The Victorian Government delivered out of the blue a significant change to Victoria’s duty regime in the 2019 State Budget. The changes were introduced as a response to the decision of the Supreme Court of Victoria in BPG Caulfield Village Pty Ltd v Commissioner of State Revenue  VSC 172 (BPG). The nature of the changes to the economic entitlement rules effectively creates a new type of duty.
The new rules, which came into effect on 19 June 2019, will have a significant impact on how development agreements are structured, as they impose a duty liability at the time the agreement is entered, before the property is developed and eventually sold.
The rules before 19 June 2019
The former economic entitlement provisions, which formed part of the landholder duty rules, were originally introduced to capture the use of development agreements (which would otherwise not attract a duty liability, as there was no direct acquisition of land or acquisition of an interest in an entity which holds land).
Duty was chargeable where an entity acquired a right to participate in 50 percent or more of the proceeds of sale or profits from land. However, the former economic entitlement provisions had limited application, as they only applied where the landowner was a unit trust or private company (i.e. not where the landowner was an individual or a discretionary trust).
Further to this, the Supreme Court of Victoria in BPG determined that the former economic entitlement provisions did not apply where an entity acquired the right to participate in the proceeds of sale of some but not all of the Victorian land held by a particular landowner.
The new rules
In response to its loss in BPG and the deficiencies in the previous rules, the Victorian Government introduced the new economic entitlement provisions, which apply to arrangements entered into on or after 19 June 2019.
Under the new rules, a person acquires an economic entitlement where the person enters into an arrangement in respect of land with value exceeding $1 million and is directly or indirectly entitled to:
- participate in the income, rents or profits derived from the land
- participate in the capital growth of the land
- participate in the proceeds of sale of the land
- receive any amount or entitlement determined by reference to the above amounts
- acquire an entitlement to any of the above amounts.
Unlike the previous rules, there is no threshold for the economic entitlement acquired (previously 50 percent) and the rules can apply to any type of landowner (not just unit trusts and private companies).
The new rules are intended to capture arrangements that provide for rights that are economically equivalent to ownership interests. The legislation was drafted broadly as any arrangement where payment is calculated with reference to the profits, capital growth or sale proceeds from land would technically be captured.
This was not the intent of the new rules and the State Revenue Office (SRO) released guidance stating that fees for service (such as real estate agents, architects, project managers, planning consultants and private advisory firms fees) are not subject to the new rules. However, there is no legislative basis for this treatment and it is only the SRO’s administrative view.
How and when is duty calculated on an economic entitlement?
Acquiring an economic entitlement is effectively treated as an acquisition of beneficial ownership in an interest in the land for duty purposes. Where an agreement provides an entity with an economic entitlement by reference to a stated percentage and nothing else, the interest in the land acquired for the purposes of the new rules is determined with reference to that stated percentage. For example, an agreement which provides for an entitlement to 20 percent of the sale proceeds from a parcel of land is treated as an acquisition of a 20 percent interest in the relevant land for duty purposes.
Where an arrangement does not however specify a percentage of the economic benefit entitlement, or include any other entitlement, it is deemed that the person has acquired an interest in the relevant land of 100 percent.
The Commissioner of State Revenue (Commissioner) then has discretion to determine a lesser percentage if the Commissioner considers it appropriate in the circumstances. The taxpayer will effectively need to satisfy the Commissioner that a lesser percentage is appropriate. This creates a great deal of uncertainty and is clearly not a satisfactory practical outcome for developers.
Once the percentage entitlement is determined, the duty is calculated based on the value of the land at the time the economic entitlement is acquired (with a sliding scale where the relevant land has value between $1 million and $2 million). The duty becomes payable within 30 days of the economic entitlement being acquired (essentially the date the development agreement is entered).
Considerations for developers
Development agreement models are not dead, but developers must now be cautious if they are considering using development agreements, and allocate sufficient time and resources to drafting those agreements, as there may be an upfront duty cost when entering into the agreement. Further, future development agreements will need to be drafted carefully to ensure that duty is not chargeable as though the developer has acquired a 100 percent interest in the relevant land.
Other service providers should also proceed with caution when entering into any arrangements involving land where they are entitled to a portion of profits, sale proceeds or capital growth in the land, as the arrangement may also be subject to the new rules.