale, and sold on 19 June 1987.

28. The second sale followed the introduction of GST, and the Commissioner assessed GST on the second sale. The Objectors submitted that they were not in the business of dealing in property, had no record, history or pattern of trading in property and that the sale of the units was not part of their taxable activity.

29. The Commissioner relied on section 67(4)(e) of the Income Tax Act 1976, which is the predecessor to section CB 12. Counsel for the Commissioner referred to Aubrey v C of IR as authority that the preparation and obtaining of the District Land Registrar’s approval of a scheme plan of subdivision and the lodging of the plan in the Land Transfer Office constitutes “division work”.

30. Barber DJ noted that Dobson v C of IR (1987) 9 NZTC 6,025 suggests that the preparation of flats plans may be regarded as work of a minor nature and that the bisection of a lot is, of itself, work of a minor nature. However, he found that the division work in this case: 31. In any case, it is accepted law that not much needs to be done in order for there to be an undertaking or scheme that is not minor, and is therefore within the ambit of section CB 12. In Lowe Richardson J discussed the concept of work of a minor nature: 32. In terms of the GST question of whether there was a taxable activity, the judge accepted the submissions of Counsel for the Commissioner: 33. There is a definite risk that a sale following an undertaking or scheme as contemplated in sections CB 12 or 13 could constitute a taxable activity. The issue is whether the subsequent sale of the retained or residual land is part of the same taxable activity.

34. The answer will turn on the particular facts. Where the undertaking or scheme is not carried out as part of any broader taxable activity by a registered person, there should be a basis for deregistration prior to any subsequent sale. In the case of a sale by a registered person in the course of a taxable activity, the sale may or may not have to be zero-rated depending on whether it is a sale to a registered person who meets the requirement for zero-rating or not.

35. There could also be input tax implications upon acquisition, in relation to any residual land that is to be retained. Under the compulsory zero-rating rules, there may be output tax payable by a purchaser who is a registered person.