King & Wood Mallesons welcomes the opportunity to respond to Treasury's consultation paper on a possible approach to replacing stamp duty and land tax in New South Wales with an alternative annual property tax (Paper).
King & Wood Mallesons acts for a range of participants in the property sector Australia-wide. While our experiences with these clients have informed our views, the views expressed in this submission are our own and are not provided on behalf of any particular client.
We provide below some specific observations in relation to some, but not all, of the topics raised by the Paper, where we believe we can provide constructive comments and feedback. We have kept our observations in this letter relatively brief. However, we would welcome the opportunity to engage with Treasury and other stakeholders to discuss our observations in more detail.
2. Executive Summary
2.1 Key observations
(Voluntary opt-in approach) A number of issues that arise from the current proposal stem from the voluntary 'opt-in' nature of the proposed property tax. While we understand the rationale for this approach, allowing taxpayers to transition to the new regime at their own pace and having regard to their own individual circumstances, it also raises a number of challenging issues. Unless these can be overcome, they have the potential to create distortions in the market which may undermine the economic benefits sought to be created from the proposed changes.
(Valuation concerns) Assessing tax based on unimproved land values presents challenges and introduces uncertainty for taxpayers, leading to the prospect of costly disputes between taxpayers and the State. This can only be addressed by ensuring that the valuation methodology used to assess value is transparent and the inputs into the valuation process are clear and capable of being readily understood by taxpayers. This is essential to instil confidence and trust in the system. We recognise that land tax is already assessed on unimproved values. However, land tax falls on relatively few landowners compared to the proposed property tax.
- (Rate of tax) The potential for increases in the rate of tax, coupled with likely increases in the value of the property, creates further uncertainty for taxpayers, and has the potential to distort the decision making process. Consideration should be given to what legal mechanisms could be used to provide taxpayers with assurance and transparency relating to future rate increases.
- (Classification of property) The Paper suggests that different rates of property tax will apply to different classifications of property. Presumably, although not entirely clear, different opt-in value thresholds will apply depending on the classification of the property in question. We highlight the need to tread carefully when delineating how property will be classified for the purposes of the property tax regime, noting the various approaches historically adopted to this issue in a taxation context.
- (Application of the surcharges and exemptions) The Paper does not expressly contemplate the existing foreign purchaser surcharge which applies when a foreign person acquires residential-related property in New South Wales. While it may be a simple enough matter to impose a surcharge rate of property tax to properties owned by foreign persons, careful consideration should be given as to whether the surcharge should apply across all categories of property and whether any exemptions should be available (for example, the exemption which currently applies for foreign developers of residential housing stock).
- (Transactions concerning interests in land that are not freehold interests) The present duties legislation imposes transfer duty on dutiable transactions over dutiable property, such that the types of transactions which are subject to transfer duty are much broader than just agreements to transfer, and transfers of, freehold. This means that the same property can be subject to multiple incidences of transfer duty depending on how it is transacted (for example, the property may be the subject of a put and call option with a nomination right or a declaration of trust). Presumably, given the complexity of decisions already facing purchasers under an
opt-in system, it will be necessary to maintain some parity between the property tax regimes and the transfer duty regimes. This assumes that these other categories of dutiable transaction are intended to be preserved under the property tax regime.
2.2 Nature and timing of reforms
- Given the complexity of the issues raised by the proposal, we would strongly caution against rushing to any particular announcement. The basic proposal to move away from transactional stamp duties in favour of a broad based property tax is not new. The economic and productivity advantages of a broad based land tax are well documented. But any transition will be challenging and settling on the preferred model for transition should not be rushed. As the Henry Tax Review recognised, in this very context, transitional arrangements are important to build community acceptance and to minimise potential disruption (Recommendation 54).
- It follows that any changes to the taxation of property in New South Wales require careful consideration of both the short and long term consequences, as well as a modelling of outcomes, to ensure that the reform achieves its objective and does not simply result in additional complexity, uncertainty and cost.
3. Issues arising from the voluntary 'opt-in' approach
- The proposal to allow purchasers to choose between paying stamp duty upfront, or paying an annual property tax, has the advantage of allowing taxpayers to decide what is best for their circumstances.
- While this may be attractive to some taxpayers, it leads to a 'two-tier' property system, where properties that have been opted in are subject to the annual property tax and those that have not remain subject to stamp duty. There may be ways to address, or at least mitigate, this by, for example, making the transition from stamp duty to an annual property tax mandatory upon the first transfer of ownership post-commencement for properties in certain designated areas. This should eliminate some of the complexity that comes with effectively segregating the market into properties that have opted in and those that have not, although there would still be segregation between properties that are in the designated area and those that are not.
- Given the proposal that, once a property has been opted-in it cannot (on a later dealing) be opted-out, it is not quite right to say that taxpayers can decide what is best for their own circumstances. The decision will be out of their hands, if the property they wish to purchase has already been opted-in.
- Taxpayers who might, for any number of reasons, prefer to pay stamp duty upfront on their property purchase may be dissuaded from purchasing properties that have already been
opted-in. The property market is effectively divided into two types of property – with potentially different groups of prospective buyers.
- This is not a short term issue. As the Paper notes, the expectation is that even after 20 years, only up to 50% of all properties would have been transitioned into the annual property tax regime.
- We suggest that consideration be given to alternative options for transition. The Henry Tax Review (pages 267-269) considered a number of options (including a voluntary opt-in approach) to facilitate a transition from stamp duty to a property tax which could be considered.
- There are a range of other issues that arise from having stamp duty and the property tax run in parallel, even for a time. There are, for example, a range of issues relating to the operation of the various duty exemptions that apply on certain changes in ownership and how those exemptions might be incorporated into an 'opt-in' property tax.
- Issues also arise in a development context. Consider, for example, a scenario where a developer acquires 3 parcels of land for the purposes of development. Two of the parcels have been
opted-in and one has not. If the separate titles require amalgamation and subdivision, what tax character will be attributed to the sub-divided lots? To mandatorily subject them to the annual property tax seems inconsistent with the voluntary 'opt-in' nature of the proposal (and may have an impact on the economics of the development itself). We appreciate that these are quite specific issues, which descend into a level of detail that (understandably) may not have yet been considered. But they do serve to highlight the wide ranging impacts of the opt-in nature of the proposal.
4. Valuation concerns
- The Paper proposes that the property tax be based on the unimproved land value of an individual property, as determined by the Valuer General.
- While stamp duty is also assessed by reference to value, in a transaction between unrelated parties acting at arm's length, the purchase price for a property will typically reflect its market value and be the amount on which stamp duty is paid. Taxpayers have certainty as to how much stamp duty they will be required to pay.
- With a property tax based on unimproved land values, which will change over time, taxpayers have less certainty as to what their tax liability will be during their period of ownership.
- This is exacerbated by the challenges that come from the administration of unimproved values. Taxpayers are capable of readily assessing the likely market value of a property (they make that assessment in determining the price they are prepared to pay), but are less able to assess the likely unimproved land value of a property. Consequently, unimproved land values are more liable to be challenged by landowners, resulting in greater potential for costly disputes for landowners and the State.
- We recognise that unimproved values are recorded on the valuation register, giving purchasers the ability to assess at the time of purchase what the annual property tax will be (based on that value). However, buyers will not be able to assess how the unimproved value (and therefore their annual tax liability) may change during their future period of ownership. This issue does not arise in relation to stamp duty.
- To mitigate this, the inputs into the process for assessing unimproved land values need to be clear and the valuation methodology needs to be transparent. This requires more than just educating taxpayers on existing processes – it requires a review of current processes to determine how they can be enhanced to provide taxpayers with the level of certainty that is needed to instil confidence and trust in the system.
5. Rate of tax
- Linked to the issue of certainty is the issue of changes in the rate of the property tax.
- A key feature of the proposal is the ability for taxpayers to decide what is best for their own circumstances. That is, whether they prefer to pay stamp duty upfront or pay an annual property tax. In making that choice, taxpayers need a sufficient level of certainty.
- The prospect of changes in the rate of annual tax is a factor that taxpayers are likely to weigh up in deciding whether or not to opt in. The potential for increases in the rate of tax, coupled with likely increases in the value of the property, creates uncertainty and has the potential to distort the decision making process, both of which have the potential to undermine the effectiveness of the reforms.
- While it is unrealistic for the State to commit to a particular rate of tax in perpetuity, it is worth considering what legal mechanisms could be used to provide taxpayers with assurance and transparency relating to future rate increases.
6. Approach to classification of property
- The Paper suggests that different rates of property tax will apply to different classifications of property. Specifically, a different rate of property tax will apply depending on whether property is owner-occupied residential property, investment residential property, primary production land and commercial property.
- We presume that the price threshold at which a property may be opted into the property tax regime could also vary depending on the classification of the property in question.
- In our experience, while it might be fairly simple to distinguish between owner-occupied and investment residential property in an urban context, whether or not a property meets an express legal test can be challenging when the land in question is mixed use, its zoning changes over time, or it is redeveloped and/or subdivided over time. In these cases, it is important to have clearly delineated criteria, to ensure that the owners (or purchasers) of such property can estimate their ongoing property tax liabilities with the required degree of certainty.
- Different governments within Australia have approached the issue of classifying property for taxation purposes in a variety of ways. There is no "one size fits all" approach and, in some cases, questions as to the classification of property need to be resolved at the discretion of the relevant taxing authority or the courts.
- Consideration should be given to the best method of classifying property having regard to the need to protect the revenue base, the need for certainty for taxpayers and the prospect in achieving a system that is easy to administer by government (i.e. with minimal scope for dispute).
- For example, will the classification be based on sole or predominant use or on the physical characteristics? While 'use' has historically been the predominant test for land tax purposes, the GST legislation has adopted tests based on the physical characteristics of particular properties. Transfer duty tends towards a combination of the two, depending on the context.
- While we see merit in both approaches to classification, on balance, we consider that a test based on sole or predominant use is to be preferred, with the ability to apportion land with multiple uses between the various classifications.
- Should a use test be adopted, we think it makes sense for such use to be tested by reference to the intention of the purchaser at the time of sale of land. This is consistent with the approach adopted by the ATO in a GST context (e.g. GST-free supply of farmland).
7. Application of the surcharges and exemptions
- The Paper does not expressly canvass whether or not the property tax regime will incorporate a surcharge in respect of land owned or acquired by foreign persons. Presumably, given that surcharges are already imposed under the existing stamp duty and land tax regimes (albeit in respect of residential land only), they will also apply under the property tax system.
- A threshold issue is whether any surcharge imposed under the property tax regime will be imposed across all categories of land or will be restricted to the residential categories only.
- Where a surcharge does apply across all categories of land:
- Will the rate vary depending on the category in question?
- For land the subject of development or redevelopment, will exemptions be available from the surcharge component where the foreign person uses the land for development activity which adds to housing stock or which grows broader economic activity in New South Wales?
- Where a foreign purchaser or owner surcharge is intended to apply, we strongly suggest that exemptions be made available for foreign developers.
8. Transactions concerning interests in land that are not freehold interests
- In addition to imposing duty on transfers and agreements to transfer freehold land, the Duties Act imposes duty on a range of other transactions (known as "dutiable transactions") over interests in land and certain other assets (known as "dutiable property").
- By way of example, the following transactions are currently dutiable under the Duties Act:
- a declaration of trust over a leasehold interest in land will be subject to full ad valorem duty based on the value of the leasehold estate; and
- the nomination of a third party to take a transfer of land pursuant to an option (noting there are variable outcomes depending on whether the option comprises a call option or a put and call option).
- It is not clear from the Paper whether such stamp duty will continue to apply at all to any dutiable transaction over dutiable property after the introduction of the property tax regime, or will only apply in respect of a dutiable transaction where the relevant land interest has not been opted-in.
- We would expect a need to maintain some parity between the stamp duty and property tax regimes which will be challenging given stamp duty is transactional while property tax is not (once land has been opted-in). This could mean that all land, when the subject of a transaction that is not a transfer or agreement to transfer freehold (sub-sale transactions), will still be subject to duty under the current regime prescribed in the Duties Act.
- The much simpler alternative would be for duty on sub-sale transactions to be abolished once the property tax system is introduced.
9. Further consultation
We would welcome the opportunity to discuss these issues further with Treasury.
In the first instance, please contact Leah Ranie on (02) 9296 2480 or Katrina Parkyn on (07) 3244 8346.