Intention of acquiring land and Land Tainting Rules
In the business world, acquiring goods can have two intentions: trading or investing. Most of the business activities related to acquiring will only have the intention of trading, such as fruit importers buy fruit from overseas with the intention of buy low and sell high (Trading and making profit) and will not have the intention of hold the goods and get investment returns. However, there are times like when people buy stocks, they can have two intentions, the intention of get stable dividends income through long-term investment, or the intention of make profits by sell it in a high price when the market goes up.
Income Tax Act 2007 - Trading Vs Investing
According to Income Tax Act 2007, amount from trading activities is income of the person and subject to income tax;
- Section CB3: An amount that a person derives from carrying on or carrying out an undertaking or scheme entered into or devised for the purpose of making a profit is income of the person.
- Section CB4: An amount that a person derives from disposing of personal property is income of the person if they acquired the property for the purpose of disposing of it.
- Section CB5: An amount that a person derives from disposing of personal property is income of the person if their business is to deal in property of that kind.
When people acquire an asset and put it under Capital Account (Investment), and eventually making a gain from selling this asset with a higher price is Capital Gain. There is no general capital gains tax in New Zealand. However, Income Tax Act 2007 specifically includes various forms of capital gain that would otherwise be considered as an ‘income’, and subject to income tax.
Acquiring land and intention
Similar with acquiring stock, there are two intentions when people acquire property. We can group it into three scenarios based on different intentions.
Scenario One:
A person only has investment intention when acquire the property (Get rental income). In this scenario, whether the capital gain from sale of the property is income subject to the bright-line test rule. Under the current bright-line property rule, if a property acquired after 27 March 2021 is sold within 10 years (5 years for new-build), the capital gains portion will be taxed as income. Regulation in detail: https://www.ird.govt.nz/proper...
Please Note: do not register GST when you acquire residential property for investment, rental from residential property is GST exempted. If you registered for GST, it is potentially an intention of disposal the property in the future (Scenario Two).
Scenario Two:
A person has the trading intention when acquire the property. In general, property developer, property builder and property trader are belonging to this Scenario. In this case, you don’t have to do test for the bright-line, as profit from sell of the property is subject to income tax in any time. And the business entity must register for GST.
Scenario Three:
When this person is a property developer, property builder or property trader or the associated party of this person buying property with the intention of investment. In this scenario Land Tainting Rule applies (Income Tax Act 2007, CB9,10,11).
This investment scenario is different from that person in scenario one. Under this scenario. The land acquired under investment intention will be “tainted”, if the land was acquired by property developer, or property trader or the associated party of these person. And the land acquired under investment intention will be “tainted” if the land was acquired by builder or an associated party of this builder and completed improvements to the land. When disposing a “Tainted” land, it is subject to income tax for 10 years.
Case Study
Case Study One：
John acquired an investment property in May 2021 (New Build), John became a property developer in Jan 2022, as this investment property was acquired before John became a property developer, this investment property is not tainted. Based on the Bright-Line test rule, this property is subject to income tax for 5 year when disposing (not 10 years from Land Tainted Rule).
Please Note: acquiring intention once confirm at acquisition will not change at transactions between associated parties (Income Tax Act 2007, CB15).
Case Study Two：
John’s developer company acquired land for development in Feb 2022. When development completed, John acquired a property for investment from his own developer company. This investment property are not subject to Bright-line test rule. This case is belong to scenario two, disposing this property at anytime is subject to income tax. Acquiring intention was confirmed when John acquired the property by his developer company (Trading), this intention will not change at transactions between associated parties.
Disclaimer: This article is intended to provide only a summary of the issues associated with the topics covered. It does not purport to be comprehensive nor to provide specific advice. No person should act in reliance on any statement contained within this article without first obtaining specific professional advice. If you require any further information or advice on any matter covered within this article, please contact The Number Studio office.