To start with, what’s a non-physical change? Let’s illustrate this with an example.

Joe has owned it a rental property for five years. He knows the land can be subdivided so he has successfully applied for and been granted a resource consent to divide the single lot into three.

The market is filled with uncertainty though, so he cheerfully decides to “sell the dream,” and market the single undivided lot for sale with the benefit of the resource consent.

Joe believes there should be no tax under the CB12 and CB13 subdivision provisions as the land has not actually been subdivided. But gaining resource consent is an example of a non-physical change to the land, and there can be tax implications from this and other types of non-physical changes.

Section CB14 taxes gains from a disposal of land within ten years of acquisition where at least 20 per cent of the profit that has arisen from a non-physical change in the status of the land.

Common examples include changes to a district plan or the likelihood of changes to a district plan, the granting of a resource consent or the likelihood of one being granted, environment court decisions, removal of a heritage protection order or other similar changes.

For the section to apply the change factor must exist at the time the landowner disposes of the land, and it must be contributing to the profit on the disposal.

An important quirk of the section is that it applies only when the change factor has contributed to 20 per cent or more of the disposal profit. The courts have suggested that to determine this, the taxpayer should compare the market value of the land before the change occurred to the market value after the change occurred, rather than the actual sale price.

Valuations are therefore key to getting evidence that could be used to argue that the section does not apply if the value increase has simply been because of market forces over the tenure of ownership.

There is also an interesting abatement provision to gains taxed under CB14 where the amount of taxable income is reduced by 10 per cent for each full year of ownership the taxpayer has had the land, so the taxable income abates to zero after ten years of ownership.

There are also some exclusions to CB14.

Section CB18 provides a residential exclusion if the person acquired the land for residential purposes or, interestingly, if the person disposed of the land to another person, who acquired it for residential purposes. So, what the purchaser of the property does with the land impacts the vendors exemption under CB18.

Section CB22 also provides a farming exclusion where the person or their family acquired the land for the purpose of an agricultural business and the land was disposed of to someone continuing to use it in an agricultural business.

The logic behind both these exclusions is that if after disposal the use of the land has not changed, then the change that has occurred to the land was essentially not the reason for the sale.

So, to round out Joe’s example. If he purchased the land for $1 million and it was worth $1.2 million at the date of disposal without the resource consent, but sold for $1.5 million with the resource consent, then $300 000 of the gain was attributable to the non-physical change, which is more than 20 per cent of the gain.

So, all the profit of $500,000 is taxable, but because Joe has owned the land five years the taxable income reduces by 50 per cent, leaving Joe with tax to pay on $250,000 – assuming the purchaser brought the land to develop it (so the residential exclusion would not apply) and it was an investment property rather than Joe’s residence

In practise, the subjective nature of CB14 often sees it overlooked by taxpayers and the tax department, but it lurks there in the legislation nonetheless as a not insignificant trap for the unwary.

PFK Withers Tsang & Co specialise in advising on property-related transactions, valuation and restructure services, and tax planning. PKF Withers Tsang & Co Phone 09 376 8860, www.pfkwt.co.nz