The State Taxation Acts Amendment Act 2019 received Royal Assent on 18 June 2019. It makes a number of amendments to the economic entitlement provisions in the Duties Act 2000 (Duties Act).
The amendments address the Supreme Court's decision in BPG Caulfield Village Pty Ltd v Commissioner of State Revenue [2016] VSC 172, which found, amongst other things, that for duty purposes, an economic entitlement could not be acquired in circumstances where the taxpayer only acquired an economic entitlement to some, but not all, of the landholdings of a landholder. The amendments also address the conceptual issues identified by the Supreme Court that certain aspects of the economic entitlement provisions are focused on the land itself, rather than the landholding entity.
Accordingly, the economic entitlement provisions in Part 2 of Chapter 3 of the Duties Act that concern obtaining an economic entitlement by reference to the land holdings of the landholder have been repealed. New provisions addressing these arrangements have been inserted into Chapter 2, specifically new Part 4B of the Duties Act, titled ‘Economic Entitlements in Relation to Land’.
The provisions that concern obtaining an economic entitlement by reference to a private landholder have been retained in the Landholder Duty regime in Part 2 of Chapter 3 of the Duties Act. They are now titled ‘Economic Entitlements in Relation to a Private Landholder’.
What follows is guidance on how these provisions apply.
Economic entitlement in relation to land
If a person enters into an arrangement in relation to land under which the person is or will be entitled (directly or through another person) to an economic entitlement in relation to the land, that person is taken to have obtained beneficial ownership in the land in proportion to the economic entitlement obtained.
The land must have an unencumbered value of more than $1 million.
A person acquires an economic entitlement if the person is entitled to any one or more of these:
- To participate in the income, rents or profits derived from the land.
- To participate in the capital growth of the land.
- To participate in the proceeds of sale of the land.
- To receive any amount determined by reference to any of the above matters.
- To acquire any entitlement described above.
The intent of the provisions is to impose duty on arrangements where a person, without acquiring an ownership interest in land, nevertheless obtains benefits that are normally reserved for the owner of the land.
Accordingly, the application of the provisions is limited to cases where an economic entitlement in relation to land is acquired other than by a transaction that is already a dutiable transaction under Chapter 2 of the Duties Act. For example, a transfer of freehold land will result in the transferee acquiring an economic entitlement in relation to the land. However, as a transfer of freehold land is already a dutiable transaction under Chapter 2, the economic entitlement provisions will not apply to the transfer.
Consistent with how Chapter 2 of the Duties Act operates, the economic entitlement provisions can apply with respect to land held by any person (including a natural person or discretionary trust) provided the $1 million land value threshold is met.
The economic entitlement provisions contained in Chapter 2 of the Duties Act can also apply to acquisitions of shares in companies and units in unit trust schemes that may be outside the scope of Chapter 3 of the Duties Act. As a result, a liability may arise under Chapter 2 where no liability would arise under Chapter 3 because the interest acquired is below the relevant acquisition threshold. However, this would only occur where the acquisition of units, shares or other security interests entitle the holder to participate in the income, rents or profits, capital growth or proceeds of sale from particular land held by the entity. Where the entitlement to income, rents, profits, capital growth or proceeds of sale is general in nature and not specific to particular land held by the entity, the economic entitlement provisions in relation to land would not apply.
When do I have to pay duty?
Where a person obtains an economic entitlement, the person is taken to have acquired an ownership interest in the land that is chargeable with duty (as a change in beneficial ownership under Chapter 2 of the Duties Act). Consistent with the economic entitlement provisions under the landholder provisions of Chapter 3 of the Duties Act, this will occur when the economic entitlement is obtained, not when the benefits that flow from the economic entitlement are realised.
To this end, where a developer enters into a development agreement with an owner of land under which the developer is entitled to an economic entitlement in relation to the land, the developer will be taken to have acquired an ownership interest in the land upon entering into the agreement. The duty payable is determined by reference to the unencumbered value of the land at the time the agreement was entered into (i.e. normally vacant land value) not by reference to the end value of the development.
Service fees are not an economic entitlement
The amendments do not change the definition of an economic entitlement. They are designed to apply to an economic entitlement in relation to land acquired other than by a dutiable transaction. Accordingly, the amendments are directed to arrangements that provide for rights and benefits relating to the land that are economically equivalent to ownership interests.
Ordinary fees for service such as real estate agent fees – even when calculated on a commission basis – are not considered to be an economic entitlement. These are a fee for service and not a benefit normally reserved for the owner of the land.
There are numerous third party service providers whose fees may be tied to the cost/proceeds of the development but are not an economic entitlement. This is the case where the third party service provider receives genuine industry fees for service. While not exhaustive, this can include:
- Architects – whose fees can include a percentage of building costs.
- Project managers – whose fees can include a percentage of project value.
- Planning consultants – whose fees can include a percentage of the value uplift after a precinct structure plan is obtained.
- Private advisory firms – that may receive a contingency fee for assisting a landowner to take their land to market.
- Lenders and financiers – who receive interest for providing finance to a development. The interest/fee cannot be tied to the performance of the development. An example of such an arrangement is a standard loan facility with interest at market rates.
Accordingly, where a person providing a service in relation to land:
- is normally engaged in a full time capacity in providing those services,
- the agreed fee/rate is within industry parameters, and
- the person is unconnected (i.e. not an associated person) to any other person who has an economic entitlement in relation to the land,
it is unnecessary for the service agreement to be disclosed to the State Revenue Office by the service provider.
However, where the service provider is associated to a person who has acquired an economic entitlement in relation to the land, the fee for service must be disclosed to the State Revenue Office when disclosing the economic entitlement. The person who obtained the economic entitlement will be required to provide evidence showing the service fee is a genuine fee for service and not a profit sharing mechanism otherwise the fee may be taken into account when determining the duty payable on the acquisition of the economic entitlement.
Fund manager fees
Fund managers can be entitled to performance fees calculated on a percentage of returns from property under management above a benchmark (i.e. out performance fee) and disposal fees calculated as a percentage of the sale price of property disposed of by the fund.
Where these fees relate to holding and maintaining property for the fund, the fees will be considered a fee for service and therefore not an economic entitlement.
For the above to apply, the fees must be within industry parameters and the property cannot have been developed for the fund by a person associated with the fund manager.
A resident in a retirement village
Where a retiree enters into a lease/licence arrangement with a retirement village operator that gives the retiree a long-term right to reside in a residence at the village, any entitlement the retiree enjoys to participate in proceeds of a subsequent sale of the residence to a new resident will not be considered to be the acquisition of an economic entitlement under Part 4B of Chapter 2 of the Duties Act. Rather, this will be considered to be an entitlement that is already held by the retiree under the lease/licence (which is generally not dutiable).
This only applies in relation to an entitlement to participate in the proceeds of the first sale of the residence from when the retiree commenced residing in the residence under the lease/licence. It does not apply where the retiree has a right to enjoy in the proceeds from more than one on-selling of the residence.
How much do I have to pay?
Where a development agreement provides a developer with an economic entitlement by reference to a stated percentage and nothing else (e.g. the agreement provides that the developer will obtain a stated percentage of the profits of the project), the interest in the land acquired for the purposes of the provisions is to be determined with reference to that stated percentage. This is irrespective of whether or not the developer ultimately receives a profit due to cost blow-outs.
Deeming provision
Where the arrangement:
- does not specify a percentage of the economic entitlement, or
- include any other entitlement of, or payment payable to, the person or an associated person, or
- entitle the person to two or more different categories of economic entitlements,
the person is taken to have acquired an interest in the land of 100%. This is subject to the Commissioner determining a lesser percentage if they consider it appropriate in the circumstances.
This is an integrity measure. Its purpose is to ensure economic entitlements are not understated by representing the benefits as fees, bonuses and other items. The provisions aim to ensure taxpayers accurately disclose what the various payments represent (e.g. a payment solely relates to reimbursement of the cost of construction and is not really a profit sharing fee) so that the duty calculation is referable only to the economic entitlement acquired.
Where a taxpayer accurately discloses the economic entitlement acquired, the Commissioner will always exercise his discretion to reduce the percentage ownership interest in the land so that duty is only imposed by reference to the economic entitlement. For this to occur, the economic entitlement must be able to be determined in percentage form.
Phasing in of duty where land is valued at $2 million or less
As set out above, the land that is the subject of the economic entitlement arrangement must have an unencumbered value of more than $1 million for the provisions to apply.
However, where the unencumbered value of the land does not exceed $2 million, duty is chargeable in accordance with the following formula:
- [(A - $1,000,000)/$1,000,000] x B
where:
- A is the unencumbered value of the relevant land, and
- B is the duty that, apart from this section, would be chargeable under Chapter 2 of the Duties Act on the acquisition of the economic entitlement.
The effect of the formula is that duty is phased in on a sliding scale. The closer the unencumbered value of the land is to $1 million, the closer the duty chargeable will be to nil (irrespective of the size of the economic entitlement/interest in land deemed to have been acquired). The closer the unencumbered value of the land is to $2 million, the closer the duty chargeable will be to the full amount that would normally apply.
Economic entitlements in relation to land are landholdings for the purpose of the landholder duty provisions
A landholding for the purpose of the landholder duty provisions (Part 2 of Chapter 3 of the Duties Act) includes land taken to be owned under the economic entitlement provisions.
Accordingly, when determining what, if any, landholder duty is payable on the acquisition of an interest in a landholder, care should be taken to include any land deemed to be owned by the company, unit trust scheme or linked entity of the landholder under the economic entitlement provisions.
Commencement
The new provisions commence from the day after Royal Assent, which means they apply to arrangements made from 19 June 2019. However, transitional provisions may apply.
Transitioning to the new framework
For the purpose of transitioning to the new framework, the new economic entitlement provisions in Part 4B of Chapter 2 will not apply if there has been an ‘arrangement’ in the broader sense of the word, entered into before 19 June 2019 concerning economic entitlements.
This means a concerted action or plan by the relevant parties to undertake specific actions under which an economic entitlement is to be acquired. While an executed binding agreement is not required to show that there is a concerted action or plan between the parties, the intended actions must be captured in writing in order to qualify as an arrangement. The written evidence needs to be sufficiently certain and must envisage how the parties intend to agree to share in the economic benefits of the land.
An example of a non-binding document that would qualify as an arrangement in this context is a Heads of Agreement between a landowner and developer setting out with sufficient certainty a proposed development of the land and how the parties intend to contract to share in the benefits of the development (e.g. by executing a draft Development Agreement annexed to the Heads of Agreement).
Arrangements entered into on or after 19 June 2019
The new provisions in Part 4B of Chapter 2 apply to ‘arrangements’ made in relation to land under which an economic entitlement is acquired. While the term ‘arrangement’ can have broad meaning and in certain contexts, it does not require a binding agreement (see above), for the purpose of the Part 4B of Chapter 2, an arrangement will not be considered to have been made unless there is at least one binding agreement entered into under which a person obtains an economic entitlement. To this end, the Commissioner considers that the term ‘arrangement’ has been used in Part 4B of Chapter 2 as these matters can involve a wider course of action than a single agreement. It is not used to capture matters that are a proposed course of action.
How the provisions apply in a landholder duty context
For the purposes of the landholder provisions of Chapter 3 of the Duties Act, the new provisions do not apply to an arrangement made before 19 June 2019 to acquire an interest in a private landholder that completes on or after 19 June 2019 (i.e. the interest is not acquired until after commencement of the provisions). Accordingly, when testing that acquisition for landholder duty, any land taken to be owned by the private landholder under the economic entitlement provisions is ignored.
Conversely, the provisions do apply to any arrangement made on or after 19 June 2019 under which an interest is acquired in a private landholder. Therefore, when testing that acquisition for any landholder duty, any land taken to be owned by the private landholder (or linked entity) under the economic entitlement provisions in Part 4B of Chapter 2 of the Duties Act is to be taken into account as a land holding of the landholder, whether or not the economic entitlement was acquired before commencement of Part 4B.
For the purposes of landholder duty, what is relevant is the date the arrangement was made to acquire the interest in the landholder.
Examples of the application of the economic entitlement provisions
Example 1: Joint venture
Joe, a retired market gardener, has obtained planning approval to subdivide part of his farm into 55 residential lots for sale to third parties. The farm is valued at $4.5 million. Joe does not have the means or expertise to undertake the development and therefore enters into a joint venture with Company B. Under the agreement, the parties will engage a construction firm (unrelated to the parties) to undertake all necessary works for the subdivision for a fixed fee, with Company B paying these costs and overseeing the construction. The gross proceeds from the sale of the lots will then be split 75% to Joe and 25% to Company B.
Company B’s entitlement to a share in the sale proceeds from the development constitutes an economic entitlement in relation to the land. As a result, Company B will be taken to have acquired an ownership interest in the land of 25% upon entering into the joint venture with Joe. This constitutes a dutiable transaction under Chapter 2 of the Duties Act, with the duty payable within 30 days of the economic entitlement being acquired (30 days of entering into the joint venture agreement).
Duty is charged on the dutiable value of the land the subject of the dutiable transaction. In this case, duty will be charged on a dutiable value of $1.125 million, being the value of the farm upon entering into the joint venture ($4.5 million) multiplied by the interest in the land taken to have been acquired (25%).
Phasing-in of duty will not apply to this scenario as the unencumbered value of the land the subject of the arrangement is above $2 million (it is $4.5 million). Phasing-in looks to the value of the land that is the subject of the arrangement, not the dutiable value of the property acquired.
Example 2: Profit sharing development agreement
ABC owns a parcel of land in Melbourne valued at $30 million. ABC has obtained planning approval to develop the land into an apartment tower. In order to proceed with the development, ABC has entered into an arrangement with a developer, XYZ, under which XYZ has agreed to fund and oversee the development.
Under the arrangement XYZ is entitled to be paid the build cost for the development plus 50% of the profit, while ABC is entitled to $30 million (i.e. the initial value of the land) plus 50% of the profit. The build cost is $80 million. The projected gross sale revenue upon sale of the developed apartments is $150 million.
As the arrangement includes a payment other than a specified economic entitlement in percentage form, the integrity provision will apply to deem the taxpayer to have acquired 100%. However, this is subject to the Commissioner exercising his discretion to determine a lesser amount if it is appropriate to do so. The intent of the integrity provision is to encourage taxpayers to be more transparent on the economic entitlements obtained under the arrangement to enable the appropriate duty to be applied. It is not the intent to take a higher duty than the total benefits received.
Accordingly, the taxpayer will need to substantiate that the build cost of $80 million is a reasonable fee for service (payment for the works) and does not include an additional element of profit from the development of the land. Assuming that the taxpayer does this, the Commissioner will exercise his discretion to determine the economic entitlement is 50%. Payment of the build cost cannot be contingent on the development being profitable or any other performance measures associated with the ultimate sale of the development (i.e. the build cost must be payable irrespective of whether the development is profitable/successful, otherwise it will be considered an economic benefit tied to the development of the land).
In the event that the taxpayer does not substantiate that the build cost is $80 million (i.e. does not substantiate that the build cost is not a profit sharing fee) or stays silent on the facts of this matter, the Commissioner will still exercise his discretion and reduce the economic entitlement to 66.67%, being the maximum percentage of benefits that the taxpayer could be said to be entitled to under the arrangement when it was entered into. The figure of 66.67% reflects XYZ's percentage entitlement as follows:
- Projected profit for the development is $40 million ($150 million (projected gross sale revenue) - $110 million [$30 million (land value) + $80 million (build cost)])
- ABC is entitled to $30 million + $20 million (50% of $40 million profit) = $50 million
- XYZ is entitled to $80 million + $20 million (50% of $40 million profit) = $100 million which, as a percentage of total revenue of $150 million, is 66.67%.
Duty is calculated by reference to the unencumbered value of the land at the time the economic entitlement was acquired, not by reference to the end value of the development. In this scenario, duty will be calculated by reference to the vacant land value ($30 million), not the end value of the development ($150 million). That is, duty will be payable on the percentage interest deemed to have been acquired in the vacant land.
Example 3: Real estate agent service fee
A development company is building an apartment tower on land it owns. Prior to construction starting, it entered into an exclusive selling arrangement with a third-party real estate agency for the sale of apartments at the development. Under the arrangement, the agency is entitled to a fee of 1.5% of the sale price for each apartment sold.
The arrangement is a fee for service and does not provide for the acquisition of an economic entitlement. As the fee is not connected to the acquisition of an economic entitlement by an associate of the real estate agency it is not necessary to disclose details of the agency arrangement to the State Revenue Office.
Example 4: Acquisition of units in a unit trust scheme
ABC Pty Ltd is the owner of two shopping centres in Victoria that it holds on behalf of the ABC Unit Trust, the sole unit holder of which is XYZ. One centre is in regional Victoria and valued at $15 million while the other is in metropolitan Melbourne and valued at $85 million. To fund an expansion of its metropolitan shopping centre, ABC Pty Ltd and XYZ (who holds 85 million ordinary units in the trust) have decided to sell the regional centre.
A potential investor, with no experience in managing shopping centres, proposes an alternative arrangement for the acquisition of the shopping centre other than via a conventional sale and purchase transaction. To maintain ABC Pty Ltd as the manager of the shopping centre, the proposal involves the creation and issue of 15 million new Class A units in the trust to the investor for $15 million. By virtue of these units the investor will be entitled to 100% of the net income, rents and profits associated with the operation of the regional centre alone. On a winding up of the trust, the Class A units would also provide the investor with an entitlement to participate in a distribution of the trust's property to the extent that the value of the regional shopping centre bears to the total value of both shopping centres (15% as at the time of the proposal).
The parties agree to the proposal and the new Class A units are created and issued to the investor for a subscription price of $15 million. While the acquisition is not chargeable with duty under Chapter 3 of the Act, the acquisition is dutiable as the acquisition of an economic entitlement under Chapter 2 of the Act. This is because it involved an arrangement under which the investor has an entitlement to participate in 100% of the net income, rents or profits derived from specific land.
