Taxing Land Profits

Before we look forward it is useful to look back at how development land was commonly held and treated for tax purposes prior to the economic downturn (1).  In the past there was a difference in the income tax treatment between residential development land and non-residential development land. Residential development land qualified for a special 20% rate of income tax which made it extremely attractive for developers to hold such sites in their personal capacity. This led to a practice whereby housing was sold to the end purchaser on foot of two agreements – one for the sale of the site on which the house stood between the developer and house-buyer and the other between a construction company (controlled by the developer) and the house-buyer. The profits realised on the sale of the site by the developer were only subject to income tax at 20% (2) while the profits realised by the construction company were subject to corporation tax at 12.5%. Overall, the tax position for developers was very attractive. The tax benefits of this structure led to developers taking on large amounts of personal debt to acquire development land and this is perhaps a part contributor to the personal debt problems suffered by many over recent years.
Trading profits realised on the sale of non-residential land were subject to income tax at marginal rates, in this regard land held for non-residential development was generally held and developed through companies to gain access to the 12.5% rate on the sale of fully developed land (3).
The tax position for persons who held land that increased in value was also attractive with a CGT rate of 20% applying to capital profits. Land was often acquired by way of buying the company that held the land. The upper rate of stamp duty was as high as 9% which meant that significant stamp duty savings could be made by acquir ing the company that held the land rather than the land itself as the rate of stamp duty on shares was 1%. Some developers also availed of “resting in contract” structures to avoid stamp duty when acquiring land.
Enactments since the economic downturn have changed the tax position for developers quite dramatically. The main changes are:
➤ The 20% income tax rate for residential land dealers was abolished from 2009 and any such profits are now subject to income tax at marginal rates;
➤ Certain profits attributable to a rezoning of land post the passing of the NAMA Act where the profits are realised in the course of a trade are subject to income tax at 80%. Capital gains attributable to such a rezoning are also subject to tax at 80%;
➤ The rate of stamp duty on land has been reduced to 2% and “resting in contract” structures have largely been legislated against;
➤ Debt written off for individual land dealers/developers will be regarded as a receipt of the trade where that debt was used to purchase or develop land held as trading stock;
➤ For individuals, if a loss arises as a result of interest charges or diminution in trading stock, relief for the loss cannot be claimed unless the interest has been paid and/or the stock sold. (4)
➤ For CGT purposes where land is acquired with borrowed money and that debt is subsequently released the base cost of the land is now reduced by the amount of the debt released or in other circumstances a chargeable gain is deemed to arise.
➤ A CGT exemption was introduced to relieve capital gains arising on property (i.e. land and buildings) acquired before 31 December 2014 where that property is held for at least seven years. If the property is held for longer than seven years a proportionate amount of the gain is relieved – for example, if land is held for nine years, 7/9ths of the gain arising is relieved.
As a consequence of these changes, developers will now need to consider how to hold development land taking into account the potential impact of the 80% tax rate introduced by the NAMA Act on profits and capital gains on land rezoning.
A question that arises is whether land should be held personally or via a company. For individuals carrying on a trade of dealing/developing land without trading losses carried forward it probably no longer makes sense to hold development land personally. This is because any profits realized on the land will be subject to income tax at marginal rates (assuming the land is not subject to the 80% NAMA tax). The 20% income tax rate for dealing in residential land was abolished from 2009 thereby removing the main motivator for the holding of land personally. Individuals with significant carried forward trading losses may seek to continue that trade in their personal capacity in order that any profits arising on future trading activities would be relieved from income tax.
Where losses forward are not available the more tax efficient route for individuals may be to have a company controlled by them acquire the land; if the company fully develops the land, the profits arising thereon should be subject to corporation tax at 12.5%.
Changes in taxing the write-off of bank debt and restricting loss relief where land is written down and interest accrued will potentially impact on certain genuine land dealers/developers. Such changes have made it less attractive to carry on a trade personally as the tax impact of potential failure is greater.
For non-dealers/developers in land (i.e. not carrying on a trade) the CGT relief for property acquired before 31 December 2014 and held for at least seven years represents an interesting opportunity. It should be more tax efficient for such an individual to acquire land personally rather than by way of a company controlled by them.This is because if the land is held by a company in order to extract any profits from that company a charge to income tax or CGT would arise, if the land is held personally gains on of sale can be received by the individual in a potentially tax free manner.
It is important to note that if an individual holds the property, any income from that property (i.e. rental income) will be subject to income tax on their lands.
Some consideration must be given to the potential impact of the 80% rate of income tax (5) and CGT introduced by the NAMA Act 2009 (6).These provisions only impact on land that has been rezoned (7) on or after 30 October 2009 or where the land has been subject to a material contravention of a development plan on or after 4 February 2010 (collectively referred to as “rezoning” hereafter).The 80% tax rate only applies on profits attributable to the rezoning. There will be some difficulty ascertaining the amount of profits chargeable to the 80% income tax rate and the amount subject to tax as normal. It is likely to be the case that a land dealer will have profits from other land dealing activities not attributable to the rezoning, i.e. some profits could be attributable to the grant of planning permission, the construction of a building and marketing of the property, such profits would be taxed as normal. Persons subject to this tax should ensure that their records are sufficient to support the position that they adopt; professional valuations of the land should prove useful in this regard. Alternatively, there may be some merit in having the construction work carried out by a separate company to split the profits clearly.
The 80% CGT rate is more limited in its application than the income tax provisions outlined above. The 80% rate of CGT only applies where there is a disposal of land and that land:
a. has been the subject of rezoning since its acquisition by the person making the disposal;
b. was acquired from a connected person and the acquisition cost for the purposes of the CGT Acts was other than market value, where the rezoning took place during the ownership period of either person; or
c. was the subject of a sequence of transfers between connected persons, if the rezoning took place during the period between the date of disposal and the latest date at which the acquisition cost, at any step in the sequence, was market value.
For the 80% rate of CGT to apply the land must have been rezoned while in the ownership of the person making the disposal and in this way it differs from the income tax position outlined above. While the impact of the 80% rate of CGT may not be significant when land is first rezoned, as time passes and land becomes more valuable the level of profit attributable to the rezoning will grow.
Points b) and c) above are designed to prevent the side-stepping of the 80% tax rate by way of connected party transfers. Certain transfers that limit the application of the tax are still permitted. Where appropriate, companies holding land are again being bought in preference to buying the land as the cost of the land to the company when it was originally acquired could be in excess of the land value today thereby potentially exposing less future profits to the 80% rate of tax.
The 80% rate of income tax or CGT is likely to mean that the value of recently rezoned land is lower than land that was rezoned prior to the passing of the NAMA Act and that persons holding such land will hold off developing or selling it until such time that the law in this area is changed.
Lessons should also be taken from the personal debt crisis where those who fared best often benefited from the protection afforded by the corporate veil. When searching for a tax efficient structure, what might suit one taxpayer may not suit another, and all cases must be considered individually.
1.This article deals with direct taxes only and is high level in nature in addition VAT is beyond the scope of this article
2. PRSI and the health levy did not apply
3. The 12.5% rate is available on the sale of fully developed land, profits arising on the sale of non-fully developed land would be subject to tax at 25%.
4. Applies only to an individual whose income related to land dealing over a three year period is less than 50% of their total income
5. Rezoning profits realised by a company are subject to income tax rather than corporation tax
6. Certain sales of land are not subject to this tax e.g. land sold on foot of CPO and sales of sites of
0.407 hectares or less not exceeding €250,000 in value
7. See section 644AB TCA 1997 and section 649B TCA 1997 for what amounts to a rezoning of land.
This article first appeared in the August issue of Accountancy Ireland (Chartered Accountants Ireland)