Hello, Please find our first installment of Tax Titbits below. If you are wondering why you have received this email - you have been automatically subscribed to receiving our newsletters via email due to being a client of Matley Financial Services. If you no longer wish to receive these newsletters (which will occur every 3 months or so), please click on the unsubscribe function. If you have any questions about the content of this email, please do not hesitate to contact Maggie on 07 824 1084. Kind regards The Team at Matley Financial Services Limited ********************************************************************************** LAND SALES AND ASSOCIATED PERSONS - NEW LEGISLATION IN PLACE
Many clients may not be aware that there has been a proposal to change the definition of Associated Persons which will have a significant effect on those who are looking at developing or dealing in land but also wish to hold long term passive rental holdings.
Section CB and CB11 consider that any tax payer or person associated with the tax payer who is in the business of erecting buildings must return all sales of land and buildings as taxable income if sold within 10 years. The interesting question of course is what is the business of erecting buildings and that refers to anyone who constructs or erects a building. It does not include someone who is a handyman or someone for example who may work on labour only contracts. However, it is important to note that it is 10 years from the date or acquisition or the date of improvement.
The issue to consider in the above illustration is that in the 1994 Act it was that the individual must be in the business of building and erecting at the time the land was acquired. In the above illustration this would be in the year 2000 when Mr T was a student and not in the business of building or erecting. Therefore if he sold it in 2009 there was no income tax payable.
However, under the 2004 and 2007 Acts it is now tested on when you are in business at the time of improvements or acquisition. Therefore in 2008 when Mr T effectively erected the storage shed and subsequently sold it in 2009 he was in the business of building or erecting buildings as he had commenced that business in 2007. Therefore the sale of the section and shed would be taxable.
However, it is not all bad as there is the ability to have a business premise exemption. In this case one could argue that the storage shed was used to store the plant and equipment of the business along with any raw material. Therefore by selling it off, it is effectively selling a capital item of the business.
The new bill that has been put before parliament and received over 800 submissions has changed significantly the definition of associated persons. Under the proposed bill and it should be noted that this has not yet been passed into legislation, however as it is passed through the consultation process there is no indication at this stage to indicate that it would not be passed and enshrined into law. It may be done under the current government or it could be done under any new subsequent government after the election.
The new amendment of the Income Tax Act would affect all land acquired after the 1st April 2009. However, it is important to note that the 1st April 2009 is a relevant date and is applicable regardless of the balance date of the entity. It seems to be based on information we have reviewed that IRD are attempting to introduce the 1973 Act which intended to capture all gains of property that are made within 10 years. In fact, IRD have gone further to say that one of the major weaknesses of the current Act is to allow builders, developers and dealers in land to effectively escape tax by operating through closely connected entities.
Regardless of whether it was the intention of parliament to introduce a capital gains tax or whether it is its intention to capture gains made on the sale of passive investment properties after 10 years, the net effect of it that its detrimental for developers who wish to hold rental properties on capital account.
With all income tax legislation it is very difficult on case specifics to individual clients to give any clear and concise direction. However, suffice to say, the old rule used to be that no two trusts could ever be associated, and commonly we would establish a development trust and we would establish an investment trust. The investment trust would be a beneficiary of the development trust and the development trust would be settled by tax payer A and have charities and the investment trust or family trust as the beneficiaries. Under this basis that the property held by the investment trust would not be tainted and the property held by the development trust would not taint the family trust. However, this is no longer the case.
Under Section YB7 that is proposed to be introduced trusts who have the commonality of settlor will now be considered associated with each other in respect to income tax.
Section YB7 relies on the Settlor definition which is contained in Section HC27 of the exisiting Act. A settlor basically is someone who includes a transfer of value to trust which is either directly or indirectly involved by one or a number of transactions connected to or otherwise. What this gobblygook effectively means that if I was to establish a trust for you as the settlor, I am acting on your instructions and therefore I am indirectly acting for you and as such you are the settlor of the trust. It also includes a settlor of the head trust would become the settlor of any sub trust and there is an overriding rule in Section HC28 (2 )of the Act that says that any action or refraining from any action to defeat an intent and application of the trust tax rules would in effect be seen as tax avoidance and undo the arrangement. Under Section YB8 which is intended to be introduced into the legislation, it will define further what that settlor is in respect to trusts. It is also important to note that from the 1st April 2009 it is proposed that a new definition of Section YB11 will bring into account those who hold the power of appointment of both trusts would be deemed to associate those trusts.
This begs the question of asking that what happens if I were to hold the power of appointment or removal of trustees on behalf of my client? The question is, am I holding this power of appointment as an agent on behalf of my client, or am I holding this power of appointment in my own capacity? If I am holding it as agent then I am in effect acting as the settlor who has given me that power of appointment and as such I would therefore be associated with any other trusts that that individual holds the power of appointment to.
While on the face of it it doesn't seem too positive for those who wish to hold capital account land and buildings and those who wish to deal or develop in the land and buildings, we are working with some tax people at this point in time to try and develop a strategy which will allow going forward some strength in continuity in the application of the new rules.
At this stage however there is one potential avenue that can be explored and that is under the new associated parties rules there is no consideration of grandparents or parents.
Therefore, one aspect that we have given consideration to those who wish to develop land or to be builders dealing with the erection of buildings, if ones parents are not in similar businesses, then they can establish for the benefit of their children and grandchildren a family trust which can hold long term property. However it is important to note that if power of appointment and removal of the trustees rests with the settlors children and they are also the settlors and hold the power of appointment for their development trust, these two trusts will be associated. So there are some rules that we are looking at this stage and will report back once we have discovered or are aware of a firm structure that can be adopted.
GST AND RULES OF ASSOCIATION
In the buoyant market that we have had and with the market that currently exists a number of clients have been looking at purchasing property with the intention of doing it up and then on selling it to make some money. The matter to note is that when often buying a property or "the bargain of the century" arrives many clients will quite happily put on the sale and purchase agreement, their name and or nominee.
You may have heard of a Deed of Nomination and a Deed of Novation. But many clients don't quite understand what the two mean and also the implications of what those two mean.
A Deed of Nomination is effectively executed at the time of sale and what the Deed of Nomination basically says is the party that appears on the sale and purchase agreement nominates another party under the Deed of Nomination to effectively purchase that property.
A Deed of Novation is in effect the person mentioned on the sale and purchase agreement actually steps aside and the second party to the Deed of Novation steps in to their shoes and has to contract with the vendor directly under the same terms and conditions that was to the original sale and purchase agreement and then complete the transaction.
While this might seem minor and pedantic, it does have some significant consequences where it comes to GST. Under a Deed of Nomination, in effect the Nominator and the Nominee are generally the associated parties. For the purposes of association there is a lenghtly test that I do not need to go into at this point in time, but suffice to say the Deed of Nomination includes everyone
Under the association one of the problems that arises that the cost to the nominee for the purposes of GST input is the lesser of market value or cost. While it may appear on the face of it that the cost to the purchaser has been the price on the sale and purchase agreement for the purposes of GST the cost to the Nominated party is actually nil. The reason for this is because the purchaser (the original party to the sale and purchase agreement) is not GST registered so therefore the GST is zero. The nominated party is therefore restricted to the lesser of cost being zero, or market value being the price on the sale and purchase agreement. This in effect means under GST rules there is no cost of input claim for the purchase of the property.
However, under a Deed of Novation as the original sale and purchase agreement is basically over turned and a new sale and purchase agreement is executed, the associated parties rules mean that the cost is exactly the same as the market value and a GST claim can be made for the purchase of the property.
However, be cautioned because one of the risks you run under the Deed of Novation is that the original sale and purchase agreement is put aside and a new one is entered into between the intended purchaser and the vendor. If the vendor has a change of heart and decides that they do not wish to enter into a contract under the same terms and conditions this means that the new party may not have such a favourable agreement.
In effect, what this means is if you are purchasing a property for the intention of doing it up and you wish to do it in another entity, ensure that you have your structures in place first before doing it because it is a lot to easier to settle on the name that is registered on the sale and purchase agreement rather than having to go through the Deed of Nominations and Deed of Novations and be potentially overturned when coming to an IRD audit.
We know of an instance where we have been involved in a consulting role for another accounting firm where a sale and purchase agreement was Nominated to a development trust and as the original sale and purchase agreement (or in this case was an auction) was in the name of a company the registration process went through under the company name and the association rules meant that they could not claim effectively $53,000 worth of GST back, but would be subject to GST on the full sale price of the lots. It is therefore important to have your structures right and if you are considering such deals, contact us immediately and we can ensure structures are put in place before sale and purchase agreements are signed.
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