Victoria's new tax will strike hard after a 10 year sleep
The tax reform checks the boxes of the Treasury number crunchers. It does ultimately replace the inefficient upfront transfer duty (some call it stamp duty) on a property purchase. Yet it retains the rivers of gold from that until the unstoppable tide of annual CIPT revenues come flooding in. And it is that very mechanism which makes the tax switch so audacious – a property's first purchase occurring from 1 July 2024 will have duty imposed one last time.
Upfront transfer duty, then 10 years of hibernation, and only then does the CIPT first apply. One by one, every commercial and industrial property in Victoria will eventually be sucked into the tax reform vortex. From the first properties acquired in late 2024, the tax base expands to cover all such properties across the whole state. This unique model gives the reform its power but also its contradictions.
Politically saleable yet draconian
The CIPT reform seems like a textbook tax switch – find a narrow, yet informed, taxpayer base and replace one tax they do not like with a better tax. Sell the easily explainable benefits – the upfront cost of the property becomes lower, less borrowing is required and the Commonwealth income tax deduction for the purchaser’s state tax is no longer delayed until the property is sold.
But this is where it gets complex…and dangerous. In a textbook tax switch, one tax is completely replaced by the other. Australia’s wholesale sales tax ended at midnight on 30 June 2000 and one second later, Howard’s GST replaced it. Under former NSW Premier Dominic Perrottet’s ambitious but short lived reform in 2023, first home buyers had the option to pay upfront duty or, instead, an annual property tax, but not both.
By contrast, the Victorian reform imposes transfer duty one last time on the first purchase from 1 July 2024 and imposes 1% CIPT on the site value of the same property starting 10 years later and maintains the existing land tax all the way through. It seems a draconian level of tax on a struggling taxpayer base – a property sector populated by retail tenants facing competition from online platforms and office tenants needing less space with employees wanting to continue their COVID experience of working from home.
Beneficial yet dangerous
Like so many complex matters, understanding is easier when you digest a comparable example. Let’s journey in Dr Who’s Tardis through to the year 2036 where you are looking at three adjacent industrial park units (5, 7 and 9 Mary St, Mulgrave) all identical in size and value (market price and site value). Looking back, 5 Mary was last sold in late 2024 and thus has experienced CIPT in 2035 and 2036. 7 Mary was sold in 2029 and will first experience CIPT in 2040. 9 Mary continues to be held by the owners who acquired it pre-2024. Thus, 5 Mary already incurs CIPT, 7 Mary will soon incur CIPT and 9 Mary may not incur CIPT for decades.
If you are looking through the eyes of a prospective buyer, then duty will not apply on your acquisition of 5 or 7, although if you acquire 5 Mary, you will be paying CIPT from the first year. You will pay upfront duty if you acquire 9 Mary but not CIPT for 10 years. You will probably be attracted to 7 Mary (no duty, and no CIPT for 4 years).
If you are looking through the eyes of a prospective tenant, then the lease for 5 Mary may require you to pay outgoings including CIPT from the first year. For 7 Mary, you may pay outgoings including CIPT from 2040. For 9 Mary, the outgoings may never incur CIPT hence you will probably be safer taking a lease over it.
The critical factor may be whether the landlord can recover CIPT as an outgoing from the tenant under the proposed lease (or the current lease to be assigned). Whether the landlord can do so will be affected by the Victorian Retail Leases Act. It has been amended to prevent landlords increasing outgoings for CIPT on those that qualify as retail leases (as it similarly already does for land tax).
If a property can fall into one of three categories, planning opportunities abound for those who know and remember the tax and danger awaits for those who do not. A tax that lies in hibernation for 10 years before awakening and springing to life. Will everyone know and remember the tax when it is their turn. Your accountant undertaking a due diligence on a land rich company purchase, your lawyer drafting the new lease, the bank lending manager for your refinancing, your property manager, your development planner, your divorce lawyer, your executor? It will only take one to forget the hibernating tax at their critical moment and, unless you are on the ball, surely there will be strife.
During the NSW Labor campaign to oppose Perrottet’s First Home Buyers’ Annual Property Tax Option, the most potent line of attack was that it was “a forever tax”. In Victoria, even if one critical party forgets the hibernating tax, the financial pain could be forever.
This may explain the psychology behind the surprising concession of a duty transition loan. If your purchase, from 1 July 2024, is of a commercial or industrial property with a value of up to $30m, you can pay off the upfront duty through 10 equal annual instalments (including interest). Take up the duty transition loan and you are less likely to forget and more likely to have the financial discipline to manage the hibernating tax when it awakens.
Delayed yet immediate
The same amount of transfer duty will be imposed on your commercial or industrial property whether you purchase on 30 June 2024 or the next day. However, if you do acquire it on 1 July 2024, then annually from 1 January 2035, you will pay 1% CIPT on your site value for as long as you hold the property. What a difference a day makes!
Surely any prospective purchaser of commercial or industrial property will want to execute the contract of sale before 1 July 2024. Act immediately to escape the delayed tax. Surely any street smart vendor across the table will be tempted to play hard ball, extracting that extra condition or price increase in the knowledge of how much is at stake for the purchaser. Surely, many property lawyers in Victoria will be at work on Sunday 30th June 2024.
What happens when you sell?
If you are the first purchaser of a property from 1 July 2024, you will escape the hibernating tax if you sell within 10 years, but the purchaser from you? Sure, the reform means that duty will no longer apply on their or any later purchase. But the tax hibernation ends 10 years after you purchased it, not 10 years after they did. Will such property purchasers agree a price forgetting that the hibernating tax could awaken at some point soon after their purchase?
Narrow yet expansive
Tax laws, like all laws, are an exercise in drawing lines in the sand. Boundaries drawn by words to segregate human activity. On this side of the line, the human activity is taxed, on the other side it is not. Like lines in beach sand, word boundaries are never straight and human activity never so simple that it neatly fits on one side rather than the other. The crafting of the scope, entry and transition rules for an otherwise narrow base of future commercial and industrial property purchases struggles with this reality. The following issues demonstrate that CIPT will strike in unexpected ways.
Mixed use property
Mixed use properties on a single title are common enough, for example, a terrace with a retail or hospitality outlet downstairs and a residence above it. For the first sale from 1 July 2024, if the primary use is commercial or industrial, the property will enter the reform. 10 years from then, if the primary use has not changed, the CIPT will apply on the entire site value including the residential part.
Determining the primary use of mixed use properties by way of the land or floor area ratios should be straight forward. However, SRO’s guidelines suggest that the Commissioner of State Revenue will ascertain the primary use and “no single factor will be determinative”. The Commissioner may consider other factors such as the “intensity of use”, level of investment and amount of return of each use and zoning. Will the Commissioner give more certainty via clear guidelines given the significant downstream consequences for affected parties?
Purchasing fractional interests
The reform applies where an interest of 50% or more of the commercial or industrial land is acquired. Thus, if you acquire an interest between 50%-99.9% of land, the entire land enters the reform and in 10 year’s time, the joint owners will be subject to CIPT. A duty transition rule applies though. If the remaining unsold interest is subject to a sale within three years of your acquisition, its purchaser will be subject to duty.
The tax planning seems obvious here. Some purchasers might acquire just 49% of the interests in land to protect that investment from future CIPT. Others might acquire just 50% of the land and wear the duty on that and future CIPT knowing that their acquisition of the remaining 50%, for example in four years, will escape duty.
Land consolidations
A land consolidation can enter land into the tax reform scheme provided that 50% or more of the consolidated land has previously entered the reform. The date on which the consolidated land enters the reform is the first date on which land that forms part of the consolidation entered the CIPT reform. Imagine that you bought a gymnasium on a land parcel of 2,000sqm in 2010. On 30 November 2024, you acquire the 5,500sqm smash repair yard next door. This latter parcel has now entered the CIPT reform. On 30 April 2033, the local council sells you the crucial adjoining parcel of 2,500sqm enabling your commercial development dream to proceed. The three parcels are consolidated on 30 June 2033. The entire 10,000sqm parcel is subject to CIPT from January 2035, Yes, all of it, even the parcel acquired in 2010 and the parcel first acquired in 2033. For the first parcel, the usual 1 July 2024 transition rule, and for the third parcel, the 10 year hibernation rule, get washed away in the high tide.
Landholder acquisitions
Landholder transactions are likely to be the most complex area for the new reform. Assume that, from 1 July 2024 you make a relevant acquisition of the 100% of the shares in a relevant landholder company and its sole asset is 100% ownership of the freehold in an office block that has an unencumbered value at more than $1m. Landholder duty applies on the land’s value and 100% of the land has entered the reform (unless Corporate Consolidation & Reconstruction Relief applies). Future sales of either the land, or it appears, the shares will not attract duty. Such transactions will inevitably bring substantial parcels of pre 1 July 2024 owned land into the reform without needing the land itself needing to have been purchased from that date.
Let’s look closer at a contrasting example where you only acquire 50% of the landholder company’s shares in one transaction. Duty applies on 50% of the land’s market value and it seems that 100% of the land has entered the reform to be subject to CIPT in 10 years. By contrast, if you acquired 10% of the shares in 2025 and 40% in 2030, you might pay landholder duty on that 40% but the land has not entered the reform hence will not be subject to CIPT. We will have parallel systems running where both the CIPT and Duty implications need to be considered in respect of future purchases of either the land or anyone’s shares. It becomes especially complex where the company also owns land that is not commercial or industrial.
The landholder duty payer is the entity that acquired the shares or units under a relevant acquisition. However, the CIPT taxpayer is the owner or joint owners of the land itself. Let’s assume that later you sell your 50% shareholding in the company. You have escaped the CIPT, but it remains for the landowner company itself. It is as if the devious mind behind the crime gets an early release from prison under parole, while the unwitting accomplice gets a life sentence.
Conclusion
The Treasuries in the states and territories that are facing high levels of debt will be looking closely at the CIPT and many may be willing it to succeed. They will be observing the transition process and no doubt the effect on revenues, property prices and the political fallout. Their thinking will be, if Victoria can succeed with the tax switch on commercial and industrial property, then perhaps we can too. And if we can succeed with that property sector, perhaps we can succeed with residential property as well.
The Federal Treasury and the two main parties will also be watching closely. The two decades of tax reform inertia at the Federal level might end if they see a bold tax increase working.
The reality, though, is that the practical impact and difficulties of Victoria’s new tax will remain obscured while it hibernates. Only when it awakes from its 10 year slumber will its pain and complexity become fully known. And only when it does so will we know who in the property sector including their lawyers, accountants and their other advisors were also asleep when it really mattered.
For more information on CIPT please contact your usual Forvis Mazars advisor or alternatively the author, Stephen Baxter on 07 9922 1166.
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Published: 21/06/2024
Author: Stephen Baxter
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