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Matthew Gilligan

New Tainting Rules By Matthew Gilligan

The long awaited new associated persons rules have finally passed into law.  On 6 October 2009 the legislation received Royal Assent.  The new rules apply to land acquired on or after 6 October and in certain instances to improvements made to buildings after that date.  More on that later, but to begin let's briefly revisit what these rules are about. 

new training rules

In the context of land transactions, up until now, it has been possible to arrange your affairs so that if you wanted to carry out property dealing / development or building activity you could separate this from your investment properties and prevent the former from tainting the latter.  The IRD have long seen this as a weakness in the legislation and a loophole and for the last couple of years have been pushing for reforms to be enacted.  The end result is that there is a new series of associated persons tests that are extremely comprehensive. 

They include new tests that associate two Trusts, new wider tests to associate two companies and companies to shareholders and a tripartite test whereby two parties can be deemed to be associated, even though not directly associated to each other, but where they have a common party to which they are both associated.  Where a property is tainted, a gain that otherwise would not be subject to income tax, is subject to income tax if sale occurs within 10 years of acquisition (or in some instances within 10 years of completion of improvements).

The new association rules are so comprehensive that if you are engaged in the business of property dealing or development and you wish to acquire an investment property post 6 October 2009 it is highly likely that the property will be tainted.  In fact the rules are designed to be so comprehensive that it is likely that the IRD would view any attempt to structure around them as tax avoidance.  That being the case, if you currently run property dealing and development activity via a Trading Trust for example, it might be tempting to wind up the Trust and trade via a different structure, but in our view this might be “throwing the baby out with the bath water”.  That is, while a Trading Trust might not necessarily prevent association anymore, it does not follow that it is automatically the wrong structure.  There are other beneficial aspects of using Trading Trusts such as flexibility in distributing income and good asset protection. 

Another aspect of tainting that taxpayers need to bear in mind is that the association to the property dealer or developer has to exist on the day that the investment property (that you do not wish to be tainted) is acquired.  Taxpayers who cease their property dealing and development activity no longer have a tainting issue and can then acquire rental property free of tainting risk.  This means if you have entities that have been involved in these types of business in the past, you should consider winding them up to cease any tainting risk. 

We also note that you have to be engaged in a business of property dealing and development.  There may be instances where somebody has conducted one or two property trade transactions but is not necessarily engaged in a business such that they would have a tainting risk. 

Finally, you should also recognise that even under the new comprehensive association rules, the 10 year test still applies. This means in a worst case scenario where a property is acquired and tainted as a result of association to a property dealer or developer you can still break the tax impact of tainting by holding the property for 10 years.  As a technical point you should note that if you are in the business of erecting buildings then tainting only applies if you make improvements to the rental property, but then applies to sale within 10 years of completing the improvements.

The moral of the story is if you are acquiring property or just concerned about the impact of these new rules on you, you should seek advice.  Please contact the writer at [email protected] or 09 522 7955 to discuss.

Matthew Gilligan
© Gilligan Rowe & Associates LP

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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.
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