moulislegal · Property Reporter

20 July 2011

The A.C.T.'s big new property tax

Daniel Moulis, Principal
Lisa Eldridge, Solicitor

Under the ACT’s crown leasehold land system, it is only possible to build something on land if your lease says you can. To get an approval to build in excess of your lease entitlements, a tax needs to be paid to the government. That tax has always been calculated as a proportion of the difference between the value of your lease before the change, when compared to the value of your lease after the change. From 1 July 2011 the system for the imposition of that tax, once called “betterment” and more lately “change of use charge”, has been completely revamped.

The new laws intend to “codify” the value of approved changes to leasehold rights so that, in theory, any property owner can work out how much it will cost to obtain “higher and better use” rights. It replaces the previous system under which property owners’ self-assessed the “before” and “after” values for approval by the ACT’s Planning and Land Authority (“ACTPLA”) on a site-by-site basis. Under that system, ACTPLA could arrive at a determination which was different to the self-assessed amount, and that determination was open to challenge in the ACT Civil and Administrative Appeals Tribunal (“ACAT”)

The changes are significant and have been accompanied by much controversy.

There are many competing opinions, from the perspective of social and economic policy, about “taxing” property owners on the gain which accrues to them if the value of their rights to use land are improved. The ACT Government sees changes in lease rights as being something in the nature of a windfall gain, or at least a gain arising from the grant of development rights that the public itself “owns”. For property developers, the tax is seen to be an unwelcome intrusion into the dynamics of speculation, development risk and profit-taking. The community itself is divided. Most might welcome the increase in revenue that the tax is designed to bring, however others realise that any tax on developers will essentially be passed on to them in the form of lower sale prices for underdeveloped land, and higher sale prices and higher rents for developed land.

In this Property Reporter, we explain the lease variation charge legislation, and review its legal operation and likely implications. We conclude that the philosophy of the charge is outdated, and that a lot of the heat could be taken out of the debate if that was recognised and the basis for the charge was to be recast. We also feel that the new legislation will force the ACT Treasury to adopt a planning role, creating yet another stumbling block for development. We also conclude that the charge compares unfavourably, in terms of expense and legal rights, to the system in place “just across the border” in New South Wales.

“Adding value” – the historical context

The earliest settlers of the area now known as Canberra, who ran their sheep across the “Limestone Plains”, would have thought this to be an unlikely site for a National Capital. But eventually, as part of a political compromise which required the site to be somewhere between the cities of Melbourne and Sydney, their paddocks were earmarked as the location for the Federal Government, and as a central meeting place for all Australians.

Establishing a new city, for no reason other than the functions of government, and to tightly control its planning and growth, was not an easy task. To achieve these goals a Crown leasehold system of land ownership was devised. Under this system, leases not only prescribed what could be done by the leaseholder on his or her land, but also how the leaseholder had to do it, at what value, and the time within which it had to be done. This both forced and controlled development. The quid pro quo was that leases were relatively cheap and sometimes heavily “concessional”. Rental leases were also granted, on favourable terms. In short: the Federal Government subsidised land ownership in order to establish the city of Canberra.

The proposition, at that time, that this was a public service town, established in the national interest, with the Federal Government as its “developer”, was unquestioned. The success of the venture was something the Federal Government believed it owned, or at least deserved to share with private developers. To recover costs and to share in the collective profit generated by development, a “betterment tax” was imposed on disputed changes to leases, calculated as a determined proportion of the increased value. The determined proportion was 50%. Undisputed changes, agreed with the planning authorities, were allowed at a negotiated value.

A different Canberra - self-governed and self-sustained

Since late 1988 Canberra has been self-governed. The management of the city, successfully established by the Federal Government, has been handed over to a locally elected Legislative Assembly having a mix of State and council powers. The rents and profits of land, and the liabilities of land ownership, have devolved to the ACT Government.

Canberra is now a very different city, politically, economically and socially. Land subsidies are only granted in tightly defined circumstances. People do not need to be enticed to live here. Private sector employees outnumber those of the public sector. Uncertainty in leasehold ownership has been dispelled by laws which permit (almost) automatic renewal of leases for only an administrative fee at the end of their 99 year terms. Investors are told that leases are “bankable” in the same way as freehold title in any other jurisdiction. Land values support that proposition. Commercial sales of leases far outnumber new lease grants of previously unleased public land.

These new realities pose this question: why does the ACT Government still hold its hand out for the payment of a “tax” on increased value, when the philosophies underpinning that tax no longer exist? The relationship of the tax to a perceived “public” share in profits which developers believe result from their own investment of capital, risk and invention is a fundamental stumbling block to the acceptance of the new LVC system by the ACT property community.

And it doesn’t need to be so. No one can doubt the need for the ACT Government to raise money to cover the costs of servicing new and intensified development. Changing the philosophy of the tax so that it represents a contribution to those costs, such as in NSW, would improve its relevance to modern day Canberra, and better promote its acceptance by investors who see both the need for and the benefits of paying such a contribution. But more about that later.

What is the new lease variation charge and how will it work?

Under the new laws, the lease variation charge (“LVC”) is to be calculated under a codified fee structure. The fees are intended to represent only the additional bundle of rights granted to the leaseholder through an approved change in use. Costs involved in exploiting those rights, such as the cost of demolition and the on-site improvements, will not be taken into consideration.

For residential properties, payment of an LVC will be triggered by an approval to increase the number of dwellings on a property. Generally speaking, the LVC will be a rate per unit or dwelling, based on the “market average” over the previous three years of similar properties in the same suburb.

For commercial and industrial properties, payment of an LVC will be triggered by an approval to change the uses permitted under a lease, or to increase the permissible gross floor area (“GFA”), or both. The codified LVC will be a rate per square metre of GFA for each zone area, by suburb, and will be based on the “market average” over the previous three years of similarly zoned premises in the particular suburb.

For mixed use properties, for example if a commercial lease is to be varied to allow for residential redevelopment, the LVC will be calculated by reference to a rate per unit or dwelling for the number of dwellings that are to be allowed under the lease. For the addition of a commercial use to a residential lease, the LVC will be calculated by reference to the GFA added as a result of the variation.

Fixed fees for approvals to consolidate leases will be payable in addition to LVCs calculated on a per dwelling/GFA basis.

The LVC fees will be determined and annually reviewed by a panel of experts, which is proposed to include representatives from the Australian Valuation Office, the Australian Property Institute, the Treasury, and ACTPLA itself.

Lessees will have no right to appeal to ACAT against an LVC in respect of any site assessed by way of codification.

Site-specific “before” and “after” values will still be used in some cases

The new laws will preserve a site-specific valuation approach in circumstances where the “codified” fees cannot be applied. In these cases a system similar to the current site-specific valuation of the “before” and “after” capital values will apply. Consideration of structural improvements and of on-site and off-site costs requirements will be excluded in determining the “before” and “after” values.

Unlike the situation which will apply to LVCs based on codified fees, where no legal appeal is allowed, site-specific valuations will be open to challenge in ACAT. However, there is a very strict time requirement imposed on lessees who may want to exercise this right. The lessee will first need to apply for a reconsideration of the decision by the Commissioner for Revenue, on the very same day that the lessee receives the “working out statement” explaining the calculation of the LVC. This is patently unfair, on any measure.

A lessee’s application to ACAT is to include a valuation from an independent valuer who is to be agreed between the lessee and the Commissioner or appointed by the President of the ACT Division of the Australian Property Institute. The valuer must not be a valuer who was involved in working out or advising the lessee when it made its application for development approval. This requirement, it must be said, is more than mildly critical of the valuation profession, and will itself add to development costs. The need for it to be proposed by the government, and its acceptance as law by the Assembly, are both highly regrettable.

75% of value for commercial leases, and graduation to 75% for residential leases
 

Although the codified amounts will be set at their full value, the percentage of the fee payable as LVC for changes to commercial and industrial leases will be 75% of the codified amount, or of the site-specific valuation. For residential changes, the fee will be gradually increased from 25% to 75% over the next five years.

Set fees and remissions in special cases

Set fees will apply for certain types of changes, in addition to any codified or site-specific LVC. Set fees will apply to variations which:

In certain cases LVC can be remitted to the lessee. These cases will include those where:

Whether a particular variation falls within any of these remission cases will be determined by the Minister, and the amount actually remitted to a lessee will be determined by the Treasurer.

Technical difficulties lie ahead

It must be said that the LVC system is based on the erroneous assumption that leases are “commoditised”. That is not the case, and the problem is particularly significant in the case of commercial leases. There are many types of uses. There are a number of definitions of GFA. The bundle of associated use rights vary depending on many factors. These are differently defined, differently expanded, and differently qualified in any one lease when compared to another. A “straightjacket” of codified fees cannot discern these differences and make value adjustments to take them into account.

As the new legislation is currently drafted, there will be one or a few types of “commercial” and ”industrial” fees, with variations between the types of fees depend on the zoning of a relevant property. There does not appear to be any difference between the codified fees depending upon the particular uses that are permitted under a particular lease. On this basis, the economics of any lease variation will be skewed towards the highest and best use in all cases. Lessees who might want to develop their land for a lower use will presumably decide that it is uneconomic to do so. As a result one might expect the diversity and vigour of development to be diminished.

These problems will affect planners and developers alike. If ACTPLA wants to include special restrictions or requirements in a particular lease, for very good reason, then the only mechanism for impacts on value to be considered is that offered by way of remission. Even if the developer concerned supports those restrictions or requirements, the cost of proceeding might not be justified.

LVCs will not be immediately responsive to market signals

The codified fee values will be based on average market value over a three year period. In a falling market the average market value will be higher than the current market value, and vice versa. The Government’s position is that “other policy measures” could be introduced in a declining market, however until they are introduced, lessees would have to pay a higher LVC than is strictly justified, and there will be a disincentive for lessees to develop to that extent.

Discretions and remissions – will the exceptions become the norm?

Curiously, the new law provides that where codification does apply, the Treasurer may nonetheless determine the LVC to be paid. Additionally, the Treasurer can approve the guidelines pursuant to which the Commissioner for Revenue will make any such determination. In doing so the Treasurer must obtain and have regard to advice from an accredited valuer that the LVC will “as far as is practicable, represent the average market value in relation to the variation”. The Treasurer must also comply with any limitations “prescribed by regulation”.

These mechanisms involve a transfer of a discretionary power to facilitate development away from the agency - ACTPLA - which is empowered to do that job. If the intention is to permit the Treasurer to accommodate site-specific concerns brought about by the special facts of any case, including the terms of a particular lease, then it might turn out that the Treasurer will be swamped by such “special” applications. Placing the Treasurer in what is essentially a land planning role is peculiar. If the Treasurer fully accepts that role, the payment of codified LVCs might become the exception rather than the norm. If the Treasury does not accept that role – and one would have to guess it would not - development will not proceed at the pace the market might otherwise demand.

The remission power is also uncertain. The list of remission circumstances in the new law is not exclusive. The law vaguely provides that a variation is a chargeable variation if it is “prescribed by regulation”. There is no certainty as to whether the remission cases will remain limited to those in the Act itself or whether they will become more extensive at any point in time. The prospect of inconsistent treatment of lessees looms large.

Whose value, and is the LVC too high?

If the LVC system is sort of like the one it replaces, why is there so much concern about it? First, it is demonstrably not like the old system. It was not at all unusual, under the “willing buyer/willing seller” site-specific system for change of use charges, to find that there would be no difference or a negative difference in the before and after values even if the GFA was to be increased. The validity of such outcomes has been much criticised by certain sectors of the bureaucracy. However the commercial reality, which valuers have recognised in the past, is that risk, reward and cost is a complex matrix. The LVC system ignores individual circumstances. As demonstrated by change of use case precedent, adding new rights to a lease does not automatically or necessarily lead to an increase in the value of a lease. Many factors come into play, including the costs associated with redevelopment and the presence of existing income producing assets on the relevant land.

Second, the codified fee “numbers” that have been published, but not yet legislated, are very much larger than have been experienced by developers in the ACT before. The codified fees for residential development are widely considered to be very expensive.

NSW development charges - flexible, cost based and “reasonable”

Which does beg the question: what happens outside the ACT? In NSW, there are essentially two types of fees payable in respect of approvals for new development. One of these is a fee related to construction cost.(1) The other fee is known as a Section 94 development contribution. It is this fee which is the best comparator to the LVC.

The NSW legislation provides that such contributions:

The present maxima for residential approvals in NSW are either $20,000 or $30,000 per dwelling, depending on the area of NSW concerned. In comparison, in the ACT in 2016, when the percentage reaches its maximum of 75%, the codified LVC rate:

It is also significant that, unlike LVCs, Section 94 development contributions are open to challenge on the grounds of unreasonableness.

A fact which went missing during most of the debate, and which was raised too late to make an impression on the voting public, is that the effect of the tax is not limited to property developers. They will still want the same profits to make their business viable. To make money, they will have to drive down acquisition costs and force up sale prices of developed stock. Alternatively, if the market just cannot support a level of profitability which is appropriate, or which is comparative to other jurisdictions, developers may well reduce their activity in the ACT. Time will tell.  

The LVC system seeks more public revenue, and takes away legal rights

It seems to us that property developers have not been entirely “crying wolf” in their criticism of the new system. It must also be said that the debate leading up to the passage of the new laws became extremely polarised, and that it was difficult to conduct a proper consideration of what was in the overall best interests of the Territory.

The need to raise revenue cannot be questioned. However the choice of persisting with a unique system that is based on the principle that government must share in the profit that developers see as being theirs and theirs alone will continue to cause complaint and controversy.

The amount of revenue which the government wants to collect is a policy consideration, and not a legal one. There seems no doubt that more will be collected than before (unless the LVC system is such a “shock” that it very significantly slows development). We would expect that in the experience of the system, and in the lead up to 2016, there will be a concern to monitor the competitiveness of the ACT as a place to invest, and to decide whether the LVC proportions need to be adjusted.

In legal terms, the LVC scheme reduces the legal rights of individual lessees, and contains a number of unreasonable provisions. It is highly technical in its application, and gives a great deal of discretion to the administrators. Ironically, for a “codified” system, this could be said to be more than the discretion which was available under the old system. However that discretion is in the hands of the ACT Treasury, and the way in which it will be used cannot be predicted.

For more information, please contact Daniel Moulis or Lisa Eldridge on +61 2 6163 1000 or email daniel.moulis@moulislegal.com or lisa.eldridge@moulislegal.com.

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(1) The fee is calculated as a proportion of the estimated costs of a development involving the erection of a building, the carrying out of work or the demolition of a work or a building. For Wollongong City Council the highest rate for development, which applies to projects with a construction cost of more than $10 million, is $15,875, plus an additional $1.19 for each $1,000 (or part of $1,000) by which the cost exceeds $10 million. Also, for subdivisions, Wollongong charges $250 to $500 (depending on whether the subdivision incorporates new roads) plus $40 to $50 per additional lot (block). In comparison, the set-fee component (excluding any codified component) of an LVC in the ACT will rise to $5,625 per block (lot) by 2016 for the first three blocks and $3,750 for each additional block thereafter.

(2) We acknowledge that it is not possible to fairly compare development fees by isolating some types of fees or taxes from other fees or taxes which might also be related to development and its associated economic activities. However the two NSW fees we have identified are the main fees involved.

This memo presents an overview and commentary of the subject matter. It is not provided in the context of a solicitor-client relationship and no duty of care is assumed or accepted. It does not constitute legal advice.