Developers could incur a substantial loss instead of making a profit
It is not uncommon for a developer and a landowner to enter into an agreement (development agreement) under which the developer develops the landowner’s land and then ‘shares’ in the property in some way. If the development agreement is not properly drawn, a developer can find itself liable for substantial GST incurred on the sale of the developed land. As this GST could be a substantial sum, it could mean that instead of making a profit, the developer incurs a loss in connection with the project.
Nature of Development Agreements
Agreements made between developers and landowners can be characterised for tax purposes as either:
- a fee for service agreement; or
- a partnership (e.g. joint venture).
GST liability partnership
When the agreement is characterised for tax purposes as a partnership (and most joint ventures will be classified for tax purposes as a partnership), then on the sale of the relevant land both the landowner and the developer are liable for GST to the Australian Tax Office (ATO).
If the landowner does not — or cannot — pay GST, the ATO will require the developer to pay all or that part of the GST that has not been paid.
GST liability — Fee for Service Agreement
When the agreement between the developer and landowner is characterised for tax purposes as a fee for service agreement, the developer will be liable for GST in respect of fees paid to it by the landowner. (Often the landowner is required to reimburse that GST to the developer and can claim an input tax credit for them).
The developer will not, however, be liable for GST payable in respect of sale of the relevant property.
Partnership Agreement or Fee for Service Agreement?
Even if the relevant agreement states that the arrangement between the parties is not a partnership, it could be regarded — for tax purposes — as a partnership.
The ATO may regard the developer and landowner as in a partnership for tax purposes:
- if the developer uses the land as security to borrow development funds;
- if the revenue from land sales is to be distributed between the landowner and developer;
- if any income from the development, eg. rents, is to be shared by the parties;
- if a close working relationship between the landowner and developer is required.
To avoid a development agreement being characterised for tax purposes as a partnership, the agreement should emphasise that the developer is to be paid a fee for services provided to the landowner.
In particular, the agreement should not provide for a division of revenue or profits but payment to the developer of a fee for service even if that fee is in whole or part calculated by reference to revenue or profit.
Summary
Very careful drafting of a development agreement is required to make sure that for tax purposes the relationship between the developer and landowner will not be characterised as a partnership.
More information
For more information relating to Land Development Agreements, please contact a member of our Property team on (03) 8600 8888.
Note: This update is a guide only and is not intended to constitute legal advice.