Consider the following scenario:
A farmer (or any other Victorian landholder) is considering entering into an agreement with a property developer to develop and sell all or a part of their land. The development agreement has the following features:
- the landholder retains ownership of the land until it is sold to the ultimate purchaser(s);
- the developer agrees to develop the land (which may be done in stages);
- in compensation for the developer assuming all the development risks, handling the financing of the development as well as the marketing and sale on behalf of the landowner, the developer will receive some combination of reimbursement for the development cost and a fee generally calculated by reference to the sale proceeds or profit of the project.
Historically, such an arrangement would not have been subject to any duty on the basis that the developer is not acquiring any ownership interest in the land. However, for a number of years there have been ‘economic entitlement’ provisions in the Duties Act 2000 (Vic) under which an agreement such as the above would only result in duty for the developer if the landholder was a private company or a unit trust and the developer obtained an ‘economic entitlement’ of 50% or more in the landholder.
However, these uniquely Victorian ‘economic entitlement’ provisions received a significant overhaul as a result of the 2019 Victorian State Budget and the passing of the State Taxation Acts Amendment Act 2019. The new version of ‘economic entitlement’ provisions which have effect from 19 June 2019 arguably have created a new duty that capture a far broader range of development arrangements and can apply whether the landholder is a private company, unit trust, discretionary trust or even an individual!
This article seeks to shed some light on these changes, which have largely flown under the radar, and the potential complexities and unexpected costs developers now face, which may have flow-on affects for anyone considering entering into a development agreement.
The economic entitlement provisions prior to 19 June 2019
The original form of the economic entitlement provisions, as summarised above, arguably had limited application/were easy to circumnavigate on the basis that the relevant landholder had to be a private company or a unit trust, and the relevant entitlement threshold was ‘high’ at 50%.
The ease with which developers were able to structure their deals to ensure the provisions were not triggered was confirmed by the Supreme Court in in BPG Caulfield Village Pty Ltd v Commissioner of State Revenue [2016] VSC 172 (‘BPG Caulfield’), which considered the situation where a developer acquired economic entitlements in only some of the landholder’s land. The Court held (amongst other things) that an economic entitlement could not be acquired in circumstances where the taxpayer only acquired an economic entitlement to some, but not all, of the landholder’s landholdings. In other words, transactions could be easily organised to overcome the application of the former provisions simply by quarantining a portion of landholder’s land from the arrangement.
The new economic entitlements provisions
Following the decision in BPG Caulfield, the Victorian government legislated (via State Taxation Acts Amendment Act 2019) new economic entitlement provisions which focus on the land itself, rather than the landholding entity.
Accordingly, a person acquires now an economic entitlement (whether directly or indirectly) if the person is entitled to participate in the:
- income, rents, profits;
- capital growth;
- the proceeds of sale; or
- any amount determined with reference to any entitlement described above;
in the relevant land, instead of in the relevant landholder.
Additionally, under the new provisions:
- there is no minimum threshold for a relevant acquisition of economic entitlements (i.e., the 50% threshold is removed);
- there is no restriction regarding the type of landowner, such that the provision can apply irrespective of whether the land is held by a private company, unit trust, individual, discretionary trust or self-managed superannuation fund, so long as the relevant Victorian land that is the subject of the economic entitlement arrangement has an unencumbered value exceeding $1 million.
So under the new rules, even if a developer obtains only a 5% interest in the profits or proceeds of sale of Victorian land with an unencumbered value of more than $1 million, they may be liable to duty.
Can conventional fee for service arrangements be subject to the new rules?
Given how broadly the new provisions are drafted, arguably any arrangement where payment is calculated by reference to any of the participation rights described above could be captured.
Recognising this, the Commissioner of State Revenue has released the SRO Economic Entitlements Factsheet, which states that fees for service (such as fees paid to real estate agents, professional advisors such as architects, project managers, planning consultants etc.) that include a percentage of building cost, project value or value uplift will not be subject to the new provisions provided the fee charged is within industry parameters and the service provider is not associated with any other person(s) who has an economic entitlement in relation to the land.
Where the service provider is associated with any other person(s) who has an economic entitlement in relation to the relevant and, the fee for service must be disclosed to the SRO and the person who obtained the economic benefit must provide evidence showing that it is a reasonable fee for service and not a profit-sharing mechanism.
Calculating the value of an economic entitlement and corresponding duty payable
Under the new rules, duty is calculated based on the unencumbered value of the relevant land at the time the economic entitlement was acquired (with a sliding scale where the land is valued between $1 million and $2 million), multiplied by the percentage of the total of all economic entitlements the entity (usually the developer) is entitled to receive in relation to the relevant land.
When determining the percentage of economic entitlements the developer is entitled to, the terms of the agreement will be key such that where the agreement/arrangement:
- provides the entity with an economic entitlement by reference to a stated percentage and nothing else, the beneficial ownership acquired is determined by reference to that stated percentage;
- does not specify a percentage; or include any other entitlements of, or an amount payable to, the person (or their associates); or provides for two or more different categories of economic entitlements, the entity is deemed to have acquired economic entitlements in the land of 100%. This is subject to the Commissioner determining a lesser percentage as he may consider appropriate in the circumstances.
For example, if the development agreement provides that the developer is entitled to a 30% share of profit and nothing else of land with an unencumbered value of $30 million, then:
- the developer is treated as having acquired economic entitlements to 30% of the relevant land;
- the developer will then be liable to pay duty on 30% of the total value of the land ($30 million) leading to duty of $495,000 (i.e., 5.5% x 30% x $30 million).
However, if the developer was also entitled to a payment of the development costs, the developer would be deemed to have acquired economic entitlements to 100% of the relevant land and would be subject to duty on the full $30 million value of the land regardless of the actual benefits that the developer actually received. In such a case, the developer would need to request the Commissioner exercise his discretion to reduce the economic entitlement and corresponding duty.
Currently there is no guidance on how the discretion may be exercised. Based on the examples set out in the SRO Economic Entitlements Factsheet, there is an expectation that the developer must be able to substantiate that the development costs is a reasonable fee for service and does not include an additional element of profit from the development of the relevant land. Further, the payment of the development costs must not be contingent on the development being profitable or any other performance measures associated with the ultimate sale of the development.
Commencement
The new provisions apply to arrangements entered into on or after 19 June 2019.
However, transitional provisions can apply where the landowner and the other entity (e.g., developer) entered into an arrangement prior to 19 June 2019. To access these transitional provisions, the parties must have “committed” to undertake specific actions under which an economic entitlement is acquired prior to 19 June 2019. The example provided by the SRO was a Heads of Agreement entered into prior to 19 June 2019 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”.
What next?
Practitioners acting for clients who are property developers should consider whether the new economic entitlement provisions could potentially apply, and an economic entitlement duty should be factored into the development costs. Consideration should also be given to whether there is a need to make representations to the Commissioner to seek to reduce any unintended duty liability where the 100% deeming rule applies. For existing development agreements entered into prior to 19 June 2019, care should be taken to ensure any amendments do not result in a dutiable economic entitlement.
This article provides a general summary of the subject covered and cannot be relied upon in relation to any specific instance. Webb Martin Consulting Pty Ltd and any person connected with its production disclaim any liability in connection with any use. It is not intended to be, nor should it be relied upon as, a substitute for professional advice.
