College of Law. Autumn Intensive CLE Seminars. Stamp Duty Update, addressing Vendor Duty and Land Rich Vendor Duty. by Anthony Johnston.

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1 - 1 - College of Law Autumn Intensive CLE Seminars Stamp Duty Update, addressing Vendor Duty and Land Rich Vendor Duty by Anthony Johnston 24 March 2005 About the Author Anthony Johnston BA/LLM is a special counsel in the Tax Group at Allens Arthur Robinson where he has specialised in stamp duty for the last 7 years, including GST in more recent times. Prior to this, he worked for 2 years as a full-time consultant at the NSW Office of State Revenue, helping to develop what became the Taxation Administration Act 1996 and the Duties Act Prior to that, he worked as a manager in the State Taxes Group at KPMG for 18 months. He has been a member of the OSR/Law Society Liaison Committee for most of the last 19 years. He was a part-time lecturer in stamp duty courses at UTS for several years.

2 - 2 - Stamp Duty Update - Vendor Duty and Land Rich Vendor Duty This paper contains 4 parts as follows. Part 1 Issues Common to Both Taxes. Part 2 Land Rich Vendor Duty Part 3 Vendor Duty Part 4 - Key Points. Vendor duty and land rich vendor duty are found in the Duties Act 1997 (the Duties Act). In relation to the 2 taxes, land rich vendor duty will be considered first, since it has not been around for very long. We have already had nearly a year to get used to vendor duty. Will they last? Part 1 Issues Common to Both Taxes Only a few weeks ago, there was a meeting between industry representatives and the new NSW Treasurer of New South Wales (NSW), Andrew Refshauge. The new Treasurer indicated that vendor duty and land rich vendor duty were being monitored but that no changes would be made before the next budget. The next budget is due in May 2005, so we should know soon whether these taxes will last. Some criticisms of them have been that: 1. They have not collected the amount of revenue that was budgeted for. 2. They may be lowering overall revenue. That is, if their effect has been to reduce the number of land transactions per annum, the amount of purchaser duty collected per annum would be reducing because of vendor duty (since, by definition, fewer sales means fewer purchases). 3. They have deterred investment in NSW and made investment in other places more attractive by comparison (in particular, in Queensland). 4. This investment trend looks like continuing, because no other Australian jurisdiction has introduced vendor taxes. 5. They do not operate fairly since there are no grandfathering provisions. Accordingly, investors are being hit with taxes which did not even exist when they made their investment decisions years ago. 6. The 12% profit exemption does not operate fairly, because it is worked out without taking into account expenditure on capital improvements. 7. The timing is wrong. That is, vendor duties have not served to hose down an overheated market; instead, they have increased the fall in an already falling market.

3 - 3 - The government's argument in favour of the new taxes is that their introduction was necessary in order to fund the concessions to first home buyers which were introduced at the same time. I have no crystal ball. I do not know how long these new taxes will last. However, bearing in mind that they are so unpopular, that they are not collecting much revenue and that the Treasurer who introduced them has now retired, it may well be that they will be abolished in May. For the time being, however, we need to deal with them. Drafting Trap Standard cost and taxes clauses commonly provide that: the purchaser will pay all stamp duty on this agreement and all transactions contemplated by it or words to that effect. In the past, this type of clause has worked reasonably fairly. However, since vendor taxes have been introduced, purchasers and their solicitors should be on the alert for such clauses and their possible consequences. The legislation requires the vendor to pay vendor duty and land rich vendor duty 1. However, the parties can contract otherwise. That is unobjectionable if they have turned their minds to these taxes and reached agreement, for example, that the purchaser will pay them rather than the vendor. However, problems will arise if the purchaser finds himself required by the vendor to pay these taxes under a clause of the kind described above, where there was no pre-contractual negotiation or agreement to that effect. In the past, the standard form contract for sale of land has been silent about stamp duty liability. In the absence of express agreement, the duty would be payable by the party liable under the legislation. However, such clauses are often included in other agreements such as: business sale agreements; share or unit sale agreements; option agreements; and heads of agreement. It is common for such documents to contain "catch all" costs and taxes clauses which pass on the liability for all duties to the purchaser. Since the introduction of vendor duty and vendor land rich duty, the prudent purchaser (and his legal adviser) would be wise to negotiate amendments to such standard clauses which "carve out" the following taxes under the Duties Act, namely: duty payable under Chapter 4 (vendor duty); and duty payable under Part 3 of Chapter 4A (land rich vendor duty). Doing so will ensure that the vendor rather than the purchaser remains liable for those taxes (unless, of course, something else has been agreed). 1 See s151 for vendor duty and s163r for land rich vendor duty

4 - 4 - Part 2 Land Rich Vendor Duty The Duties Amendment (Land Rich) Act 2004 introduced vendor land rich duty in a new Chapter 4A of the Duties Act, to apply retrospectively from 10 November What is land rich vendor duty? Attached as Appendix 1 is a table which contains a list of questions and answers which are intended to sum up the main features of land rich vendor duty. How does land rich vendor duty work? The new tax operates as follows: A liability for duty arises when a significant interest holder makes a relevant disposal of an interest in a land rich entity. A significant interest holder 2 is a person who currently holds, or who has previously held at any time in the previous 3 years, a significant interest 3 in a land rich entity (20% or more for private unit trusts and 50% or more for wholesale units trusts and private companies). A land rich 4 entity is what it has always been. That is, the same "land rich" tests will be used to determine whether a company or trust is land rich for both land rich acquisition duty purposes and land rich disposal duty purposes. A relevant disposal 5 is any disposal of shares or units, provided the disposal is made by a significant interest holder. That is, there is no minimum disposal threshold before a liability for land rich disposal duty arises. When a relevant disposal occurs, duty is payable by the person who makes the disposal at vendor duty rates (currently 2.25%) based on the value of all NSW landholdings of the landholder multiplied by the percentage interest disposed of. What type of tax is this is it an anti-avoidance measure? The bill containing the vendor duty provisions was introduced to Parliament in May Six months later, the bill containing land rich vendor duty was introduced. In these circumstances, it would be tempting to regard land rich vendor duty as simply a backup for vendor duty. That is, if you were planning to sell land in NSW land and expected to pay vendor duty on the sale, you should also expect to pay an equivalent amount of land rich vendor duty if you sell the company or unit trust which owns the land, rather than the land itself. 2 See s163n(2) 3 See s163d(2) 4 See s163b 5 See s163n(1)

5 - 5 - On this basis, land rich vendor duty could be regarded as an anti-avoidance measure. That is, one aimed at ensuring that the same duty is paid when an entity is sold rather than the NSW land owned by the entity. That is the rationale given in the second reading speech in the Legislative Assembly when Graham West, Parliamentary Secretary and member for Campbelltown said: Just as acquisition duty is necessary to protect the transfer duty tax base, it is necessary to tax the indirect disposal of interests in land to protect the vendor duty tax base. As a result the measure introduced by this bill will not increase revenue from incidence of erosion of the tax base 6. vendor duty. It will, however, reduce the It might be remembered that land rich duty was introduced in 1986 for much the same reasons. That is, it was aimed at recovering the same duty when a "land rich" entity was sold as would have been payable if the underlying land had been sold, rather than the entity. However, most of us would be aware that land rich duty has become much more than simply a backup for conveyance duty. It has now become a tax in its own right. In the same way, land rich vendor duty should, in my view, be regarded as a tax in its own right, not just as a backup for vendor duty. Comparison with traditional land rich duty Some differences between acquisition duty and disposal duty are as follows: 1. Land rich acquisition duty applies to the purchaser (or acquirer) of an interest in a land rich company or trust. Land rich disposal duty applies to the vendor (or disposer) of an interest. Now both can be liable to duty in respect of the same transaction. 2. Any disposal, however small, can trigger a liability for land rich disposal duty. By contrast, land rich acquisition duty is only payable when a significant interest is acquired or increased. 3. A liability for land rich acquisition duty attracts duty at conveyance rates (up to 5.5%). A liability for land rich disposal duty attracts duty at vendor duty rates (currently 2.25%). Some similarities between acquisition duty and disposal duty are as follows: 1. Both are found in Chapter 4A of the Duties Act. 2. The same definitions apply, by and large, for both taxes. 3. The one transaction can give rise to a liability for both taxes. 4. Both involve lodgement of a statement in the prescribed form and the payment of duty on the statement. 5. Both require lodgement of a statement even where the acquisition or disposal is exempt. What type of tax is this is it a schizophrenic tax? As its name suggests, land rich vendor duty, has elements of 2 taxes, namely: land rich duty; and vendor duty. 6 See Hansard for 10 November 2004

6 - 6 - This being the case, should it be regarded primarily as a land rich duty, or primarily as a vendor duty? In my view, it is neither. Instead it is something of a hybrid. That is, while it has elements of each component tax, it has features all of its own that make it best regarded as an entirely new tax, not just a different manifestation of either land rich duty or vendor duty. However, if you prefer to regard it as one or the other of its component taxes, then it is probably has more similarities with land rich duty than with vendor duty. In other words, it will be easier to come to grips with if thought of as a variant of land rich duty, rather than as a variant of vendor duty. How does land rich vendor duty fit into the Duties Act? Land rich vendor duty was not just tacked onto the Duties Act. Instead, its introduction involved: removing the traditional land rich provisions from Chapter 3; relocating them in a new Chapter 4A; and reworking those provisions so that they incorporated land rich vendor duty provisions as well. With respect, the Parliamentary Counsel should be congratulated for the neatness with which this task of integration has been achieved. The new Chapter 4A contains: Part 1 which contains definitions which apply to both types of tax; Part 2 under which land rich acquisition duty is charged; Part 3 under which land rich disposal duty is charged; Part 4 which contains general principles applicable to both types of tax; Part 5 which contains exemptions and concessions applicable to each type of tax; and Part 6 which contains exemptions applicable to disposal duty alone; and Part 7 which provides for registration of unit trust schemes. It should be noted that: 1. Chapter 4A distinguishes between land rich acquisition duty (which we have been living with since 1986) and land rich disposal duty (which has only just been introduced). 2. The core definitions with which we are familiar (eg land rich, private unit trust scheme, private company, land holdings, significant interests) apply to both acquisition duty and the new disposal duty. 3. Many of the exemptions are the same for both taxes (see Part 5) although there are several which apply only for disposal duty (see Part 6). 4. There is now a regime for registering unit trusts (see Part 7).

7 - 7 - Calculating Disposal Duty Exempt Landholdings Although all of the landholdings of an entity will continue to be taken into account for the purposes of determining whether an entity is land rich, certain landholdings are excluded when it comes to calculating the duty payable on a relevant disposal. Exempt if applicable vendor duty exemption A landholding is exempt (ie. not counted for the purposes of calculating duty) if the Chief Commissioner is satisfied that a direct transfer of the land would have been exempt from vendor duty on the basis of one or more of the following vendor duty exemptions: exemption for farms (section 162H); exemptions for new and substantially new buildings (Division 4 of Part 5 of Chapter 4); improved vacant land (section 162S). The exemption for new and substantially new buildings can be claimed once only in relation to a disposal by a person or an associated person. This means that a landholding will not be an exempt landholding on the "new buildings" basis in relation to a relevant disposal if the landholding has previously been claimed to be an exempt landholding on the same basis in relation to a previous disposal. Accordingly, persons wishing to rely on this concession should consider whether they should dispose of their interest in the relevant landholder in one single disposal, because they can only rely on the concession once. Profit exemption There is also an important exemption for a NSW landholding which has not increased in value by more than 12% since the date the person making the relevant disposal first acquired an interest in the company or trust, or since the date that the company or trust first acquired the landholding, whichever is the later. Where the increase in value of a particular parcel of land is between 12% and 15%, there is a phasing-in of the duty. This is similar to the vendor duty provisions applying to direct dealings in land. In applying these tests, improvements made after acquisition are taken into account in working out the value on disposal. However, the cost of the improvements is not added to the acquisition cost of the land for the purposes of the 12% test. That is, the duty may be payable even where there has been no real profit, or there has even been a loss. Passive Disposals A liability for duty can arise from a passive disposal, such as the issue of new shares or units which dilutes the interest of existing investors. This possibility arises because a liability to land rich disposal duty is triggered when a person ceases to have an interest in a landholder, or the person's interest decreases, regardless of how that happens. However, duty will not be imposed on a passive disposal if the Chief Commissioner is satisfied that the disposal occurs entirely as a consequence of actions, decisions or events over which the owner

8 - 8 - of the interest (and associated persons) had no control, and the person and associated persons do not receive any consideration or benefit as a consequence of the disposal (see 163ZP). Two points to note about this concession are: It depends on the Chief Commissioner being satisfied of the relevant matters. Therefore, it is necessary to apply for the exemption. It is not possible to self-assess. The Chief Commissioner must be satisfied that neither the person nor any associated persons had any control over the actions, decisions or events leading to the disposal. It may be difficult to so satisfy the Chief Commissioner where, for example, the relevant person is a director of a land-rich company, or where the relevant unitholders of a trust control the corporate trustee. Transitional Provisions Land rich vendor duty applies to relevant disposals occurring on or after 10 November 2004 (the date the Bill was introduced into Parliament). However, transitional provisions exclude disposals made pursuant to an agreement entered into before 7 May 2004 (the date the original vendor duty bill was introduced into Parliament). The provisions apply to disposals by persons who have held a significant interest in a land rich entity at any time during the period of three years prior to the disposal. However, the 3 year period does not extend back prior to 10 November In summary, land rich disposal duty will apply to disposals occurring on or after 10 November 2004 by a person who: holds a significant interest (20% or 50%) at the time of the disposal; or has held a significant interest at any time during the previous 3 years (not counting significant interests held prior to 10 November 2004). Registration of Unit Trust Schemes Like Victoria, NSW has now introduced a regime requiring registration of: wholesale unit trusts; imminent wholesale unit trusts; and imminent public unit trusts. Once registered, these schemes will be subject to the 50% significant interest threshold, rather than the 20% threshold which applies to private unit trust schemes. So there is an incentive for registering. However, for the purposes of land rich disposal duty only, imminent public unit trust schemes and imminent wholesale unit trust schemes will be regarded as private unit trust schemes whether or not they are registered. Consequently, for the purposes of considering whether a relevant disposal has been made by an investor in an imminent public unit trust or imminent wholesale unit trust, the threshold for determining whether the investor is (or was previously) a significant interest holder will be 20% (rather than 50%).

9 - 9 - A trust which satisfied the definition of "wholesale unit trust scheme" under the former provisions will be treated as if it were registered during a transitional period expiring on 30 June By then such trusts are expected to have been registered. If not, the transitional relief will end and they will be subject to the 20% threshold until they get registered. To date, the Register of Wholesale Unit trust Schemes published on the website of the Office of State Revenue (OSR) only discloses 2 trusts which have been registered under Part 7 of Chapter 4A. There are similar transitional measures which treat certain trusts as registered imminent public unit trusts or registered imminent wholesale unit trusts for a transitional period of 12 months. However, once that expires, they will need to be actually registered in order to have the benefits of registration. Compliance Costs Land rich acquisition duty has always had the potential for significant compliance costs. These costs arise from the need to apply various tests to determine whether an entity is land rich. Sometimes the outcome is clear cut - the land assets are clearly worth less than $2m or they are clearly below the 60% threshold. However, when the outcome is not clear cut, applying the tests can be expensive because the taxpayer may need to obtain expert valuation and legal advice. Where land rich acquisition duty is at stake, the transaction will usually involve the acquisition of a significant interest (20% or 50%). However, in the case of land rich disposal duty a disposal, no matter how small, can attract a liability, if it is made by a person who has held a significant interest during the previous 3 years. In the case of a small disposal, the costs of establishing whether or not there is a liability are likely to be disproportionately high - they might even exceed the duty at stake. Consequently, compliance costs will generally be a bigger issue for land rich disposal duty than for land rich acquisition duty. They may well prove a deterrent for those contemplating a small scale disposal. For both acquisition duty and disposal duty purposes, a wholesale unit trust scheme will only be eligible for the 50% (rather than 20%) significant interest threshold under the new provisions if it is registered with the Chief Commissioner as such. Accordingly, the new provisions introduce an additional cost for a wholesale unit trust scheme - the cost of becoming registered.

10 Part 3 Vendor Duty The State Revenue Legislation Amendment Act 2004 introduced vendor duty in a new Chapter 4 of the Duties Act, to apply from 1 June Since then, Chapter 4 has been amended by the State Revenue Legislation Further Amendment Act 2004 (being Act No 67 of 2004) and the Duties Amendment (Land Rich )Act 2004 (being Act No 96 of 2004). What is vendor duty? Attached as Appendix 2 is a table which contains a list of questions and answers which are intended to sum up the main features of vendor duty. How does vendor duty work? Vendor duty operates as follows: 1. A liability for vendor duty arises when a vendor duty transaction occurs in respect of a landrelated property. 2. A vendor duty transaction is: (a) (b) (c) a transfer of land-related property an agreement for sale or transfer of land-related property; or a declaration of trust over land-related property 3. Land related property is: (a) (b) (c) land in NSW; a land use entitlement (basically, something equivalent to company title); an interest in (a) or (b) 4. When a vendor duty transaction occurs, duty is payable by the vendor at vendor duty rates of 2.25%. Transactions not subject to vendor duty The following land transactions which are subject to duty elsewhere in the Duties Act are not subject to vendor duty: 1. the grant of a lease (which in the usual case would be liable for lease duty on the "cost" and for transfer duty on the premium under Chapter 5); 2. the surrender of a lease (which in the usual case would be liable for purchaser duty under Chapter 2); 3. statutory vesting and vesting by court order (which in the usual case would be liable for purchaser duty under Chapter 2); and 4. the transfer of an option (which in the usual case would be liable for purchaser duty under Chapter 2).

11 Exemptions Various exemptions have been allowed as follows: 12% profit threshold exemption; sale of business (less than 60% land) exemption; principal place of residence exemption; exemption for new and substantially new buildings; exemption if transaction not liable under Chapter 2 as a dutiable transaction; Chapter 11 exemptions include vendor duty (eg corporate reconstructions); improved vacant land exemption (the Landcom exemption); exemption for gifts to charities; exemption for farms; various miscellaneous exemptions. Some of these deserve closer consideration as follows. Sale of business (less than 60% land) exemption (S162T) If a business is being sold and its assets include NSW land, vendor duty will be payable unless the dutiable value of the NSW land assets of the business is less than 60% of the total dutiable value of all sold assets which are dutiable property. To apply this test, you need to identify all sold assets which are dutiable in NSW (the dutiable property) and then determine what proportion of their value is made up of NSW land assets. This approach can have some unexpected results. Example 1 Assume a business is sold for $10m. All its assets are in NSW. They comprise: Asset Value Proportion of total price Dutiable property? Relevant Percentage NSW land $4m 40% yes 80% plant & equipment $1m 10% yes 20% stock in trade $3m 30% no N/A debtors $2m 20% no N/A $10m 100% 100% Here the value of NSW land is $4m, which is only 40% of the total sale price. However, the value of "dutiable property" is $5m. Accordingly, NSW land comprises 80% of the dutiable property. Consequently, the transaction fails the 60% test and vendor duty will be payable on the $4m.

12 Example 2 Assume a business is sold for $10m. It is conducted from Victoria and has assets in Victoria and NSW. Its only NSW asset is vacant land in NSW worth $1m (acquired with a view to expansion into NSW). Here the value of NSW "dutiable property" is $1m. Although that is only 10% of all business assets being sold, it is 100% of the NSW dutiable property being sold. Consequently, the transaction fails the 60% test and vendor duty will be payable on the $1m. 12% profit threshold exemption (S162J) No vendor duty is payable if the dutiable value of the land-related property on the transfer date exceeds the dutiable value of the land-related property on the "vendor acquisition date" by not more than 12%. In a simple sale of freehold land, you compare the sale price with what the vendor paid when he acquired the property to apply the percentage test. The cost of improvements made by the vendor between acquisition and sale is not taken into account in working out the "profit". Within the 12-15% range, the tax phases in as follows: 75% discount if between 12-13%; 50% discount if between 13-14%; 25% discount if between 14-15%. The vendor acquisition date is the date on which the vendor first acquired a legal or equitable interest in the land-related property. However, where the vendor is the legal personal representative of a deceased person, the vendor acquisition date is taken to be the date on which the deceased person first acquired an interest. If the vendor is selling/transferring a leasehold interest: and the vendor acquired the lease by a dutiable transaction (eg it was assigned to the vendor), the dutiable value on the vendor acquisition date is the dutiable value of the leasehold estate when it was so acquired; and the vendor did not acquire the lease by a dutiable transaction (eg it was initially granted to the vendor), the dutiable value on the vendor acquisition date is the unencumbered value of the leasehold estate on the vendor acquisition date (that is, you can apply the percentage test even if no premium paid when the lease was granted). The profit threshold only determines whether the tax is payable. If payable, the tax is charged on the total sale price, not the profit.

13 Overcoming GST distortions in working out profit - s162n(5) There is a provision whereby distortions resulting from GST are supposed to be taken into account in working out the profit (otherwise, the 10% GST uplift could well eliminate the effect of the 12% profit threshold). The provision is s162n(5) which is as follows: If the Chief Commissioner is satisfied that GST is payable in respect of a vendor duty transaction, and that the transaction by which the vendor acquired the land-related property on the vendor acquisition date was not the subject of GST, the dutiable value of the land-related property on the vendor acquisition date is to be increased, for the purposes of this Division only, by 10%. The operation of this provision can be illustrated by an example, as follows. Assume that Blackacre: was acquired for $100 before the introduction of GST; and is now sold for $150 plus GST; the total consideration payable by the purchaser who pays a GST-inclusive price is $165. Section 162N(5) works out the profit for the purposes of applying the 12% profit test as follows. from $165 being the GST-inclusive sale price deduct $110 being the deemed acquisition price pursuant to s162n(5) giving a $55 profit However, the real profit in this case would be only $50 (not $55). The real profit is the profit worked out after disregarding the distorting effect of GST, as follows. from $150 being the GST-exclusive sale price deduct $100 being the actual acquisition price giving a $50 profit Accordingly, while s162n(5) attempts to overcome the distorting effect of GST, and while it is better than nothing, it does not operate to give the real profit when actually applied. Margin Scheme complications Unfortunately, s162n(5) only applies where the original acquisition was not subject to GST. Consequently, it will not apply where the margin scheme applied to the original acquisition. This could cause an unfair result where the original acquisition was under the margin scheme but little or no GST was actually paid in respect of it (for example, there may have been a nil margin). In such circumstances, vendor duty may be payable because of a notional 12% increase in the price resulting from GST of 10% being paid on the sale, even though there may be no real profit at all (or a profit of much less than 12%). As currently drafted, s162n(5) can even operate against the revenue. For example, if there was no GST payable on the acquisition of a property because the acquisition occurred before the commencement of GST on 1 July 2000 and the property is now sold under the margin scheme, then bumping up the dutiable value on the acquisition date by a full 10% may artificially reduce the real profit, bearing in mind that the GST payable on the sale under the margin

14 scheme may be much less than 10% of the price (because GST under the margin scheme is 10% of the margin, not 10% of the price). For example, assume that: Blackacre was acquired pre-gst for $100; it is now sold under the margin scheme for a GST-inclusive price of $122; the margin for GST purposes is $22 ($122 - $100); and the GST payable on the sale under the margin scheme is $2 (1/11 th of $22). In such circumstances, s162n(5) would apply because GST is being paid on the sale of Blackacre under the margin scheme and the acquisition of Blackacre was not subject to GST. Accordingly, s162n(5) would operate to bump up the acquisition price from $100 to $110. The 12% profit test would then be applied as follows. from $122 being the GST-inclusive sale price under the margin scheme deduct $110 being the deemed acquisition price pursuant to s162n(5) giving a $12 profit Accordingly the profit in this case, calculated in accordance with s162n(5), is not greater than 12% and so the sale would be exempt from vendor duty under s162j. However, the real profit in this case would be $20 (not $12). The real profit is the profit worked out after disregarding the distorting effect of GST, as follows. from $120 being the GST-exclusive sale price deduct $100 being the actual acquisition price giving a $20 profit A profit of 20% is obviously greater than 12% and, if calculated on this basis, the exemption should not apply. However, under s162n(5), it will. This is an anomalous outcome for the revenue and is another illustration of why s162n(5) would benefit from some amendment. Section 162N(5) could be made more fair by amending it so that GST payable on both the acquisition and the disposal is ignored when working out whether there has been a 12% profit. Vendor Duty under 2005 edition of the standard Contract for Sale of Land The new edition of the standard form contract has been settled, but is not yet available in print. However, from an article by Tony Cahill in the March 2005 issue of the Law Society Journal, it appears that vendor duty will be addressed in the new contract as follows: on page 1 there is a disclosure as to whether or not vendor duty is payable (default:no); on page 1 there is a disclosure as to whether or not the deposit can be used to pay vendor duty (default:no); the warning about a potential liability for stamp duty has been expanded to include a warning about vendor duty;

15 clause 3 deals with paying vendor duty out of the deposit; and clause 4 deals with getting exempt stamping, where no vendor duty is payable. Clause 4 provides that if the vendor serves a vendor duty exemption application on the purchaser within 7 days of the contract date, the purchaser must have the transfer marked exempt before it is submitted for execution by the vendor. Unless amended, the contract provides that the purchaser can charge a $33 fee, by way of a settlement adjustment, for assisting in this way. This clause seems to accord with what is presumably the usual procedure where a vendor duty exemption applies, namely a procedure whereby the vendor's solicitor: prepares the contract and exemption application at the same time; gets them signed by the vendor at the same time; and hands them both over on exchange. Where the deposit is used to pay vendor duty under clause 3, quite elaborate provisions apply as follows: 1. The amount of deposit moneys released: (a) (b) (c) (d) cannot be greater than the vendor duty payable; must be drawn in the form acceptable to the OSR; can only be used to pay vendor duty; and cannot be released earlier than 14 days before the completion date. 2. If deposit money is released and it is found that vendor duty is not actually payable: (a) (b) the cheque must be returned, if the duty has not yet been paid; and if it has been already paid, the vendor must lodge a refund application and request the OSR to pay the refund to the stakeholder. 3. The deposit moneys cannot be used to pay vendor duty unless the amount held by the stakeholder exceeds the vendor duty payable (so the clause would not apply if a deposit bond was used, instead of actually paying the deposit to a stakeholder). Releasing the deposit (or part of it) is obviously not to be agreed to lightly. Among the consequences can be: the loss by the purchaser of the money released if the sale falls through because the vendor becomes insolvent and the mortgagee steps in to carry out a mortgagee sale; and the time for paying the GST by the vendor is brought forward (because the release of deposit moneys to discharge a liability of the vendor is probably sufficient to trigger the payment of all GST payable on the transaction on the basis that it is a payment of part of the consideration).

16 The Cascading Effect Working out the amount of vendor duty payable is straightforward where the vendor is paying it. For example, if Blackacre is sold for $100 and vendor duty is payable and the vendor pays it, the vendor duty will be $2.25, being 2.25% of the dutiable value of the transaction (in this case, the consideration). The position becomes more complicated where the parties have agreed that the purchaser will pay the vendor duty on behalf of the vendor. The purchaser might think that he was undertaking an obligation to pay a total of $ ($100 + $2.25) in such circumstances. However, if the purchaser pays $102.25, then the consideration on which the vendor duty is calculated in such circumstances would be at least $102.25, which would give rise to a liability for vendor duty of $2.30, not $2.25. In this way, a difficulty arises in calculating the amount of duty because the subject matter of the calculation (the consideration) is being increased by the very thing which is being calculated (the vendor duty). The calculation difficulty that this causes is generally referred to as the "cascading effect". Overcoming the Cascading Effect - S158(3) There are various ways of eliminating the cascading effect. The most simple way is to insert an overriding provision in the legislation to the effect that, where the purchaser has agreed to pay vendor duty on behalf of the vendor, the amount of vendor duty payable should be calculated in the same way as if the vendor duty were being paid by the vendor. That is, the dutiable consideration should be determined as though the vendor duty gross up was not part of the consideration. In fact, when the vendor duty provisions were first introduced, s158(3) operated in just that way. It operated so that, if Blackacre were sold for $100, then $2.25 would be payable by way of vendor duty whether the vendor was paying it himself or the purchaser had agreed to pay it on behalf of the vendor. However, this simple approach was quickly abandoned. Schedule 2[4] of the Duties Amendment (Land Rich) Act 2004 inserted a replacement s158(3). The amendment operated from the date of assent to that Act, namely 15 December The new provision is not nearly as simple as the original one. This may be because it also covers the situation where the purchaser agrees to pay the vendor's GST, not only where the purchaser agrees to pay the vendor's vendor duty. In order to overcome the cascading effect, the new s158(3) applies in this way. Example 1 Where the purchaser pays the vendor's GST but not the vendor's vendor duty In this case, the vendor duty is worked out under s158(3)(a) as though the GST reimbursement amount was 10% of the price (even though it will usually be more than that).

17 To illustrate this, on a sale of Blackacre for $100 the vendor duty will be worked out as though the dutiable consideration was $110 made up as follows. $100 for Blackacre $10 (10% of $100) on account of the vendor's liability for GST $110 Pursuant to s158(3), the vendor duty on this deemed consideration would be $2.48 (2.25% of $110). For GST purposes, the consideration would be $ ($100 plus $2.48), which would give rise to a GST liability of $10.25 (10% of $102.48). That would require a GST gross up of $10.25, rather than the $10 deemed under s158(3)(a) to be the GST gross up. Example 2 Where the purchaser pays the vendor's vendor duty but not the vendor's GST In this case, the vendor duty is worked out under s158(3)(b) as though the vendor duty reimbursement amount was 2.25% of the price (even though it will usually be more than that). To illustrate this, on a sale of Blackacre for $100 the vendor duty will be worked out as though the dutiable consideration was $ made up as follows. $ for Blackacre $2.25 (2.25% of $100) on account of the vendor's liability for vendor duty $ The vendor duty on this would actually be $2.30 (2.25% of $102.25), not the $2.25 deemed under s158(3)(b) to be the vendor duty gross up. Example 3 Where the purchaser pays the vendor's GST and the vendor's vendor duty In this case the consideration (and hence the vendor duty) will be worked out under the combined operation of s158(3)(a) and (b) as though: the GST reimbursement amount was 10% of the price (ignoring amounts payable on account of GST and vendor duty); and the vendor duty reimbursement amount was 2.25% of the aggregate of the price and the deemed GST payable. To illustrate this, on a sale of Blackacre for $100 the vendor duty will be worked out as though the dutiable consideration was $ made up as follows. $ for Blackacre $10.00 (10% of $100) on account of the vendor's liability for GST $2.48 (2.25% of $110) on account of the vendor's liability for vendor duty $ The vendor duty on this would actually be $2.53 (2.25% of $112.48), not the $2.48 deemed under s158(3) to be the vendor duty gross up.

18 For GST purposes, the consideration would be $ ($100 plus $2.53), which would give rise to a GST liability of $10.25 (10% of $102.53). That would require a GST gross up of $10.25, rather than the $10 deemed under s158(3)(a) to be the GST gross up. In summary, where Blackacre is sold for $100 and the purchaser agrees to pay the vendor's GST and vendor duty, s158(3) operates to give the following results: Deemed consideration Actual consideration Price $ $ GST gross-up $10.00 $10.25 Vendor duty gross-up $2.48 $2.53 $ $ In summary, s158(3) takes a deeming approach. It works out the vendor duty by taking the actual price and adding a deemed GST gross-up and a deemed vendor duty gross-up in order to arrive at a deemed aggregate consideration for the purposes of calculating the vendor duty payable. Implications of the deeming approach As will be seen from this example, the amount of vendor duty payable on a transaction will increase where the purchaser has agreed to gross it up and pay it on behalf of the vendor. That is, $2.25 would be paid on the sale if the vendor paid the duty himself. However, pursuant to s158(3) the vendor duty becomes $2.30 where the purchaser has agreed to gross it up. This is only an increase of 5 in this example. However, this amounts to a proportionate increase of 2.25%. To take a more realistic example, if a commercial building is sold for $10m the vendor duty would be $225,000 if the vendor pays it. If the purchaser pays it, the duty amount will increase by approximately $5,000 to a total of just over $230,000. The OSR website contains a calculator to assist the taxpayer to calculate vendor duty when it is payable. Unfortunately, it is not sophisticated enough to take into account the situations described above. That is, it will not help you calculate vendor duty when the purchaser is grossing up either the vendor's GST or the vendor's vendor duty. 7 Drafting Suggestions Section 158(3) applies: if the monetary consideration expressed to be paid or payable by the purchaser under the vendor duty transaction includes an amount payable to discharge the vendor's liability for GST and/or vendor duty. On a strict reading, this seems to require the gross up amounts for GST and/or vendor duty to be quantified and specified in the contract before the section can apply. 7 Another uncertain issue is how s158(3) would operate where the vendor duty rate is discounted so that it is effectively less than 2.25%, such as where it is phased in under s162k

19 On this basis, to trigger s158(3) in relation to example 2 above, the contract should be drafted so as to require the purchaser to pay the vendor the following amounts: $100 for Blackacre $2.30 on account of the vendor's liability for vendor duty $ Section 158(3) then comes into play by calculating the dutiable value (the total consideration) on a deemed approach, rather than an actual approach. On this basis, to trigger s158(3) in relation to example 3 above, the contract should be drafted so as to require the purchaser to pay the vendor the following amounts: $ for Blackacre $10.25 on account of the vendor's liability for GST $2.53 on account of the vendor's liability for vendor duty $ While adopting the above drafting suggestions should assist in ensuring that s158(3) applies where it is needed to avoid the cascading effect, it is to be hoped that s158(3) would be applied even where the gross up amounts were not specified in the contract. That is, it is to be hoped that the OSR would not insist on separate specification of the gross up amounts before being prepared to work out the relevant vendor duty payable in such circumstances in accordance with s158(3) bearing in mind that, unless s158(3) is applied, it may be impossible to work out the duty because of the cascading effect. Scope for Structuring Where the purchaser has agreed to pay the vendor's GST and/or vendor duty on behalf of the vendor, there would be some advantages in selling the entity which owns the land rather than the land itself, where that choice is open. A sale of a land rich entity is liable for land rich vendor duty charged at the same rate as vendor duty. However, land rich vendor duty is charged on the unencumbered value of the underlying land of the entity being acquired 8 rather than the consideration payable (which would be the dutiable value for calculating vendor duty in the case of an arms' length transaction). Also, no GST is payable on a share or unit transaction, since it is an input taxed supply for GST purposes (so there will be no increase of the dutiable consideration on account of GST where an entity is sold, rather than the underlying land). Consequently, if GST and/or vendor duty will be payable and the purchaser is reimbursing the vendor for these taxes and the choice is between selling Blackacre or selling the entity which owns Blackacre, then it would be preferable to sell the entity rather than Blackacre, because less duty will be payable. 8 See s163s(1)

20 In example 3 above, the vendor duty would be $2.48 because the duty is charged on the consideration of $100 plus additional consideration in the form of the GST gross up amount and the vendor duty gross up amount. However, if the entity which owns Blackacre is sold instead, then the land rich vendor duty will be only $2.25, because duty will only be charged on the value of Blackacre, which is $100. That is % more duty will be payable in this example if Blackacre is sold rather than the entity which owns Blackacre. Also, because no GST is payable, the purchaser will avoid the cost of funding a GST gross up, if the entity is purchased rather than Blackacre. Another advantage for the purchaser is that the duty on the land rich acquisition will also be less because it will be charged on the unencumbered value of Blackacre, rather than on a consideration which has been increased because of gross up payments. These comments assume that the unencumbered value of Blackacre would be determined by a valuer without regard to GST. That would seem to be a reasonable assumption. However, whether or not that is the case is ultimately a valuation question. How is vendor duty working, operationally? Recent enquiries of the OSR indicate that, generally, vendor duty is operating smoothly. However: legal practitioners who stamp electronically have been coping with vendor duty better than those who don t; and the principal place of residence exemption (the PPR exemption) has caused the OSR more administrative hassles than any other aspect of vendor duty. Don t assume that the PPR exemption will apply just because your vendor client wants to claim it. The OSR warns that many applicants for this exemption find that they do not qualify when they try to come within the parameters of the exemption, as set out in the legislation. Consequently, this seems to be a case of ensuring that you obtain informed instructions. Comparison of Taxes The final attachment to this paper is a table in Appendix 3 which makes some comparisons between land rich acquisition duty, land rich disposal duty and vendor duty.

21 Part 4 Key Points The key points to take away from this talk might be summarised as follows: 1. When acting for purchasers, beware of costs and taxes clauses which might pass on vendor duty or land rich vendor duty to the purchaser, where that has not been negotiated and agreed. 2. If a transaction is eligible for exemption from land rich vendor duty, the same statement must still be prepared and lodged with the OSR as would be required if it were liable for duty, rather than exempt. 3. When the new contract comes into use, look carefully at the new provisions covering vendor duty and consider whether they will be acceptable to your client (whether you are acting for the vendor or purchaser). 4. If a contract requires the purchaser to pay vendor duty and/or GST on behalf of the vendor, calculate the amount of the GST gross up and/or vendor duty gross up payable in accordance with s158(3) and insert the amount(s) in the contract, so that s158(3) can operate to overcome the cascading effect. 5. If a purchaser has agreed to pay the vendor's GST and vendor duty, there will be less duty payable overall if the purchaser is able to buy the entity which owns Blackacre rather than Blackacre itself (because duty on an entity purchase is based on the unencumbered value of the land, rather than on a "dutiable value" in the form of a consideration which is artificially increased by tax gross up payments). 6. A significant interest threshold of 50% (rather than 20%) will only apply to a wholesale unit trust scheme if it is registered under Chapter 4A. 7. A trust which was a "wholesale unit trust scheme" under the previous provisions will be treated as if it were registered during a transitional period expiring on 30 June By then such trusts are expected to have been registered, otherwise, they will become subject to the 20% significant interest threshold, like all other private unit trusts.

22 Appendix 1 Land Rich Vendor Duty Question Answer When did it start? 10 November 2004 Where does it apply? NSW only What is the rate? 2.25% (but discount of duty payable if phasing in applies 9 ) Who pays it? Can it be passed on to the purchaser? Is this a tax on instruments? What is taxed? What is a relevant disposal? What is a significant interest holder? A person who makes a relevant disposal Yes, by agreement No, but a statement must be prepared and lodged A "relevant disposal" A disposal of any interest in a land rich company or unit trust by a significant interest holder A significant interest holder is a person who currently holds, or who has previously held at any time in the previous 3 years, a significant interest in a land rich entity What is a significant interest? 20% or more for private unit trusts; and 50% or more for wholesale units trusts and private companies What is an interest? What is a land rich entity? An interest is an entitlement to a distribution of property from a landholder on a winding up or otherwise same threshold tests as for land rich acquisition duty Threshold land value percentage $2m Threshold land value percentage 60%, but 80% if landholder is a primary producer and stays one for 5 years When does a liability arise? When must land rich vendor duty be paid? When a relevant disposal occurs within 3 months of a liability arising Where are the provisions? In Chapter 4A of Duties Act 1997 Can a liability be exempted by way of corporate reconstruction relief? By analogy with land rich acquisition duty, yes, but only under the "just and reasonable" discretion (S163ZB(2)). See also paragraph (7) of guidelines in Ruling DUT See s163zj

23 Appendix 2 Vendor Duty Question Answer When did it start? 1 June 2004 Where does it apply? What is the rate? Who pays it? Can it be passed on to the purchaser? Does it apply to the sale of leasehold and other interests in land? Does it apply to sales by an executor, receiver, mortgagee in possession? Is this a tax on instruments? What is taxed? NSW only 2.25% (but discount of duty payable if phasing in applies) Vendor or Transferor (or person declaring a trust, if applicable) Yes, by agreement Yes, but not to the grant of a lease Yes for executors, but exemption for sales by receivers and mortgagees No, but they can be stamped on account of it A "vendor duty transaction" in respect of "land-related property" What is a vendor duty transaction? transfer agreement for sale or transfer declaration of trust What is land-related property? (a) land in NSW (b) a land use entitlement (c) an interest in (a) or (b) What is duty calculated on? Dutiable value of land-related property How is dutiable value determined? Greater of consideration and value (same as Chapter 2) When does a liability arise? When must vendor duty be paid? When must vendor duty be paid on an agreement for sale/transfer? In a normal sale, what is stamped? Are both dutiable? Are business sale agreements dutiable? When a transfer occurs (or is taken to occur) Generally, within 3 months of a liability arising On settlement, if for consideration and there is a transfer on completion (even if settlement > 3 months after exchange) The contract and transfer Transfer not chargeable if made in conformity and contract stamped (but still requires stamping) Yes, if land sold (subject to relevant exemption) Where are the provisions? In Chapter 4 of Duties Act 1997 Can a liability be exempted by way of corporate reconstruction relief? Yes (S162Y)