Family and close relationship transactions - Bright-line issues

A few weeks back, I briefly mentioned the release of PUB00351, a draft interpretation statement titled ‘Income tax – Application of the section CZ 39 bright-line test to certain family and close relationship transactions.’

The draft IS is a stark reminder of how draconian the bright-line rules can be, and that even transactions between close family members can trigger bright-line issues for the transferor, resulting in exposures to income tax payable on the deemed disposal gains.

The IS focuses on three specific transfer scenarios, and if you do not have the time, or in fact any inclination to read the 45-page document, then you could cheat and probably obtain the requisite knowledge to be able to advise your client, just by reading the accompanying six-page fact sheet.

The first point to note is that as the IS refers to the application of section CZ 39, its commentary is only targeted towards transactions where you entered into a binding agreement to purchase residential land from 29 March 2018 to 26 March 2021 (inclusive).

Moving on to the three scenarios, the first considers a transfer of residential land from a parent to their child, perhaps to assist the child in buying the land, where the child is unable to complete the transaction themselves at the outset for whatever reason.

If the land is transferred from the parent to the child during the five-year bright-line period, any deemed disposal gain will be subject to taxation (assuming the main home exclusion does not apply) via the application of section CZ 39. I say deemed disposal gain because remember that when the land tax provisions are triggered upon the disposal of land, an anti-avoidance provision steps in to deem a market value consideration to have applied to the transfer, even if for example, the parent transferred the land to the child for the parent’s original cost.

However, excluded from a bright-line application will be a scenario where the parent was acting either as a nominee or a bare trustee for the child. In this respect, Inland Revenue (IR) will expect you to be able to provide sufficient evidence that the nominee or bare trust arrangement was in existence. It is also IR’s view, that since a bare trustee should have no active duties in relation to the land, if a mortgage is registered in the parent’s name in respect of the land, then the parent cannot be a bare trustee, because a legal responsibility for the loan is an active duty and not a passive duty of a bare trustee.

The second scenario involves a transfer of an interest in land from a person to their new partner – so from a sole owner scenario to equal co-owners. Once again, the anti-avoidance rules will trigger a deemed market value disposal of the land to your partner, with the consequence that 50% of the interest will be subject to bright-line taxation if the transfer occurs during the 5-year bright-line period.

The third and final scenario considers a disposal of the land by a beneficiary who has inherited an interest in the land under a will, to other beneficiaries who have also received their interests in the same land under the will. This disposal of the interest in the land to the other beneficiaries, will not trigger a bright-line taxation issue for the transferor beneficiary – under the rule which exempts the disposal of land by a will beneficiary from bright-line taxation. Note here that if the transferee beneficiaries then go on to dispose of the land during the 5-year bright-line period, then while their initial allocation of land interests under the will would not be subject to bright-line taxation, the land interest that the transferee beneficiaries received from the transferor beneficiary will not be excluded from potential bright-line taxation.

As a final point, it should be noted that most of the aforementioned transactions would also restart the bright-line clock for the transferees – roll-over relief not applying to these scenarios.

Should you wish to make a comment on PUB00351, the closing date for submissions is 12th October.

This article from the 'A Week in Review' newsletter was originally published Tuesday 27th September 2022. If you have any questions or would like a second opinion on any national or international tax issues, please contact me [email protected].?

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