Bright Line Test Tax Articles

Bright Line Test (4): Company & Residential Land


We will continue to discuss the same topic as before – Bright-line test, with special focus on a different ownership such as company. In the next issue, we will deal with the same topic, but focusing on trust ownership.

You will recall that we assumed Keith, if there are some lots remaining unsold, will hold them in the name of a company he is going to set up. Let us further assume that Keith, after the sale of some of those subdivided lots during the last couple of years, now owns five remaining lots – subdivided lots in the name of a company.

The first issue to examine is whether the company is a land-rich company as defined in the Income Tax Act 2007. The company is a land-rich company if 50 percent of the value of the company, by market value, is attributable to residential land.

For the purpose of this article, we will assume that the company is a land-rich company because the company is only holding five residential lots, no other assets. Then, it is also important to realize that there is a clause in the Act, GB52, which is designed to be an anti-avoidance scheme. Anti-avoidance scheme operates when the two conditions are met: first, if the company disposes of its shares (not the land itself) for the purpose of CB6 (land acquired for the purpose or intention to sell) or CB6A (Bright-line test for residential land) of the Act; second, if some of those lands were acquired within the two years period from the date of the disposal of the company shares, clause GB52 will come in and play.

What is the implication of that section? Once the requirements in the GB52 are met, the company is treated as disposing of residential land that it acquired within two years of the share disposal to the shareholder at costs.

Let us give an actual example to explain this in detail. John and his wife set up a company, Company Z, on 01.01.2016, and each owns 50% of the company shares. On the following day, John and his wife purchases a residential land for $500,000 and makes settlement on the company. The residential land is the sole asset of the company, following the company is a land-rich company. On 01.01.2017, the land value has been appreciated to $600,000. John sells his company shares to Smith, being $300,000.

You will see that Company Z is a land-rich company for the purpose of GB52 and will then be treated as disposing of 50% of the residential land to John for $250,000. John will then be treated as disposing of the residential land back to the company for $300,000. As a result, John will have to pay income tax on the $50,000 gain from the deemed sale.

Now we need to consider further – principles of deductions in land-rich company case. It is important to make a distinction between ordinary rules of deduction and deduction(s) under the Bright-line test. Let us give you an example. If the company Z incurs any costs, holding costs for instance, it is necessary for the company/taxpayer to establish that the holding costs has a nexus with income in the hands of the company and also to the extent they are not private in nature, if the company wants to utilize the expenses by way of a deduction. This is the ordinary rules of deduction.

What is the difference between the rules of deduction under the Bright-line test and ordinary rules of deduction? There is a big difference in that if the losses are claimable solely against the Bright-line income (Bright-line income), the losses are ring-fenced. What does this mean? Bright-line losses are, speaking simply, generally losses incurred in relation to land transactions such as purchase and sale of the land and likewise, Bright-line income is resulted from land transactions.  Accordingly, if John, as a shareholder of the company, wishes to offset the income against loss incurred, John has to show that there is an expense relating to CB6 or CB6A. This follows John may not be able to claim deductions only on the grounds, for example, he has an employment income.

This article is designed to give general information to the audiences and readers of this article. This is not designed to provide a legal advice to a particular person of particular circumstance. If you have any enquiries, you should seek legal advice on that issue. A. B. Lawyers Limited does not accept any liability arising from misjudgment by the audience, without having independent legal advice on his/her case.