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Trust income from property transactions liable for income tax and GST

This item has been adapted from an article written by Marilyn Hay

A recent Taxation Review Authority (TRA) decision has held that amounts derived by a trust that bought and sold properties were income on the basis that the properties were acquired for the purpose of intention of sale. The TRA also held that the trust was in the business of erecting buildings and that the exemption for residential land did not apply in this case. In addition, the TRA found that the trust was deemed to be registered for GST. The trust was therefore liable for income tax and GST output tax on the sales of the properties. The TRA also found that the trust was grossly careless when taking its tax position and that shortfall penalties should be imposed for gross carelessness.

The facts and background

The taxpayers were the trustees of the B Family Trust (the trust). The trust was established by deed dated 9 October 1996. The settlors were Mr and Mrs B. The trustees of the trust were Mr and Mrs B and Ms X, a solicitor, as independent trustee. Pursuant to a further deed signed on 14 September 2005, Ms X retired as a trustee and QR Trustees Ltd, the trustee company of Ms X’s law firm, was appointed. The primary beneficiaries of the trust were Mr and Mrs B while the discretionary beneficiaries included Mr and Mrs B’s children. The deed of trust provided that the decisions of the Trustees were to be taken by all trustees unanimously and were to be recorded in writing. Amongst the powers granted to the trustees pursuant to the trust deed were the powers to buy and sell property and to carry on a business activity.

Over a 12 year period between September 1996 and September 2008 the trust bought and sold 11 properties. A total of 10 of those  properties were purchased as vacant sections. The trust built dwelling houses on nine of the sections. The periods that the B family lived in the properties ranged from two to 10 months before the properties were sold with the exception of the last property purchased which Mr and Mrs B lived in for around two and a half years.

Following an audit into the tax affairs of Mr and Mrs B and the trust, the Commissioner issued default assessments to the trust for income tax and GST on the basis that the proceeds of sale from seven of the 11 properties were income and that the buying of land, building of houses and selling of those seven properties was sufficient to constitute a taxable activity for GST purposes. The Commissioner also assessed the trust for shortfall penalties on the basis that it had been grossly careless in taking its tax positions or alternatively, it had failed to take reasonable care.

The trust maintained that it bought and sold the properties as residences for the beneficiaries of the trust and that it was not liable for income tax, GST and shortfall penalties. The onus was on the trust to prove on the balance of probabilities that the Commissioner’s assessments were not correct.

The issues

The issues for determination were as follows:

(1)  Whether the amounts derived on the disposal of the seven properties were income under s CD 1(2) of the Income Tax Act 1994 on the basis that:

  • the properties were acquired for the purpose or intention of sale (s CD 1(2)(a))
  • the trust was in the business of erecting buildings (s CD 1(2)(d)), or
  • whether the residential exemption set out in s CD 1(3)(b) applied to six of the seven properties.

(2)  Whether the trust was liable to account for GST output tax for the six-monthly GST periods ended 31 March 1999 to 30 September 2005.

(3)  Whether the trust was liable for shortfall penalties for the income tax shortfall in respect of the 2004 to 2006 income years and for the GST shortfall in respect of the six-monthly GST periods ended 30 September 2004 and 30 September 2005 for gross carelessness or alternatively, for not taking reasonable care.

The TRA’s decision

The TRA held that the trust had not discharged its burden of proof of showing on the balance of probabilities that the Commissioner’s assessments were not correct. The Court found as follows:

Section CD 1(2)(a): acquisition of land with the intention or purpose of disposal

  1. The trust failed to prove on the balance of probability that at the time of acquisition of each of the properties the trust did not have, at least as one purpose or intention, a purpose or intention of sale.
  • An amount derived from the sale of land is income of a person if the land was acquired for the purpose or intention of selling it. The relevant time for determining a taxpayer’s purpose or intention is at the time of acquisition (ANZAMCO Limited (in liq) v C of IR (1993) 6 NZTC 61,522 cited).
  • The taxpayer has the onus of proof to show on the balance of probabilities that it did not acquire the land with the purpose or intention of sale (Jurgens and Doyle v C of IR (1990) 12 NZTC 7,074 (HC) cited).
  • Section CD 1(2)(a) is satisfied by any purpose or intention to on-sell the land. It is not confined to a dominant purpose or intention. Accordingly a taxpayer must show that none of the taxpayer’s purposes or intentions was to resell or dispose of the land. Furthermore, while a general acknowledgment of the possibility of sale in the future is not sufficient, a contingent or conditional purpose or intention is sufficient to trigger the section (Case Y3 (2007) 23 NZTC 13,028 cited).
  • While the purpose or intention is subjectively assessed, it is the contemporaneous statements and actions of the taxpayer that must be considered of greatest weight (Commissioner of Inland Revenue v National Distributors Limited (1989) 3 NZLR 661 (CA) cited).
  • Section CD 1(2)(a) does not require the purpose or intention to have been manifested at the time of acquisition by any necessary minimum steps towards resale. Each case has to be evaluated in its own context (C of IR v Boanas (2008) 23 NZTC 22,046 cited).
  1. Mr and Mrs B entered into the agreements for sale and purchase within their capacities as trustees of the trust with the requisite purpose or intention of resale. Although Ms X adopted a passive role and permitted her co-trustees to operate as decision makers for the trust and as a consequence may have had a different intention, a passive trustee cannot delegate their responsibilities in this fashion. In these circumstances, it is the intention of the co-trustees which becomes the intention of the trust and Ms X could not set up a different intention from that of her co-trustees.
  1. The purpose or intention to sell was attributed to the trust.
  1. Throughout the relevant period, the trust was engaged in a pattern of activity involving the purchase of vacant land, constructing a dwelling house and on-selling. It could reasonably be inferred therefore that at the time of purchase of each of the properties there was an intention on the part of the trust to on-sell.
  1. It may have been the intention of the trust that the B family would reside in a particular property as a family home. However, this occupation was only to allow for the finishing work to be completed before the property was on-sold.

Section CD 1(2)(d): in the business of erecting buildings

  1. The trust failed to prove on the balance of probability that it was not carrying on the business of erecting buildings.
  1. An amount derived from the sale of land is income of a person if, at the time the land was acquired, the person carried on a business of erecting buildings, the person made improvements to the land, and either the land was acquired for the purpose of that business or it was sold within 10 years of the improvements being made.
  • Although the trust did not maintain separate business accounts or have employees and was not registered for GST and did not employ an accountant, the trust’s activities of purchasing sections, building dwelling houses and selling were carried out in a coherent and organised way.
  • Each project involved a considerable financial and time commitment by the trust and Mr and Mrs B on behalf of the trust. While a profit was not achieved on the on-sale of every property, the intention was to make a profit thereby building up equity for the trust to reinvest in the next development. By the time of the last few sales, considerable profits were being made on each property.
  • Although Mr and Mrs B were not qualified builders and they employed a professional builder to do the construction work, it was not necessary for a taxpayer to carry out the construction work to be in the business of erecting buildings.
  • In the present case Mr and Mrs B arranged the purchase of the land and funding for the project, had the plans drawn up, organised the building contract for work to gib stopping stage, project managed the build and completed the finishing work. On this analysis, the type of business in which the trust was engaged was one of “erecting buildings”.
  • With regard to s CD 1(2)(d)(ii), it may be inferred from the findings under s CD 1(2)(a) as to purpose or intention of disposal that the  sections were acquired by the trust in each case for the purpose of the business of erecting buildings. Even if that was not the case, in the alternative, each of the properties was sold within 10 years after the date that the dwelling house was completed.

Section CD 1(3): Exemption for residential land

  1. The houses were not occupied “primarily or principally” as family residences for the B family. The exemption for residential land did not apply in this case.
  1. While Mr and Mrs B occupied each property after it had been completed to gib stopping stage, this occupation was incidental to the trust’s intention and purpose to sell the property and was for a temporary period.  Mr and Mrs B moved into the property to enable finishing work to be completed before the property was marketed and sold and the process was completed.

10. The trust was engaged in the acquisition of sections, construction of dwelling houses and subsequent sale to the extent that a regular pattern of such transactions was established.

Liability for GST

11. The total value of the trust’s supplies made in the course of carrying on all taxable activities in the 1999 tax year exceeded the then threshold of $30,000. Accordingly, the trust was deemed to have been registered from 1 February 1999 and was therefore liable to account for GST output tax on the sales of the properties with six monthly GST periods ending 31 March 1999 to 30 September 2005.

12. The trust was engaged in the business of erecting dwelling houses on the properties. This did not occur as a whole series of “one off” transactions nor did it occur on an intermittent basis.  By the time of the purchase of property 4, the trust was involved in the activity of buying land, building houses and on-selling the developed properties. This activity continued on a regular and frequent basis over a number of years.

13. It was not necessary that the trust had an intention to supply a third party for consideration. The focus in s 6 of the Goods and Services Tax Act 1985 was on whether the activity involved, or was intended to involve, the supply of goods and services to another person for consideration. In this case, there could be no argument that each transaction involved a supply to a third person.

14. Although Mr and Mrs B may have undertaken a range of activities as recreational pursuits that they enjoyed, this was not sufficient. The activities in question could not be considered as being a private recreational pursuit or a hobby.

Shortfall penalties

15. Before a shortfall penalty can be imposed, the taxpayer must have taken a tax position. In this case, the trust took a “tax position” by not filing income tax and GST returns by due date. That tax position was that the trust was not liable to account for any income tax or GST for the relevant periods. The trust subsequently filed nil income tax and GST returns confirming its earlier tax position. The correct tax position was that the trust was liable for income tax and GST on the sales of the properties.

Gross carelessness

16. A taxpayer is liable to pay a shortfall penalty under s 141C of the Tax Administration Act 1994 if the taxpayer is grossly careless in taking that position. The trust was grossly careless when taking its tax position and shortfall penalties for cross carelessness applied. It was agreed that the penalties should be reduced by 50% pursuant to s 141FB and they were assessed on that basis.

Joint and several liability

17. It is a well established principle that a trustee is personally liable for all debts incurred in the conduct of a trust. In the first instance, however, that trustee will have indemnity from the assets of the trust.

18. In the present case Mr and Mrs B were jointly and severally liable for all income tax, GST and shortfall penalties. With regard to the independent trustees, the joint and several liability of QR Trustees Limited was restricted to the GST period ending 30 September 2005 and the income tax year ending 3 March 2006 (together with related shortfall penalties) due to the fact that this company replaced Ms X as independent trustee on 14 September 2005. Ms X was jointly and severally liable for all other income tax and GST periods and related shortfall penalties.

Case 5/2013 [2013] NZTRA 05 TRA 019/11, 30 September 2013.

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