Windfall Gains Tax – 10 problems with new regime
The Windfall Gains Tax Act (2021) suffers from a number of basic problems which are likely to compromise its efficiency, equity and effectiveness.
The Windfall Gains Tax Act 2021 (WGT Act) will establish a new tax on the uplift in land value resulting from a planning scheme amendment that changes the zoning of certain land in Victoria on or after 1 July 2023. The current legislation was prepared within a short timeframe after limited industry consultation. It suffers from a number of basic problems which are likely to compromise its efficiency, equity and effectiveness.
Problem 1 – It is unlikely to deter speculators
Any person that has acquired land in the expectation of making a profit from its resale shortly after rezoning rather than from its development (i.e., a ‘speculator’) will have two basic options available to it under the WGT Act:
- it can hold the land until a point in time at which the rezoning process is so far progressed that the rezoning is inevitable and then sell the land before the actual rezoning; or
- it can hold the land until after the rezoning and then sell it.
Under the first scenario, the speculator will not incur the WGT liability – it will be incurred by the new registered owner at the time of the rezone event. Under the second scenario, the speculator will incur the WGT liability, but it will simply defer it for up to 30 years.
In response to the first scenario, it may have been anticipated by government that any purchaser acquiring pre-rezone land will discount the price it is prepared to pay a vendor for the expected WGT liability. There are however two basic problems with this assumption:
- the amount of the WGT liability will be unknown, because the dual Capital Improved Value (CIV) variables on which the WGT liability will be calculated after the rezone will also be unknown. Therefore, at best, only an estimated amount of WGT could possibly ever be reduced from the price;
- market forces could easily create a situation in which a purchaser is left with no option but to pay the estimated WGT if it wants to buy the property ahead of others. In effect, the speculator’s WGT liability (or, more particularly, a purchaser’s preparedness to pay it) will very likely become a point of difference between competing bidders that the speculator will be able to exploit as it works towards paying little or no part of the anticipated WGT liability.
In response to the second scenario, it may have been anticipated by government that the speculator’s crystallised but deferred WGT liability will be taken into consideration in the price a buyer is prepared to pay the speculator for the land. Again, that may or may not in fact be the case. Whilst the WGT liability will be known at the stage at which the land is being transacted (which is an improvement on the first scenario), market forces could still easily create a situation in which the WGT liability is negotiated out of the price by a speculator as it trades off competing bidders.
A speculator will also be under no particular pressure from a deferred WGT liability to accept competing bids which discount the price for WGT. The deferral lasts for 30 years. A speculator will be able to wait until a better offer comes along, and deal with the WGT at that later point in time. During that time the value of the land will probably increase. So, the effective cost of any WGT to a speculator will likely be further offset by the increase in value as its land becomes increasingly valuable.
Problem 2 – Price uncertainty in land transactions
The price a developer is prepared to pay an owner for land is mainly determined by the purpose the developer can put the land to. In practice, price is a function of land value and the land value is determined by a process of reverse engineering a feasibility model which makes a range of assumptions about how the land can be utilised, what it can be sold for (in part or whole), and what it will cost to generate the sale revenue. The assumptions are estimates, informed by market forces and the first-hand experience of a developer in developing comparable land. Like any estimate, a developer can get it wrong. However, based on its experience and the best market information available at the time, it is prepared to take a risk that its estimates will prove close to actual.
When it comes to estimating a likely WGT liability several years out from a possible rezone date, a developer will need something approximating a crystal ball to get it right. The rezone date itself will be an estimate that could be years wrong. The nature of the rezone (and therefore uses to which the land can be applied) may be predictable because of Victoria's reasonably transparent planning process. However, anything remains possible. Predicting CIV1 and CIV2, and therefore the value spread that will be taxed at 50%, will be nigh impossible, even for the most well-informed developer. The WGT estimate a developer will therefore be required to build into its feasibility model to help determine value could therefore be wildly under or overstated.
Uncertainty of this nature creates value and therefore price uncertainty in land transactions. A natural response will be for the buyer market to deeply discount values and therefore prices to insulate themselves from the risk. However, vendors will not be keen to transact at discounted values and, with a 30-year deferral timeframe, have no real compulsion to transact at discounted values. The overall effect therefore could be a delay in the release of developable land to the market - an outcome which is definitely not in the government’s best interest.
Price uncertainty created by an un-estimatable tax will also mean vendors and purchasers spend a considerable amount of time and resources posturing over the treatment of WGT in land sale contracts. The position of each treatment of WGT, and who will accept liability, will be fundamentally opposite. Vendors will want developers to wear the WGT based on the logic that it is meant to be a development tax. In contrast, developers will want vendors to wear it based on the logic that they will pay a rezoned price for the land and WGT should be a cost to the vendor of achieving that price.
Irrespective of where the parties land in a negotiation, such tensions take time and cost to resolve. The quantum of the tax, and its uncertainty, will therefore elevate WGT to be a front-line issue in the negotiation of land sales, when really a more efficient and equitable tax (like Growth Areas Infrastructure Contribution (GAIC)) should be a background issue.
Problem 3 – Developers incentivised to behave like speculators
If a developer waits to acquire rezoned land off a speculator or any other vendor, it will acquire the land with a deferred WGT liability. The developer will be unable to re-defer the already deferred WGT because there is only a single deferral right under the WGT Act. Thereby:
- the ability of the developer to progressively pay down the WGT as the land is developed in stages and sold off (as is the case for GAIC) will be lost; and
- the developer will be required to pay the full amount of the deferred WGT at settlement of the contract of sale (in many cases years before the land is actually developable); and
- the developer will be required to pay 6.5% duty on the WGT payable at settlement of the contract of sale.
Contrast this outcome to a developer that behaves more like a speculator and acquires land pre-rezone:
- upon rezone it will be entitled to defer the WGT for up to 30 years;
- if it subdivides the land within that timeframe, it will progressively pay off the WGT liability as it settles the subdivided lots; and
- it will not pay duty on the deferred WGT.
The time advantage of deferring and paying down the WGT in stages will be enormously valuable. The developer will not be required to fund the WGT at settlement and, because all funding has a cost, the legislative scheme will strongly incentivise developers to behave more like speculators and acquire land before rezoning, because in so doing material WGT, duty and funding savings will be achieved.
Problem 4 – Tax not aligned with land development
The only circumstance in which the payment of WGT will align with revenue generation is if a developer acquires land before it is rezoned (like a speculator). If the developer is not the owner of the land at the rezone date, the owner will use up the single deferral right and the WGT will be payable, in full, at settlement by either the vendor or purchaser. Development and sale of the land, in whole or part, could then be many years ahead.
Banks generally do not fund payments of tax. WGT payable at settlement by a developer will therefore need to be self-funded by the developer, from its balance sheet. Larger listed developers are more likely to have this funding available to them. Smaller unlisted developers will find it far more challenging. Thereby, not only will the legislative regime not align the payment of the tax with actual land realisation, but it will have a distortionary market effect by favouring large, well-capitalised, developers who have the balance sheet to pay it early in the development cycle.
Problem 5 – Challenging pre-rezone land valuations
Landowners holding land earmarked for rezoning will not only be acutely aware of the value increase from a rezoning, but also the significance of the pre-rezone value of their land (so called 'Capital Improved Value 1' (CIV 1) in minimising the amount of WGT they will eventually need pay. Given CIV1 will be sourced from annual council rates notices, it seems fairly obvious that landowners will be incentivised to start objecting to the annual council valuations underpinning their rates assessments in an effort to elevate their CIV1 well ahead of the rezone. In so doing landowners will understand that they will increase their annual rates assessments (and potentially their land tax assessments), but those increases will likely be palatable relative to the 50% WGT that will otherwise be imposed on a large value spread between CIV1 and CIV2. The Valuer General will control and likely dictate the CIV2. So, landowner focus on elevating CIV1 in the years leading up to the anticipated rezone seems a likely outcome.
Problem 6 – Few pre-15 May 21 contracts and options actually exempted
Because the exemption in section 39 has been crafted to only apply to contracts settled after a rezoning, in practice a large number (possibly a majority) of contracts entered into before 15 May 2021 will not end up exempting the contracted land from WGT. Even if a pre-15 May 2021 contract was entered into on 5-year settlement terms, the rezone would need to occur before 15 May 2026 for the contract to be settleable within the 5-year contract period. Given the WGT will not commence until 1 July 2023, this doesn’t allow a lot of time for land to be rezoned and still qualify for the exemption.
More usual settlement terms are 3 years for broadacre land and 12 months for CBD infill sites. A pre-15 May 2021 contract with a 3-year settlement window will therefore become unexempt as early as 15 May 2024, less than one year after the WGT commences. A pre-15 May 2021 infill contract will probably not even make it to the start date of the tax itself (1 July 2023).
The effect of requiring pre-15 May 2021 contracts to be settled after rezoning is therefore depreciative for a purchaser. As time runs on the potential rezone date, the prospect of a pre-15 May 2021 contract with a fixed settlement date sheltering the land from WGT will progressively diminish. The effective pool of pre-15 May 2021 contracts that will potentially benefit from the exemption will therefore quickly diminish to the point where the exemption is no longer an exemption at all.
This outcome was compounded by the government's extension of the commencement date of the WGT legislation. Heralded as an industry concession, the 1 July 23 start date (instead of 1 July 22) had the effect of further reducing the potential pool of pre-15 May 2021 contracts that could potentially qualify for the exemption.
Problem 7 – Pre-15 May 21 rezoning process land
The criteria for exemption under section 40 have been set at such a height that a lot of land subject of a rezoning process commenced before 15 May 2021 will probably not qualify for exemption. Moreover, the process for obtaining exemption from the Commissioner is expected to be so time consuming and rigorous, that it will prove difficult for developer’s to effectively forward plan based on mere legal advice that they ‘may’ qualify for exemption. To some degree this situation may be addressed by landowners and developers seeking a private ruling from the State Revenue Office on the potential application of the exemption (i.e. before the rezone occurs). However, obtaining a timely private ruling from the Commissioner can be challenging. The Commissioner could easily say that until land is rezoned the WGT is a hypothetical matter, so landowners and developers must wait until after the rezone to confirm their entitlement to exemption.
Problem 8 – Incentivise Development Agreements
Development Agreements will likely play an increasingly important role in the management of WGT. Why would a developer acquire a rezoned site with a deferred WGT pregnancy when it can simply procure it via a Development Agreement? By using a Development Agreement, a developer will:
- not need to find the capital to acquire the site;
- ensure continued access to WGT deferral and staging (leveraging the speculator’s or landowner’s earlier deferral);
- save duty otherwise payable on deferred WGT at settlement of a contract of sale;
- pay less duty under the Economic Entitlement Rules; and
- obtain a degree of control over the site which is more or less equivalent to ownership.
Government efforts to disincentivise the use of Development Agreements by imposing duty through its Economic Entitlement Rules will therefore be undermined by its new WGT legislation. As land transactions move progressively ‘off grid’ (because Development Agreements are not centrally registered like land transfers), there will also likely be a steady decrease in the amount of transaction data available to the government for purposes of valuing land and formulating planning and land utilisation forward policy.
Problem 9 – Transactional inconsistencies
Different outcomes around the timing and payment of WGT will be achieved depending on how land is transacted. In the case of a 50/50 joint venture arrangement, a developer will have several options available to it to manage the incidence of WGT already deferred by the owner:
- if it acquires a 50% interest in the land itself, 100% of the WGT will become payable (irrespective of how the land is held);
- if the land is held by the owner through a company, it could acquire a 49.9% stake in the company and not trigger the WGT;
- if the land is held through a discretionary trust, it could conceivably be added as a beneficiary of the trust and not trigger the WGT;
- it could enter into a Development Agreement to implement the 50/50 profit sharing arrangement and not trigger the WGT; or
- it could loan an amount of money to the landowner in return for 50% of the profit derived from its development and register a mortgage to secure that loan and not trigger the WGT.
There may also be scope for the developer to take a 50% stake in the land for no monetary consideration and simultaneously promise to deliver the development at its 100% cost and share 50% of the profit with the landowner. However, the developer will then probably need to argue with the Commissioner over whether the promise constitutes non-monetary consideration, and therefore be prevented from accessing section 29.
Irrespective of which option is used, such a variety of outcomes around the timing and payment of WGT is indicative of an inefficient and inequitable tax.
Problem 10 – It may not fund infrastructure investment
Like GAIC, WGT was no doubt modelled by government to help contribute to the cost of future Victorian infrastructure. However, unlike GAIC, which gets paid into GAIC-specific funds for expenditure on genuine infrastructure projects situated in the UGB, WGT will be paid into consolidated revenue to be spent on any projects of the government’s choosing (including non-infrastructure-based projects).
Even if WGT is used to fund infrastructure investment, there is also no guaranteed alignment between the location where the tax is raised and the location where it is spent. The significant amount of WGT expected to be raised from the rezoning of land proximate to Victorian regional centres like Bendigo, Ballarat and Geelong, could therefore easily be used to subsidise further infrastructure investment in and around central Melbourne.
The ten issues identified are expected to impact the equity, efficiency and effectiveness of the new WGT. However, that is not to suggest that the government will not raise the anticipated levels of revenue. It will still raise that revenue, but the way in which it raises it will come at a cost to landowners and developers which could have been mitigated through a better crafted tax. When it is considered that:
- there was little to no time imperative on the implementation of the new WGT (as evidenced by the government’s unilateral decision to postpone its introduction for 12 months);
- industry groups were eager to consult with government and assist the Treasurer’s office in the design of a fair and efficient new tax; and
- Victoria already has a well-established and highly regarded infrastructure contribution tax in the form of GAIC,
this is a disappointing outcome.
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