REAL ESTATE FINANCE and INVESTMENT ALERT
Commentary on the economic impact of COVID 19, including its impact on the property market, has been widespread. The pace of legislative reform associated with COVID 19 has been unprecedented.
Our experience with legislative reform is that other than for the more established and well-funded participants in an industry impacted by the reform, most participants are not fully aware of the impact on their business until it is too late or increasingly costly to adjust their affairs to minimise the consequences of the reform.
In this Alert, we discuss some aspects of recent non-COVID 19 reforms (some of which we have previously reported on (see most recently our June 2020 Alert) which are likely to catch property investors and developers unaware. These are:
- The unknown scope of the NSW Building Industry Reforms;
- The personal liability of directors and managers of companies in the building industry for breaches of the NSW Building Reforms; and
- Some significant potential financial costs for investors in property in NSW.
THE UNKNOWN SCOPE OF THE NSW BUILDING INDUSTRY REFORMS
As reported in our June 2020 Alert, in early June the NSW Government passed the Design and Building Practitioners Act 2020 (NSW) (DBPA) and the Residential Apartment Buildings (Compliance and Enforcement Powers) Act 2020 (NSW)(RABA).
The new additional statutory duty of care contained in the DBPA became effective on assent to the legislation while the other provisions of the DBPA start on 1 July 2021.
The RABA commences on 1 September 2020.
Unfortunately, as you will see below, in the absence of regulations there can be no certainty in relation to the scope and application of a number of key aspects of each Act. At the time of writing this Alert, no regulations have been released for either Act.
Who is subject to the DBPA?
The DBPA imposes obligations on:
- Design Practitioners
- Principal Design Practitioners
- Building Practitioners
- Professional Engineers, and
- Specialise Practitioners,
each as defined or referred to in the DBPA.
Regulations can prescribe additional parties to be Building Practitioners and can also exclude parties from being regarded as Building Practitioners.
All parties involved in a project should determine if they fall within any of the above categories to ascertain whether the DBPA applies to them. Given the nature of the definitions and the ability of regulations to add persons to, or exclude persons from, the definition of Building Practitioners, parties involved in building work should not assume that they are excluded from the scope of the Act.
What sort of work is subject to the DBPA?
The main activity to which obligations relate under the DBPA is “building work”. Building work means:
“work involved in, or involved in coordinating or supervising work involved in, one or more of the following:
- the construction of a building of a class or type prescribed by regulations;
- the making of alterations or additions to a building of that class or type,
- the repair, renovation or protective treatment of a building of that class or type”.
The regulations can prescribe additional work as being building work for the purposes of the Act and can exclude work from being building work.
The new statutory duty of care contained in the DBPA (see our June 2020 Alert) is already in effect and applies to construction work, which includes building work and also extends to:
- “the preparation of regulated designs and other designs for building work;
- the manufacture or supply of building product used for building work; and
- supervising, coordinating, project managing or otherwise having substantive control over any of” the above type of work.
The breadth of the meaning of building work, and the potential for other work to be included by regulation or for exclusions to apply, creates uncertainty as to the scope of the DBPA. Parties who are to be involved in a project will need to do their homework to determine whether or not the project is subject to the Act.
In the case of the new duty of care, parties will need to do their homework in relation to current and past projects as soon as possible due to the retrospective operation of the duty.
Who is subject to the RABA?
The RABA imposes obligations on Developers.
Developers are defined in the Act to mean:
- “the person who contracted or arranged for, or facilitated or otherwise caused (whether directly or indirectly) the building work to be carried out,
- if the building work is the erection or construction of a building or part of a building – the owner of the land on which the building work is carried out at the time the building work is carried out,
- the principal contractor for the building work within the meaning of the Environmental Planning and Assessment Act 1979,
- in relation to building work for a strata scheme – the developer of the strata scheme within the meaning of the Strata Schemes Management Act 2015,
- any other person prescribed by the regulations”.
All parties involved in a project will need to determine if they fall within the meaning of “developer” to ascertain whether the RABA applies to them. Given the broad (and uncertain) scope of the definitions, and the ability of regulations to add persons to the definition of developer, parties involved in residential building work should not assume that they are not developers for the purposes of the Act.
What sort of work is subject to the RABA?
The RABA makes it clear that it only applies to building work in relation to residential apartment buildings. This is defined as being “a class 2 building within the meaning of the Building Code of Australia and includes any building containing a part that is classified as a class 2 component but does not include any building or part of a building” excluded by regulations under the RABA.
Regulations can also extend the provisions of the RABA to other classes of buildings.
Although a Class 2 building is referred to in the Building Code as being “apartment buildings…typically multi-unit residential buildings”, it also includes a building containing 2 or more sole occupancy units each being a separate dwelling. As a result, it can extend to smaller developments than the name of the Act and the term “residential apartment building” implies.
It is unclear whether a mixed-use development, which includes a residential component, would be treated as being a residential apartment building for the purposes of the RABA. This may not be the case where the construction of the non-residential stratum is separate from the residential stratum.
The powers of the Secretary of the Department of Customer Services under the Act (which may be delegated to the new Building Commissioner) can be exercised in relation to residential apartment buildings completed within the period of 10 years before the exercise of the power. Subject to the operation of the transitional provisions, it appears that powers (such as carrying out investigations and issuing rectifications orders) will be available to the Secretary or Building Commissioner for previously completed residential apartment buildings up to 10 years old.
PERSONAL LIABILITY OF DIRECTORS OF COMPANIES IN THE BUILDING INDUSTRY FOR BREACHES OF THE NSW BUILDING REFORMS
It is common for construction projects to be undertaken by special purpose vehicles (SPV’s) established by the sponsors of the project. Generally being companies or unit trusts, they provide a number of benefits including a layer of protection to the ultimate owners of the project in respect of various claims and liabilities associated with the project.
Under each of the DBPA and RABA, liability for a contravention of the Act or regulations by a corporate entity is imposed on both the company, its directors and other persons who are concerned in the management of the entity if the director or other person “knowingly authorised or permitted the contravention”,
This raises risks to directors and managers of companies associated with residential construction projects and reduces the benefits associated with the use of SPV’s.
SOME SIGNIFICANT POTENTIAL FINANCIAL COSTS FOR INVESTORS IN PROPERTY IN NSW
On 24 June 2020, the NSW Parliament passed a number of changes to stamp duty and land tax laws in NSW which will have a major impact on property investors. Some of the more significant ones are discussed below.
Discretionary trusts, and in some cases unit trusts in which a discretionary trust is a unit holder or companies which have a discretionary trust as a shareholder, which own or acquire an interest in residential related property may be subject to significant increases in transfer duty and land taxes if the terms of the relevant discretionary trust deeds are not amended by 31 December 2020.
The effect of the changes is that unless the trust deed of a discretionary trust specifically provides that:
- no foreign person can be a “potential beneficiary”, and
- the terms of the trust cannot be amended to allow a foreign person to become a potential beneficiary in the future,
the trustee will be regarded as being a foreign trustee. It will, therefore, be liable for surcharge purchaser duty (as payable by foreign purchasers) on acquisitions of interests in residential related property in NSW and be subject to the land tax surcharge payable by foreign purchasers in relation to such property owned by the trust. The surcharge purchaser duty is 8% in addition to the normal transfer duty payable. The land tax surcharge is an additional 2% on top of the normal land tax rate.
The term residential related property is not limited to existing dwellings and includes:
- a parcel of land where there are one or more dwellings on the land or a parcel of land on which there is a building under construction that, when completed, will constitute one or more dwellings, and
- a parcel of vacant land zoned or otherwise designated for use for residential or principally for residential purposes.
In order to avoid the above consequences, the Office of State Revenue has given parties affected by the changes until 31 December 2020 to amend their trust deeds so as to exclude foreign persons from being beneficiaries.
Investors or developers which have an investment in residential property or are considering acquiring an interest in such property (see above comments on the meaning of residential related property) using a discretionary trust or a unit trust in which a discretionary trust is a unitholder or a company which has a discretionary trust as a shareholder, may be affected by these changes. For those investments, consideration should be given to amending the discretionary trust deeds as mentioned above no later than 31 December 2020.
If an existing discretionary trust already has any foreign beneficiaries, the relevant parties should get advice as to what can be done to remove such beneficiaries or transfer their interest to non-foreign persons in order to minimise the above consequences.
Note: On 29 July 2020 the NSW Government introduced draft legislation intended to facilitate built-to-rent (BTR) projects. Part of the proposed reforms is to reduce the land tax applicable to such projects and to remove the application of surcharge purchaser duty and the land tax surcharge payable by foreign purchasers in respect of such projects.
We assume this would also apply if a discretionary trust was involved in such project however as the legislation has not been passed this is yet to be confirmed.
Calculation of landholder duty
The threshold, above which landholder transfer duty was payable when a purchaser acquired a 50% or greater interest in a private company or a private unit trust which owned land in NSW worth more than $2m, was previously calculated on the unimproved value of the land. If the property had an unimproved value below this amount, no duty would be payable on the acquisition of shares/units in the land-owning company or trust.
From 24 June 2020, the threshold is calculated on the unencumbered value of land owned in New South Wales, which includes the improvements constructed on the land. This greatly increases the number of transactions to which landholder duty will apply thereby adding to the transaction costs to be incurred by the purchaser.
Rescission of put and call options followed by a new contract with a new purchaser now subject to duty
Investors/developers often enter into put and call options with landowners to secure land prior to entering into a contract to purchase. This can be done for various purposes, including obtaining FIRB approval for the purchase (in the case of foreign purchasers) or development approval for the proposed project (in the case of developers).
One effect of doing so is to delay the time from which transfer duty is payable on the purchase until the option is exercised and a contract for sale entered into.
In circumstances where the purchaser cannot obtain the approvals it seeks, it may wish to rescind/terminate the option. If such termination occurred and the vendor then entered into a contract to sell to a third party, no duty was previously payable by the original proposed purchaser.
The Duties Act 1997 has now been changed so that if there is an arrangement under which the vendor agrees to sell the property to a third party and the initial proposed purchaser is released from the option, the arrangement will be treated as if the initial purchaser assigned the call option to the third party. This will result in the initial purchaser being liable for transfer duty on the value of the property, in the same manner as if the call option had been assigned to the actual purchaser.
As a result, investors/developers need to carefully consider how they can secure a property, while seeking any approvals they need to proceed, without triggering these new provisions. Getting this wrong will prove to be very costly.
The property industry has been significantly affected by COVID 19. The Stage 4 Victorian lockdown has highlighted this even more. Given this, the timing of the introduction of the above legislation (which is not related to COVID 19), other than the proposed concessions for BTR projects, is unfortunate as they each place additional costs and stress on an industry which is already considering how to move forward in the new world we live in (and will continue to live in for many years to come).
These legislative changes will also impact on the ability of developers and investors to obtain finance and the terms of such finance.
A new world indeed.
Please feel free to contact us to discuss any of the above or any loan facilities, current or future, in respect of which we may assist you in negotiating changes to fairly account for your financial circumstances and navigating the increasingly complex provisions found in such documents to so we can achieve better commercial outcomes in your finance arrangements.
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The comments made in this Alert do not constitute the provision of any legal, tax or accounting advice by Peter Faludi Consulting or any Director or employee thereof and therefore you should not rely on this Alert in making any decisions relating to present or future transactions in which you are involved. We strongly recommend that you seek legal, tax and/or accounting advice (as relevant) in relation to the same.
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