| Ruling no. | DA-066 |
|---|---|
| Status | Draft |
| Issue date | TBC |
| Date of effect | TBC |
Preamble
The economic entitlement provisions in Part 4B of Chapter 2 of the Duties Act 2000 (the Act) apply if a person acquires an economic entitlement in relation to relevant land, other than by a transaction that is already a dutiable transaction under Chapter 2 of the Act. Where a person acquires an economic entitlement, the person is taken to have acquired beneficial ownership of the land in the percentage calculated under section 32XE of the Act.
Section 32XE of the Act sets out how to determine the percentage of beneficial ownership. Section 32XE(2) specifies circumstances when the beneficial ownership acquired under an economic entitlement will be deemed to be 100%. However, the Commissioner has discretion under section 32XE(3) to determine a percentage less than 100% if appropriate in the circumstances.
Once the percentage of beneficial ownership has been determined under section 32XE of the Act, duty is calculated by reference to that percentage multiplied by the unencumbered value of the land at the time that the economic entitlement is acquired (not the time when the benefits that flow from the economic entitlement are ultimately realised). If the unencumbered value of the land is between $1 million and $2 million, duty is phased in using the formula set out in section 32XG of the Act.
The purpose of this ruling is to provide guidance on how to determine the percentage of beneficial ownership of land taken to have been acquired under an economic entitlement, including circumstances where the Commissioner considers it appropriate to exercise discretion under section 32XE(3) to determine a percentage less than 100%. This ruling is provided as a guide only and is not exhaustive. If your circumstances are not covered in this ruling, please apply for a private ruling in accordance with Revenue Ruling GEN-009v3 – General Information on Private Rulings.
Ruling
Beneficial ownership of land taken to be acquired
The percentage of beneficial ownership of land taken to be acquired under an economic entitlement is the total of all of the entitlements referred to in section 32XC(1)(b) of the Act that the person (and its associated persons) is or will be entitled to receive or acquire at the time the arrangement is entered into. Those entitlements are as follows:
- 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.
Where an arrangement provides a person with only one entitlement identified above, by reference to a specific percentage, and nothing else is payable to the person or an associated person, the beneficial ownership of the land taken to be acquired will be the stated percentage. This beneficial ownership will be taken to have been acquired on entry into the arrangement and, accordingly, it is not necessary to enquire into what amounts may or may not be ultimately received by the person.
Deeming provision
Under section 32XE(2) of the Act, the beneficial ownership taken to be acquired under an economic entitlement will be deemed to be 100% where the arrangement:
- does not specify the percentage of the entitlement referred to in section 32XC(1)(b) that the person is or will be entitled to receive or acquire,
- in addition to specifying a percentage of the entitlement referred to in section 32XC(1)(b), also includes any other entitlement, or amount payable to, the person or an associated person, or
- entitles the person or an associated person to 2 or more of the entitlements referred to in section 32XC(1)(b).
Section 32XE(2) of the Act is an integrity measure and is to be read in the context of section 32XE(1) and 32XE(3) of the Act. It is not intended to operate in isolation to deem a higher percentage of beneficial ownership of land than the total of all the entitlements that the person (and its associated persons) is or will be entitled to under the arrangement.
Commissioner’s discretion
Under section 32XE(3) of the Act, the Commissioner has discretion to determine a percentage less than 100% in any particular case if satisfied that it is appropriate in the circumstances to do so.
In considering whether to exercise the discretion, the Commissioner will have regard to the total of all the entitlements referred to in section 32XC(1)(b) of the Act that the person, together with any associated persons, have acquired under the arrangement. The entitlements are determined as at the time the arrangement was entered into.
Where a person accurately identifies all of the entitlements referred to in section 32XC(1)(b) that the person and its associated persons have acquired under an arrangement, and which can be quantified as a percentage less than 100%, the Commissioner will always consider it appropriate to exercise the discretion. In these circumstances, the Commissioner will reduce the percentage of beneficial ownership taken to be acquired from the deemed 100% to a percentage which is equivalent to the economic entitlement acquired.
Arrangements that do not specify the percentage of an economic entitlement
Where an arrangement does not specify the percentage of an economic entitlement, the Commissioner will always exercise the discretion to reduce the percentage of beneficial ownership from 100% where the entitlement acquired can be accurately quantified as a percentage less than 100%. In these circumstances, the Commissioner will exercise the discretion to determine that the beneficial ownership acquired is the proportion of the economic entitlement that the person, together with any associated persons, acquired under the arrangement.
Where a development agreement provides a developer with an entitlement to participate in an unspecified percentage of the gross proceeds of sale of land, the focus is on the proportional entitlement to those proceeds that the person acquired at the time the arrangement is entered into, not the net benefit or profit that may or may not ultimately flow to the developer. This will be the case notwithstanding that the developer may be obligated to incur costs in connection with the development of the land.
In quantifying the proportion of a particular entitlement referred to in section 32XC(1)(b) of the Act, the Commissioner will have regard to the facts, information and circumstances pertaining to the arrangement, including any methodology or formula to calculate the entitlement which is recorded in the arrangement or connected documents and relied upon by the parties.
In recognition that the inputs in these methodologies or formulas are often uncertain at the time the arrangement is entered into, the Commissioner will consider the values included in financial models or feasibility studies prepared for the arrangement and relied upon by the parties. Generally, the Commissioner will adopt these values if they include appropriate market-based assumptions and estimates, such as where there is an independent assessment to quantify and verify that the costings are reflective of market conditions.
Additional amount payable to a person or an associated person
The Commissioner recognises that it is common for an arrangement to provide a developer with one economic entitlement referred to in section 32XC(1)(b) of the Act, which is specified as a percentage, plus an additional amount which may be payable to the person or an associated person as a service fee.
In these circumstances, the Commissioner will exercise the discretion to reduce the percentage of beneficial ownership from 100% where the developer substantiates that the additional amount is not, or does not amount to, an economic entitlement. Upon exercise of the discretion, the percentage of beneficial ownership taken to be acquired will be determined as the percentage specified in the arrangement.
Where a person does not substantiate that an additional entitlement or amount is not an economic entitlement, the discretion may still be exercised if the Commissioner can quantify, as a percentage less than 100%, the total of all the economic entitlements acquired under the arrangement. In these circumstances, the Commissioner may consider the additional entitlement or amount to be an economic entitlement when determining the percentage of beneficial ownership taken to be acquired by the person.
For guidance on when a service fee may amount to an economic entitlement, please see Revenue Ruling DA-065.
Arrangements that provide for 2 or more economic entitlements
Where a development agreement provides a developer (or a developer and an associated person) with a combination of 2 or more economic entitlements, the Commissioner will exercise the discretion if the Commissioner can accurately quantify, as a percentage less than 100%, the proportion of the total of the entitlements that the developer (or the developer and an associated person) acquired under the arrangement.
This will involve consideration of the nature and effect of the arrangement, including the types of entitlements that are provided under the arrangement. If the Commissioner exercises the discretion in a case where an arrangement provides for 2 or more entitlements each of which is specified by reference to a different percentage, the Commissioner will generally not reduce the percentage of beneficial ownership below the higher of the percentages, unless satisfied that some lesser percentage is more appropriate in the circumstances.
Where a development agreement contemplates 2 or more discrete methods which may be used to quantify 2 or more entitlements, the Commissioner will exercise the discretion to determine a percentage less than 100% if the Commissioner can accurately quantify each percentage entitlement under the arrangement. If the Commissioner exercises the discretion, the Commissioner will determine the percentage of beneficial ownership by reference to the entitlement which is most appropriate to the facts and circumstances of the matter, as well as the nature and effect of the development agreement as a whole. For example, where a development agreement entitles a developer to the higher of 70% of the gross proceeds of sale of land or 50% of the profits derived from the land, the Commissioner will reduce the beneficial ownership from a deemed 100% to 70%.
Phasing in of duty
Where the unencumbered value of the land is between $1 million and $2 million, the phasing in of duty formula applies. Duty is chargeable under section 32XG of the Act in accordance with the following formula:
- [(A - $1,000,000)/$1,000,000] × 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 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. 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.
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 himself so enters into a joint venture with Company A, an unrelated property development company, under which Company A is entitled to receive 25% of the proceeds of sale of the lots. Under the arrangement, Company A engages an unrelated building company to undertake the development, including planning and subdivision for a fixed fee with Company A paying these costs and overseeing the construction.
Company A’s entitlement to receive 25% of the sale proceeds from the development constitutes an economic entitlement in relation to the land. As a result, Company A will be taken to have acquired beneficial ownership of 25% in the land upon entering into the joint venture with Joe. This constitutes a dutiable transaction under Chapter 2 of the Act, with the duty payable within 30 days of the economic entitlement being acquired (i.e. 30 days of entering into the joint venture agreement).
Duty is charged by reference to the dutiable value of the land the subject of the dutiable transaction, being $1.125 million. This is the value of the 25% beneficial ownership taken to have been acquired by Company A upon entry into the arrangement (25% × $4.5m). The phasing in formula will not apply because the unencumbered value of the land the subject of the arrangement is greater than $2 million. Phasing in looks to the value of the land that is the subject of the arrangement, not the dutiable value of the beneficial ownership taken to be acquired in the land.
Example 2: Profit sharing development agreement
Company B owns land in Melbourne valued at $30 million and has obtained planning approval to develop the land into an apartment tower. In order to proceed with the development, Company B has entered into an arrangement with a developer, Company C, under which Company C has agreed to fund and oversee the development. In exchange, Company C is entitled to receive from Company B an amount by way of reimbursement of the costs of construction as well as a development fee equal to 40% of the total profit from the sale of the apartments. Under the arrangement Company B is entitled to $30 million, being the initial market value of the land, plus 60% of the total profit from the sale of the apartments. The build cost is estimated to be $80 million with projected gross sales revenue upon sale of the developed apartments at $150 million.
As the arrangement includes an economic entitlement, being the entitlement to receive 40% of total profit, as well as a payment other than an economic entitlement expressed in percentage form, the integrity provision will apply to deem Company C to have acquired 100% beneficial ownership of the land. However, this is subject to the Commissioner exercising the discretion to determine a lesser amount if it is appropriate to do so.
Upon lodgement, Company C can seek the exercise of the Commissioner’s discretion to determine a percentage interest of 40%, rather than the deemed 100%. To satisfy the Commissioner that this is appropriate, Company C will need to substantiate that the build cost of $80 million is a reasonable estimate of the cost of construction and does not include an additional element of profit from the development of the land. Where reimbursement of the cost of construction is contingent on the profitability of the development or any other performance measures associated with the ultimate sale of the development, it may be considered an economic entitlement, being a right to participate in the proceeds of sale of the land.
Where Company C does not satisfy the Commissioner that the cost of construction is reasonable and does not include an additional profit element, the Commissioner may still exercise the discretion and reduce the economic entitlement to 64%. This is the maximum percentage that Company C is entitled to under the arrangement, being calculated 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)])
- Company B is entitled to $30 million + $24 million (60% of $40 million profit) = $54 million
- Company C is entitled to $80 million + $16 million (40% of $40 million profit) = $96 million which, as a percentage of the total gross proceeds of sale of $150 million, is 64%.
Duty is calculated by reference to the percentage of beneficial ownership deemed to have been acquired in the land at the date of acquisition, being $19,200,000 (64% × $30 million).
Example 3: Development fee determined by reference to gross sales proceeds
Company D owns land in Melbourne and has entered into a development agreement with a developer, Company E, under which Company E has agreed to develop the land and incur all costs of the development. Under the agreement, Company E is entitled to receive a development fee determined by reference to all gross proceeds of sales of the land less a landowner’s retention amount of $4 million.
As the economic entitlement is not expressed in percentage terms Company E is deemed to have acquired 100% beneficial ownership of the land, subject to the Commissioner’s discretion to determine a lesser percentage.
Company E comes to the Commissioner seeking exercise of the discretion and provides the Commissioner with all the information required to quantify its economic entitlement. This includes a feasibility study prepared by an independent third party which includes appropriate market-based assumptions and estimates. The feasibility study estimates that the gross proceeds of sale will be $10 million. Company E also provides an independent cost plan which shows estimated development costs of $4 million. A valuation report prepared by a competent valuer is also provided which values the land at $2 million.
In these circumstances, the Commissioner will consider it appropriate to exercise the discretion to reduce the beneficial ownership in the land taken to have been acquired by Company E from 100% to 60%, being Company E’s entitlement to gross sale process ($6 million) as a percentage of total estimated gross sale proceeds ($10 million).
This is the most appropriate method to estimate Company E’s entitlement because at the time the arrangement is entered into, Company E’s economic entitlement comprises a development fee determined by reference to gross sale proceeds, not the net benefit or profit that may or may not ultimately flow to it based on the inputs in the feasibility study.
Example 4: Service fee payable to an associated person
Company F owns land valued at $1.5 million and has entered into a development agreement with Company G, under which Company G has agreed to develop the land. In exchange, Company G is entitled to receive 50% of the profit derived from the sale of the developed lots.
Company G appoints Company H, a wholly owned subsidiary, as its development and project manager. Company H will carry out the development and provide development and project management services for Company G in exchange for a fee equal to 2% of the proceeds of sale of the developed lots.
As the arrangement includes an amount payable to an associated person of Company G, Company G is deemed to have acquired 100% beneficial ownership of the land. Company G seeks the exercise of the Commissioner’s discretion and provides evidence that the service fee is at market rates, demonstrating that the service fee is not a profit-sharing mechanism and does not amount to an economic entitlement.
Upon being satisfied, the Commissioner will exercise the discretion to reduce the beneficial ownership taken to be acquired from 100% to 50% reflecting the economic entitlement acquired by Company G under the arrangement.
As the unencumbered value of the land was between $1 million and $2 million, duty will be calculated using the phasing in formula set out in section 32XG of the Act. The duty chargeable on the arrangement would be calculated as follows:
[($1.5 million - $1 million) ÷ $1 million] × the duty otherwise payable
The duty otherwise payable is $40,070. This amount is calculated by reference to the value of the land upon entering the development agreement ($1.5 million) multiplied by the beneficial ownership in the land taken to have been acquired (50%) by Company G.
Commissioner of State Revenue
Rulings do not have the force of law. Each decision made by the State Revenue Office is made on the merits of each individual case having regard to any relevant ruling. All rulings must be read subject to Revenue Ruling GEN-001.
This is a draft ruling only, and is not available for publication, nor may it be relied upon by taxation officers, taxpayers or practitioners.
