Victoria phases out duty on commercial and industrial property
By Jim Koutsokostas and Bradley White
The Victorian Government has announced that transfer duty (formerly ‘stamp duty’) will be phased out for commercial and industrial properties from 1 July 2024. Instead, an annual 1% tax on the unimproved value of such property will be introduced (Annual Property Tax). This was announced as part of the state’s Budget, handed down on 23 May 2023.
On the same day that NSW introduced legislation to turf out its new annual property tax, Victoria is going its own way. Where NSW failed, Victoria may succeed. In contrast to its NSW equivalent, the broader application of the Victorian Annual Property Tax to commercial and industrial land may cement its success – and its potential extension to residential land in years to come.
In short, the first time a parcel of commercial or industrial land is transferred after 1 July 2024, the transferee will still have to pay transfer duty, either:
- as a lump sum; or
- over 10 years, in annual instalments and at interest.
Ten years after the transfer of that property, the Annual Property Tax will apply, locking that property into the new system (apparently, regardless of whether the transfer duty was paid as a lump sum or in annual instalments). This means subsequent transfers of that property will not trigger a transfer duty liability, but will instead be subject to the Annual Property Tax.
The Annual Property Tax will not impact industrial and commercial property acquired before 1 July 2024, but only once such property is transferred (and therefore permanently entered into the new regime).
The announcement is brief, and raises a number of questions – which we hope will be resolved during industry consultation.
How will the Annual Property Tax be administered?
Questions remain as to the administration of the Annual Property Tax. What will be the definition of ‘commercial’ and ‘industrial’? Does the Government currently have the data available to determine whether a property is commercial or industrial, rather than residential? Will it include primary production land used in a farming business (and therefore potentially ‘commercial’)? Will apportionment apply for land that is mixed use?
A good starting point may be the concepts used for the Victorian regional commercial, industrial and extractive industries property duty concession.
Otherwise, we could potentially look to the ‘land use code’ system of South Australia, which abolished stamp duty on transfers of all property except for residential and primary production property. The South Australian Valuer General effectively assigns a code to each property based on its current use. When the property is later transferred, this code is then used to ascertain its current use, and therefore whether duty should apply.
How will the Annual Property Tax work with other duty rules and taxes?
It will be interesting to see how the Annual Property Tax will interact with landholder duty, duty on economic entitlements and duty on sub-sales, to name a few. Perhaps these rules will only apply to land that is not classified as commercial or industrial – such as residential land. These classifications are yet to be defined.
Additionally, the Victorian Government has not yet mentioned whether the Annual Property Tax will also replace land tax. As it is given no mention in the announcement, it is likely that the Annual Property Tax will be charged alongside land tax.
In respect of federal income tax, it is likely that the Annual Property Tax will be treated similarly to duty and land tax – that is, as a holding cost of a CGT asset and therefore added to the asset’s cost base. But, as an annual cost, will it be deductible similarly to land tax in certain limited instances? Or will it be considered a cost of holding a capital asset?
What happens if the property is sold within 10 years of the first post-1 July 2024 transfer?
Where a parcel of commercial or industrial land is transferred after 1 July 2024, and the transferee opts to pay the relevant transfer duty over 10 years, will the balance of that liability need to be paid prior to or at the time of any subsequent transfer of that property within that 10-year period?
We would expect that upon that subsequent transfer being made, the property will be immediately subject to the Annual Property Tax.
What exemptions will apply?
The announcement did not contain any detail regarding the availability of exemptions.
For example, duty exemptions currently apply (in certain circumstances) to:
- transfers of properties to charities;
- contributions of land by owners to their superannuation funds; and
- distributions of land from trusts to beneficiaries.
We would hope to see existing transfer duty exemptions largely replicated for the Annual Property Tax, so that taxpayers are not disadvantaged.
What will the interest rate be on duty deferred?
The transfer duty charged on the first transfer of commercial or industrial property after 1 July 2024 can be deferred and repaid annually over 10 years – but at interest. No indication has been given as to the rate of interest. In other instances (eg the new Windfall Gains Tax regime), the 10-year Australian government bond rate (currently 3.618%) has been adopted. Whether a consistent approach is applied here remains to be seen.
This Annual Property Tax may be seen as a boon for businesses and is being touted as one. The benefit it provides for the acquisition of new business property is undeniable – the reduced upfront purchase costs should mean the additional funds can be reinvested in the growth of the business. On paper, it should provide businesses with greater flexibility, enable new property acquired at a reduced up-front cost, and property being transferred more easily between related entities.
Transactions under consideration: to defer or not to defer?
On one reading of the announcement, any first purchaser of commercial or industrial property after 1 July 2024 is potentially worse off. In addition to transfer duty (either paid up-front or deferred), they will also be subject to the Annual Property Tax after 10 years.
This is being billed as a way to soften the impact of a transition to the new Annual Property Tax, but may not achieve that in reality. Purchasers of commercial and industrial properties may be worse off under this proposal, given transfer duty is charged on the greater of the unencumbered (market) value of the property and consideration paid for it, whereas the Annual Property Tax is to be charged on the unimproved value of the land. Where the improvements on the land are of substantial value, this transitional measure may dilute the effect of this measure, and possibly produce a worse outcome for some transferees.
Therefore, in most cases, a business considering acquiring such property within the next year or two, may be considering whether the acquisition should occur before 1 July 2024.
We expect that the announcement is likely to cause some short-term uncertainty and distortion of the Victorian commercial property market, as buyers weigh up the costs of delaying transactions against the potential cost savings that may be realised from the (as yet, unenacted) measure.
This announcement may also have material impacts upon the settlement of certain commercial and private disputes, which require the transfer of interests in Victorian land. Again, parties to any such settlement may be considering whether it is in their best interests to delay the finalisation of the dispute.
What does this mean for tenants and landlords?
A key question is whether landlords will try to pass on Annual Property Tax to tenants under their lease agreements. No doubt new leases will begin to specifically mention the Annual Property Tax, although generic ‘rates and taxes’ clauses in most existing leases will likely be wide enough to capture the tax. Property fund managers will also likely need to factor in the Annual Property Tax and its impact on investor returns.
The Retail Leases Act 2003 (Vic) precludes the recovery of land tax – will the Government amend that legislation to exclude the Annual Property Tax as well?
What does this mean for financiers?
The reduction in the upfront cost of purchasing a property may reduce leverage for borrowers. However, financiers must be mindful of the risk that a borrower does not pay the Annual Property Tax.
This has the potential to erode the financier’s security position as it is likely that the Annual Property Tax will be a statutory priority that must be paid first in a mortgagee sale. Financiers may impose annual reporting obligations on borrowers and specific covenants regarding on-time payment of the tax.
Where to next?
Key details of the reform will be revealed later this year, after consultation with industry. Between now and 1 July 2024, we anticipate that businesses will be considering whether existing or planned acquisitions (or divestments) of commercial or industrial property should be fast tracked (or delayed).
This article was written with the assistance of Tracey Hoffman, Law Graduate.
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