Duties Alert: Commissioner’s Practice Note confirms Revenue NSW’s position on Options to Purchase Land in NSW

Summary

The “change in beneficial ownership” provisions (covered in our note here) have been in force in NSW since 19 May 2022. Nearly 3 years on, Revenue NSW has issued its long awaited Commissioner’s Practice Note (Practice Note) on the application of the provisions to the grant of options to purchase land in NSW (Land Purchase Option). Whilst the provisions bring welcome clarity to Revenue NSW’s position, the long delay between enactment and Revenue NSW issuing guidance means that practices which may have developed over the past years will need to be revisited.

The key takeaways from the Practice Note are:

• Duty on grant of Land Purchase Option: the grant of a “call option” or a “put / call option” (but generally not a bare “put option”) is liable to duty with duty calculated on the greater of the consideration given and the unencumbered value of the option.
• Consideration: the consideration given for the grant of a Land Purchase Option is broader than any stated option fee. It can include “works in kind” and pre-agreed “anniversary fees” and any contingent consideration under the agreement (but generally not extension fees). All relevant circumstances must be taken into account.
• Arm’s Length Dealings: where parties are acting at arm’s length the consideration for the grant of the Land Purchase Option will generally be taken to be the unencumbered (market) value of the Land Purchase Option. Where this is not the case a valuation of the option is required.
• Surrender / Termination: the surrender / early termination of a Land Purchase Option is liable to duty on the greater of the consideration given for the surrender / termination and the unencumbered (market) value of the interest extinguished. The mere lapse of a Land Purchase Option is not dutiable.
• Anti-Avoidance: a Land Purchase Option which includes a put / call option will not be considered an avoidance arrangement where there is an intention to nominate a to be established unit trust and the dominant purpose of the arrangement is to ensure there is sufficient time to raise capital.

​​​​​​Change of Beneficial Ownership – Refresh

The charging provisions under the Duties Act 1997 (NSW) (NSW Duties Act) prior to the amendments imposed duty on specified dutiable transactions involving dutiable property (e.g. a sale, a transfer, a declaration of trust and a vesting under statute or court order relating to land). The new regime, which is largely modelled on similar provisions in Victoria, makes any other transaction that effects a change in beneficial ownership dutiable. The provision provides:

“This Chapter charges duty on: … another transaction that results in a change in beneficial ownership of dutiable property, other than an excluded transaction.”

Beneficial ownership is not defined but it includes the ownership of property by a person as trustee of a trust. The concept of a “change in beneficial ownership” is defined inclusively as:

• the creation of dutiable property,
• the extinguishment of dutiable property,
• a change in equitable interests in dutiable property,
• dutiable property becoming the subject of a trust,
• dutiable property ceasing to be the subject of a trust.

Critically, s 11(1)(k) provides that dutiable property includes an “option to purchase land in New South Wales” which means that its grant or extinguishment are dutiable transactions under NSW Duties Act.

Options and Conditional Contracts Distinguished

The Practice Note considers the duty implications of Land Purchase Option. However, the Practice Note also devotes time to distinguishing options to purchase from conditional contracts. From a duty perspective, a conditional contract (regardless of whether the condition is a precedent to formation or performance) is liable to duty on first execution of the contract with duty assessed on the greater of the consideration and the unencumbered value of the underlying land. In contrast, an option to purchase is dutiable on the greater of the consideration given for the option (e.g. any option fees) and the unencumbered value of the option itself (with duty payable by reference to the purchase price (inclusive of option fees) / value of land when the option is exercised).

As the duty implications of the two transactions are materially different, the Practice Note emphasises that regard must be had to the precise rights / obligations created by the particular arrangement in order to determine its character for duties purposes. It will be important to revisit standard form drafting to ensure that the parties’ intention is properly reflected, given Revenue NSW’s focus on the substance of these arrangements.  

The Practice Note also confirms that rights of pre-emption are not captured by the concept of an “option to purchase land in New South Wales” and generally bare put options will also not meet this definition as it is properly an “option to sell” not an “option to purchase” (although complex put option arrangements must be considered on a case by case basis).

Grant of a Land Purchase Option

Consideration for the Grant of a Land Purchase Option

Where an arrangement involves the grant of a Land Purchase Option (and it is properly an “option to purchase land in New South Wales” (and not a conditional contract)), duty will be assessed on the greater of the consideration given for the Land Purchase Option and the unencumbered value of the Land Purchase Option itself. The Practice Note provides a list of common kinds of consideration:

• a stated option fee;
• any other charges, fees or payments, whether to the grantee or another party;
• reimbursement of the landowner's legal fees for the preparation of the option documents;
• non-refundable security deposits or arrangements styled as “loans” which are in substance option fees when regard is had to the terms of repayment;
• break fees / charges (however characterised) paid out of otherwise refundable escrow / other funds; and
• the value of in-kind works that the grantee undertakes (or procures at the grantee's cost) for the benefit of the landowner.

Pleasingly for taxpayers, the Practice Note also clarifies Revenue NSW’s position (previously stated in Commissioner’s Practice Note 025) that where security deposits would be refunded to the grantee / provider of the funds upon expiration of the Land Purchase Option, they will generally not be treated as consideration for the grant, and accordingly not attract a liability to duty.

The Practice Note also draws a distinction between payments which are contingent (e.g. anniversary fees or milestone payments) on a future pre-agreed event and payments for the modification of rights under the Land Purchase Option (e.g. an extension fee or a variation fee). In summary:

• Contingent Consideration for Grant of Option: where a Land Purchase Option specifies an amount that is payable on certain anniversary dates during the option term, the total of all anniversary payments potentially payable will be taken into account in determining the duty payable on the grant of the Land Purchase Option (this logic should also apply to other payments which are contingent on pre-agreed events occurring). This is on the basis the anniversary payments are contingent consideration (which are expressly dutiable under s 22(1)).
• Variation of Rights: if instead the Land Purchase Option specifies that a quantified extension fee is payable by the grantee at the election of a party to extend the term of an option or the parties separately agree in the future to modify the rights under the option for consideration payable by the grantee, these amounts are not dutiable on the initial grant of the Land Purchase Option as they are not for the grant of the option. This consideration is for the variation of the rights / obligations under the option. (It is likely that any such payments will be brought to duty when the option is exercised under s 22(4) if they are not expressed to form part of the purchase price when the option is exercised.)

The Practice Note also recognises that consideration that is to be paid or provided under related documents or arrangements may also be consideration for the grant of a Land Purchase Option.

When is there a Market Value Test of the Land Purchase Option

It is always necessary to consider whether the unencumbered (market) value of the Land Purchase Option exceeds the consideration given for its grant. However, the Practice Note, consistently with Revenue NSW’s usual practice, indicates that, where parties are acting at arm’s length, the consideration will be taken to equal to unencumbered value.

The Practice Note provides practical examples of where Revenue NSW will regard parties as acting at arm’s length. The Practice Note emphasises that regard will be had to:

• whether the parties have pre-existing business dealings;
• any personal relationships;
• where there is commonality in the ownership structure of the parties, whether common directors recuse themselves from deciding to proceed with the transactions; and
• whether the exercise price under the option, reflects the market value of the land at the time the option is entered into.

Where parties are not acting at arm’s length, a valuation of the Land Purchase Option will be required to substantiate the dutiable value.

Double Duty Issues Remain

The Practice Note also reaffirms Revenue NSW’s view that any duty payable on the grant of a Land Purchase Option is not to be credited against the duty payable on the eventual contract / transfer entered into pursuant to the option.

Surrender / Termination of a Land Purchase Option

The definition of the term "change in beneficial ownership" in s 8(3)of the NSW Duties Act includes an "extinguishment of dutiable property". The Practice Notes confirms that the surrender or early termination of a Land Purchase Option involves the "extinguishment" of dutiable property such that the change of beneficial ownership provisions apply to the transaction.

In contrast to a surrender or termination, the lapse of a Land Purchase Option at the expiration of an option term is not liable to duty. Whilst the lapse arguably results in the extinguishment of the option (or the reversion of an equitable interest back to the landowner), as there is no action taken by either party to cause this and it is solely a consequence of the grantee's rights expiring, the Practice Note confirms that duty will not be payable in these circumstances.

Where there is an early surrender or termination of a Land Purchase Option, duty will be payable on the greater of the consideration given for the surrender / termination and the unencumbered (market) value of the interest extinguished.

Other kinds of Options

The Practice Note also recognises that options may be used in other transactions involving land that do not involve a right to purchase freehold title. For example, a landowner may agree to provide a person an option to enter into a lease of land or to obtain an easement over the land.

The Practice Note confirms that such options do not provide the grantee with the right to purchase land and accordingly are not dutiable property under s 11(1)(k).  Further, the grant of such options does not create any equitable interest in the land (a matter which is relevant for landholder duty). On this basis, Revenue NSW accepts that duty does not apply to the grant of such options

It should be noted however that it is important to distinguish between an option for the grant of a lease / easement and an option to purchase an existing lease / easement. An option to purchase an existing lease is an option to purchase land in New South Wales which is dutiable (i.e. it is treated as a Land Purchase Option).

Anti-Avoidance

The introduction of the change of beneficial ownership provisions was accompanied by amendments to Part 10A of the Taxation Administration Act 1996 (NSW) to include within the definition of a “tax avoidance scheme” a scheme the dominant purpose of which is to postpone the payment of tax. As alluded to above, it can be difficult to distinguish between a conditional contract and a Land Purchase Option (particularly a put / call option) and in some circumstances the use of either legal arrangement may be appropriate to address the parties’ commercial needs (albeit with materially different duty consequences).

Pleasingly for taxpayers, the Practice Note clarifies that the anti-avoidance provision would not apply to a transaction where a promotor enters into a put / call option with a right to nominate to third party, and the promotor establishes a new unit trust for the purpose of raising capital to fund the acquisition of the property, and that new trust is ultimately nominated as the purchaser. An analysis of the surrounding circumstances remains of critical importance to determine the dominant purpose of the transaction (e.g. facilitating the raising of capital).