This month’s article is a continuation of last
month’s on
associated persons “traps”. Last month I highlighted two traps that can catch the unwary when moving property between associated entities.
This month I have another two traps that readers should be aware of.
Trap 3 – Tainting for Life
Friends, Jesse and Skylar, are 50% shareholders in a property development company called JS Developments Limited. They are currently
developing a property by subdividing it into four and constructing four new dwellings on the four lots. They plan to sell three, with Jesse
retaining one as his home. The plan is to have the company sell this lot upon completion to Jesse’s Family Trust. They understand that the
company will pay GST on the sale, and income tax if there is a profit realised. Jesse’s Trust is not GST registered and will not have a GST
liability in relation to the property should it sell it in the future. However, Jesse has heard that the Trust may have to pay income tax if
it sells the property for a gain in the future. This surprises Jesse.
Jesse’s fears are well founded. Where a property is moved between associated parties, the associated purchaser is basically regarded as
having the tax characteristics of the original owner - in the context of that property. In other words, the property is tainted as a
development property by virtue of the company having bought the land initially for development purposes, and that tainting continues to stay
attached to the property for as long as it is moved between associated persons. Another way of saying this is that the property is tainted
for life. A few years ago, it was suggested this aspect of the associated persons rules might be reviewed, but there has been no law change
to date, so it is an issue. It would apply equally if the property were moved out of a development company and into an associated rental
company for long-term rental purposes.
Trap 4 – Bright-line Clock Reset
Jimmy and Kim want to buy a new home and convert their existing home to rental use. They have owned and lived in the existing home for 15
years. They have received advice that they should sell the existing home into a new rental company at the same time as settling the new
purchase. They do not believe there would be any adverse tax consequences in doing so given that they have lived in the property for so
long. However, they wonder whether transferring it into a company means that future sale is more likely to be taxable.
In some respects, the associated persons rules are helpful in a situation like this because for most of the land tax provisions, the new
rental company inherits the original acquisition date so is seen as owning the property for 15 years. This decreases the likelihood of any
future sale giving rise to a taxable gain. However, there is one provision where this deemed acquisition date does not hold and that is the
bright-line rule. As readers are likely aware, residential property bought and sold within a five-year period is caught by the bright-line
rule. When restructuring ownership of a property like this, you need to be aware that the bright-line clock resets. This means if the
company were to sell the ex-home within five years of it being transferred into the company, any gain realised within the company is
taxable.
Be careful about restructuring the ownership of an ex-home or a rental property, even if there are advantages in doing so, because sale
within five years could give rise to a taxable gain that would not have existed otherwise.
Summary
There are a variety of nasty traps to catch unwary taxpayers carrying out transactions between associated entities. These traps exist both
in the context of income tax and GST. The antidote is to get good professional advice before engaging in such transactions. If you have
queries or concerns about the topics raised in this article, please contact us at GRA on +64 9 522 7955, info@gra.co.nz or via
our website.
Matthew Gilligan
Director
Contact Matthew at mg@gra.co.nz or call +64 9 522 7955
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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 author.