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Taxpayer not assessable on sale of land acquired with intention of resale

The High Court decision in Junior Farms Limited v CIR (CIV-2009-404-2870, Brewer J, 22 July 2011), while perhaps a “fair” result in the circumstances of the case, is difficult to sustain by reference to the Income Tax Act 2007. That said the decision may prove useful for any advisor or trustee where a tax event has arisen following an unintended resettlement.

The case is simple on its face. Junior Farms Limited owned a large block of un-subdivided land that had been rezoned light industrial and flood plain. The entire block of land together with all plant and livestock was sold for $2.681m pursuant to an agreement dated 9 November 1994. In a subsequent agreement between the same parties, dated the following day, the purchaser was to sell the flood plain portion of the land back to the Junior Farms for $100 following a planned sub-division. At the time of the transaction the flood plain land was worth approximately $1.9m.

In 1999 the subdivision was completed and the flood plain land was conveyed back to Junior Farms upon payment of the agreed $100. In 2001 Junior Farms sold the flood plain land to the Manukau City Council for $3m.

It is common ground that the transaction could have been structured to achieve the parties’ object without the sale and re-purchase of the flood plain land. It is also common ground that Junior Farms subsequently re-acquired the flood plain land with an intention of resale.

The Commissioner assessed Junior Farms for income tax on its gross profit of $2.999m.

Applying the principles of construction of Vector Gas Limited v Bay of Plenty Energy Limited Brewer J found that the case turns on the construction of the two separate contracts and whether in fact these constituted a single transaction.

Finding the latter to be the case Brewer J found that the parties never intended for Junior Farms to dispose of the flood plain land and that a constructive trust existed in respect of the flood plain land.

With all due respect to his Honour’s reasoning and the fact that this has resulted in what is a good outcome for the taxpayer, the decision cannot withstand scrutiny either on its own facts in the face of the clear words of the applicable legislation.

This is not a case where assistance was required to establish what the parties intended. There was no ambiguity or other issue regarding the interpretation of the arrangement. The only issue with the agreements as entered into is that a tax consequence arose that had been neither contemplated or intended.

This is not a case where it is necessary to apply Vector Gas to determine what the parties agreed. The agreements were clear on their face and accepted as that by all parties. Further, even if the constructive trust did arise, as acknowledged by his honour, any imputed trust arrangement was breached by the purchaser when the land was reconveyed to a third party. Accordingly, it is difficult to maintain the position that the land was held at all times for the benefit of Junior Farms.

There is insufficient information in the decision as reported to determine that question further following the intervening sale. Regardless, in the writer’s view, even if the constructive trust argument is valid, the legislation will still apply to tax the outcome following the transactions that did occur. There is no provision in the applicable income tax legislation to tax according to what happened to the beneficial interests. The relevant taxing provisions apply to the transactions entered into by the owners of the legal title, regardless of whether or not there is a change in beneficial interest.

Nonetheless, Junior Farms reflects the Court’s view at present regarding whether tax applies at a legal or beneficial level and can be applied accordingly. For this reason the case could prove extremely useful where an inadvertent resettlement has arisen – say where a variation of a trust amounts to a resettlement so that depreciation recovery income would otherwise arise. Providing the variation has not resulted in a change of beneficial interest, applying Junior Farms, no liability for depreciation recovery income will arise following the resettlement.

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