D-Day for development agreements
Significant changes to the imposition of duty in Victoria commenced on 1 July 2019, and it is far from business as usual. Partner Nicholas Stevens explains how the duty regime has changed and why developers, fund managers and financiers need to tread carefully.
It is common for developers to undertake projects under arrangements that involve title to the development land being retained by the landowner and control of the land for development activities being granted through a development agreement. If structured correctly, a chief advantage of this approach is the duty saving ordinarily incurred in a direct transfer of land to the developer.
Under a typical development agreement, the developer is entitled to charge the landowner for the development costs incurred and a margin on those costs and/or a share of the profits derived from the project. Unique to the Victorian duties regime, the "economic entitlement" provisions can create a duty liability in relation to the monies received by developers under these sorts of contractual arrangements. Importantly, the pre-existing economic entitlement provisions would only be triggered where—
- the landowner was a company or unit trust, and so did not include an individual landowner or a discretionary trust (eg a family trust).
- the developer (including its associated entities) is entitled to receive 50 percent or more of a prescribed list of "economic entitlements" derived from the development (eg the proceeds of sale, rental income or capital growth).
Under these rules, developers were often able to successfully structure transactions outside the ambit of the economic entitlement provisions.
With the flow of funds to State coffers at risk of running dry from a drastic reduction in property related duty revenue, the widely used tax advantages of development agreements were low-hanging fruit for the Victorian State Government. In a substantial overhaul of the existing provisions, the new-look economic entitlement regime is far broader in its application and devastating to the utility of the historical development agreement structure.
The key changes are:
- The provisions now apply to all individual, corporate and trust landowners (not just companies and unit trusts) that have a land value greater than $1 million.
- The 50 percent threshold is no longer required for the provisions to apply.
- The economic entitlements are treated as a beneficial interest in the land, with duty imposed on the percentage of beneficial interest acquired in the land. This can have an impact on the tax treatment of future transactions undertaken by the developer. There is also potential for the entitlement to trigger landholder duty if the developer is a company or unit trust scheme.
- The developer is deemed to have acquired a 100 percent beneficial interest in the land if the development agreement does not specify the developer's percentage of the economic entitlement or this cannot be determined. This is a particular risk where there are references to multiple species of payments or entitlements to the developer and/or their associates.
- The Commissioner of State Revenue has a wide discretion to determine the developer's beneficial interest in the land and can take into account various fees or bonuses payable to the developer or their associates in determining that calculation. This is irrespective of whether the party receiving the benefit is a party to the agreement.
The changes apply to all agreements on and from 1 July 2019. The assignment or variation of any pre-existing agreements should be carefully considered to ensure any impact of the new provisions arising from the assignment or variation is understood before proceeding.
How and when is duty charged?
Generally, duty is payable on the percentage of the developer's beneficial interest acquired in the land multiplied by the market value of the land at the time the liability is incurred.
The liability to pay duty arises when the economic entitlement is acquired, rather than when the benefit of the entitlement is received. For example, the liability to pay will occur on signing the development agreement, as opposed to receipt of funds at settlement of the development land.
Unintended consequences for fund managers
The impact of the changes is not limited to business carried on by traditionally structured property developers. The wide net cast by these reforms is causing serious concern for the fund managers we assist to operate development and debt funds investing in Victorian projects.
Seeking to impose duty on any entity that acquires an economic entitlement in relation to Victorian land, the scope of the new provisions can technically be applied to a range of commercial arrangements where fees are charged by reference to capital growth or property sale proceeds. Common examples for the funds management industry include fund management fees, performance fees and project management fees. When applied literally to these types of transactions, the provisions seem to go far beyond the stated objectives of implementing the new measures.
In response to industry concern, the State Revenue Office (SRO) has issued non-binding guidance on the application of the new provisions. While these purport to offer some relief where the entity is providing "genuine industry fees" for service, the position will need to be examined on a case by case basis.
Financiers not immune
Financiers making a "preferred-equity" style investment in projects will find themselves in a similar position to developers and need to consider the implications of the new economic entitlement provisions to those arrangements.
The changes are far reaching and could negate the feasibility of development agreements to undertake or finance real property. Developers, fund managers and financiers should—
- revisit existing investment models and documentation before entering into new transactions involving Victorian land
- seek tax and legal advice on the optimal structure moving forward for these transactions.
Our lawyers can work with you and your tax advisors to assist with structuring advice and ensure documentation is clearly drafted in accordance with the legislation and SRO guidance.