Chapter 2 - Background

2.1 Subpart CB of the Income Tax Act 2007 contains provisions that deal with the taxation of income from the disposal of land. In particular, section CB 6 deals with land acquired for the purpose of or with the intention of disposal, and the taxation of income derived from the disposing of the land. Therefore if a taxpayer acquires the land with the intention or purpose of disposal and subsequently disposes of the land, any profit they make from the disposal is taxable.

2.2 The legislative history of section CB 6 is lengthy, as the profits made from the sale or disposition of real property were first considered to be a source of “business income” in the Land and Income Assessment Act 1891. The Appendix to this paper provides further background information on the history and treatment of this provision.

2.3 The policy intent of this section is to capture property speculators, who can be described as persons who buy and sell land with the intent or purpose of making a profit without necessarily developing or improving the land, and relying instead on chance, trend or volatility of the property market to provide financial gain.

2.4 This was clarified in Hansard when the Land and Income Assessment Act 1908 was amended by the Land and Income Assessment Amendment Act 1912:[1]

This is not an alteration in the law, but for the purpose of making the present Act clearer. Persons who speculate in land are liable to assessment for income tax on the profits from buying and selling the land.

2.5 The key distinction between section CB 6 and a capital gains tax is the subjective element, as the tax burden only falls on those who have the necessary intention or purpose to use land as if it were a trading asset. In this way the section attempts to distinguish between those who hold land as a capital asset and those who hold it as a revenue item. The economic rationale is that if a person is consciously transacting so as to make gains from buying and selling land without being taxed on these gains, it would be inefficient for them to divert work effort away from taxable activities towards this task.

2.6 Although this issues paper focuses on section CB 6, the date of acquisition affects most of the land provisions in subpart CB. Therefore clarifying the date of acquisition will also increase certainty in relation to most of the following land-taxing provisions:

• section CB 15 clarifies when land is acquired by associated persons for most of the land provisions in subpart CB;
• sections CB 7, CB 9, CB 10, and CB 14 clarify when the 10-year period begins for a business dealing in land (including land development, subdivisions, and change of land under the Resource Management Act 1991); and
• sections CB 18 and CB 19, which clarify when land is acquired for the purposes of the residential and business exemption.

The issue: applying different dates of acquisition

2.7 The uncertainty this issues paper seeks to address is caused by the timing of when the taxpayer’s intention or purpose should be tested. The Courts have held that the relevant time for determining a taxpayer’s purpose or intention is at the time the taxpayer acquired the land.[2]

The appropriate time at which to consider a taxpayer’s intention or purpose under this provision is the date of its acquisition of the land.

2.8 However there is minimal case law to provide sufficient guidance on when acquisition actually occurs.

2.9 The tax case Beetham v CIR held that land is acquired when the parties to an agreement become bound by the contract to purchase and to sell that is, when the contract becomes unconditional, and an order for specific performance of the land transfer is available.[3]

2.10 However Bevin v Smith, a non-tax case held that under the general law a purchaser acquires an equitable interest in land if specific performance in its wider sense (for example, caveat or damages) is available to protect the purchaser’s rights under the contract.[4] Specific performance in this case means all the equitable remedies are available to protect the interest of the purchaser under the contract, so it is a question of whether equity will, by injunction or otherwise, prevent the vendor from dealing with the property in a way that is inconsistent with the contract of sale.

2.11 The interpretation of these two cases (and those that followed) has resulted in a number of differing views over when land is acquired.

2.12 Furthermore because the definition of “land” in the Income Tax Act 2007 includes estates and interests in land, and the taxpayer acquires different interests and estates in “land” under a typical sale and purchase agreement which are then merged when the title is registered, neither the legislation nor common law have provided sufficient clarity over which “land” the date of acquisition should apply to.

Possible interpretations of section CB 6

2.13 There are two reasonable interpretations of this section. The first is that the date of acquisition is the date when the first interest (equitable or legal) in land arises under an agreement for the sale and purchase of land (the “first interest” interpretation). The date of acquisition would therefore fall in one of the initial phases of a sale and purchase agreement, either:

• the date the agreement was entered into (even if the agreement was still conditional); or
• the date when all the conditions of the contract had been fulfilled and the purchaser can seek an order from the Court requiring the specific performance (that is the transfer of the land title) of the agreement (most commonly known as when the agreement goes “unconditional”).

2.14 A different interpretation is when the date of acquisition is determined by the “land” that is being disposed of (the “disposal interpretation”). Here, the date of acquisition would fall on the date the taxpayer acquires the interest or estate that is then subsequently disposed of. This can occur at different times under the agreement depending on how “disposal” is interpreted, but is more than likely to be the later phases of a sale and purchase agreement, that is either settlement or registration or in the alternative the date the agreement goes unconditional. For example:

• If the taxpayer, after acquiring a legal fee simple estate, subsequently disposes this legal fee simple estate, the land is acquired when the legal fee simple estate (the title transfer) is registered by the Registrar-General of Lands under the Land Transfer Act 1952. It is only at this time the taxpayer is able to deal with the land in an absolute sense and is able to dispose of the land, or alternatively, create new interests in land.
• If the taxpayer disposes of a lesser interest − for example, a legal easement, the date of acquisition is when the legal fee simple is acquired by the taxpayer. As described above, this date is when the land title is registered.

2.15 The following diagram illustrates and explains the different phases of a typical sale and purchase agreement.

2.16 These two interpretations have resulted in taxpayer uncertainty over which date to apply to their land transaction(s) and, in some cases, has had unintended tax outcomes. This has been a particular problem in situations when “land” is bought off the plans and a land title has not yet been registered.

2.17 The uncertainty in the law is also exacerbated by the fact that agreements for the sale and purchase of land may span over a number of months or years, and interests in land can be assigned to another person before the purchaser’s name is registered on the title.

2.18 The following example shows how the tax outcomes may differ depending on the interpretation that is applied.

Preferred interpretation from a tax policy perspective

2.19 A fundamental consideration of a coherent, broad-base, low-rate tax system is that taxes should be efficient through minimising distortions and impediments to economic growth. This “efficiency” consideration also needs to be weighed against the opportunity for tax planning and providing a sustainable revenue base for the Government.

2.20 It is acknowledged that if the Government chooses to clarify the date of acquisition, taxpayers will have the opportunity to alter their behaviour under either interpretation to avoid evidence of having an intention or purpose of resale, or may capture some taxpayers for whom the policy is not intended. However, this is a risk that already exists under the current legislation and if the legislation is sufficiently clarified, greater transparency should benefit all parties.

2.21 We consider that a “first interest” interpretation is the most appropriate interpretation from a tax policy perspective and results in greater certainty and economic efficiency than the “disposal” interpretation, for the reasons discussed below.

Increase in land value and certainty of tax liability

2.22 A person’s intention regarding the land may change between the date the agreement was initially entered into and a subsequent date, such as the date of registration. This concern is illustrated in the example above. If the person’s intention is to purchase the property for resale, a “first interest” interpretation means that it is clear from the outset that any subsequent increase in value will be taxable.

2.23 A “disposal” interpretation, on the other hand, means that a person must wait until a later date (for example, registration) to determine whether the land is revenue-account property. They must account for tax not only on asset appreciation going forward, but also any increase in value in the past – between entering the contract and the date of registration. There could also be an argument that it should only be from the date the intention was changed.

Distortion of behaviour and the lock-in effect

2.24 As noted above, the choice of interpretation can also lead to behavioural distortions. Under the “disposal” interpretation, a person desiring certainty may delay entering into a sale and purchase agreement until the title is nearly ready, as intention would be determined on the date of registration. This could increase certainty but, in doing so, may influence the person’s behaviour if they otherwise would have entered into the agreement on an earlier date.

2.25 A further distortion that occurs under the “disposal” interpretation, and where land values are increasing, is that there is an incentive for the taxpayer to defer disposing of the land (the lock-in effect) until title is acquired. However, if land values are decreasing, there is an incentive for the taxpayer to dispose of the land before title is acquired, and to state that the land was acquired for the purpose of resale in order to claim a tax loss. Under the “first interest” interpretation, such distortions do not arise because the intention is determined at the earlier phases of the sale and purchase agreement.

Impact on property market

2.26 In addition, the disposal interpretation could produce arguably an inefficient outcome for the property market. Consider, for example, the development of an apartment complex that will take a number of years to complete. The developer may not proceed with construction unless a number of the apartments have been pre-sold. If purchasers are unwilling to enter into an arrangement until a date closer to completion and registration, because they need certainty about their tax liability, the developer may lack sufficient capital (or means to secure capital) to proceed with the development. There may also be an incentive for the purchaser to require a lower price (operating as a risk margin) to compensate for the uncertainty. However, this situation may not arise in practice because the price and the willingness to enter into a contract are influenced more by non-tax factors.

Other factors to consider under the “first interest” interpretation

Agreements not in writing or registered on the land title

2.27 Although most disposals of estates or interest in land are executed through a sale and purchase agreement, not all disposals require a sale and purchase agreement/written form of a contract, or need to be registered on the land title. For example, leases and assignments of a lease do not need to be registered on the title, and in some circumstances may not need to be evidenced in writing. Therefore a date of acquisition test which is based on the phases of a sale and purchase agreement may appear to be limited to only disposal in these agreements.

2.28 However, the underlying principle of the first interest interpretation where the date is based on the first interest that arises in an agreement (either the date the agreement is entered into or the date the agreement goes unconditional and the Court can order specific performance of the legal title transfer) is still relevant in these types of disposals. This is because there must be some form of agreement between the parties, irrespective of whether it is or is not evidenced in writing or registered (or not) on the title.

Options to acquire land

2.29 The definition of “land” in the Income Tax Act 2007 includes “options to acquire land”. If the Government decides to clarify the legislation to reflect one of the dates under the first interest interpretation, then:

• if the date of acquisition is the date the agreement was entered into, then for an option, this is the date the option was granted; or
• if the date of acquisition is the date the agreement goes unconditional, in the case of an option this is the day that the option is exercised.

1 (29 August 1912) 159 NZPD 624.

2 AnzamcoLtd (in liq) v CIR (1983) 6 NZTC 61,522 (HC).

3 72 ATC 6042, see also Case Y3 (2007) 23 NZTC 13,028, Annalong Pty Ltd v FCT 72 ATC 4141.

4 [1994] 3 NZLR 648.