No option but to pay duty: NSW now imposes duty on changes in beneficial ownership

On 19 May 2022, substantial amendments were made to the Duties Act 1997 (NSW), including the introduction of a new head of duty which imposes duty on transactions which result in a change in beneficial ownership of dutiable property. This formulation of dutiable transaction broadened the duty base, and the wording captures an extremely wide range of transactions. In this article we set out the impact of this particular legislative amendments on some typical real estate transactions which involve the use of options in usually land-related transactions.

The transactions involving land now subject to the NSW Duties Act

The existing provisions will continue to affect transactions involving options to purchase land, and operate in conjunction with the new provisions imposing duty on changes of beneficial ownership.

The new amendments inserted an additional type of dutiable transaction: another transaction that results in a change in beneficial ownership of dutiable property other than an excluded transaction.

The term “change in beneficial ownership” includes:

• 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; and
• dutiable property ceasing to be the subject of a trust.

These amendments were designed to capture transactions which were not previously caught under the existing heads of dutiable transactions (for example, under the transfer of dutiable property head of duty).

The NSW Duties Act also lists excluded transactions which will not be caught under this head of dutiable transaction (although none are relevant for the purposes of this article). This list can be expanded by the regulations, but so far regulations have not been published.

For those involved in options to purchase land, this will all mean factoring both the new provisions under the NSW Duties Act and the existing provisions relating to options:

• the transfer, or an agreement for the sale of transfer, of dutiable property attracts duty as a dutiable transaction;
• exercising a right of nomination under a call option or the novation of a call option for valuable consideration is taken to be a transfer of that call option;
• dutiable property includes land and any interest in land except to the extent that, amongst other things, it is, or is attributable to, an option over dutiable property;
• dutiable property specifically includes an option to purchase land in New South Wales;
• the duty liability on the dutiable transaction is calculated on the greater of the consideration for the dutiable transaction and unencumbered value of the dutiable property;
• the consideration for the transfer of land (including an agreement for the sale or transfer of land) that occurs as a consequence of the exercise of an option to purchase land is taken to include the amount or value of the consideration provided by or on behalf of the transferee for the option;
• the duty chargeable in respect of the transfer of land (including an agreement for the sale or transfer of land) that occurs as a consequence of the exercise of an option to purchase land is to be reduced by the amount of duty paid by the transferee on the transfer of the option to the transferee;
• the duty liability generally falls on the purchaser or transferee of the land; and
• an additional type of duty known as call option assignment duty applies in respect of the assignment of a call option which is part of a put and call option arrangement. In this respect, exercising a right of nomination or novation of the call option for valuable consideration may be taken to be an assignment of that call option and as such may incur call option assignment duty. This duty is chargeable as if there were a transfer of the dutiable property which was the subject of the call option and this liability falls on the person who assigns the right under the call option.

Foreign purchaser surcharge

The foreign purchaser surcharge provisions have generally mirrored the dutiable transaction provisions such that, where a dutiable transaction involves residential-related land and the transferee is a foreign person, an additional surcharge (currently at a rate of 8%) was imposed. This would generally apply in respect of the existing provisions described above, including surcharge call option assignment duty.

However, the new change in beneficial ownership provisions were enacted without equivalent foreign purchaser surcharge provisions. Therefore, a transaction which results in a change in beneficial ownership of dutiable property of residential-related land to a foreign person, which is not otherwise charged to duty by the pre-existing provisions, does not appear to attract the foreign purchaser surcharge.

A typical transaction involving options to purchase land

Entering into the option

Most options are drafted as an irrevocable offer by the grantor to sell land to the grantee. The typical mechanism for the grantee to exercise the option is by providing the grantor of the option with an exercise notice together with a signed copy of the contract for sale of land, an unsigned draft of which is usually annexed to the option.

The grant of an option to purchase land creates an equitable interest in the land for the grantee of the option, and as such would be caught by the new change in beneficial ownership of land provisions thereby giving rise to a duty liability. The duty liability is calculated by applying the rate of duty (top rate of 5.5%) to the greater of the consideration for, and unencumbered value of, the option. In an arm's length transaction this will generally be the call option fee.

Other amounts may also be treated as consideration for the option, which may have varying descriptions within the document such as a security deposit. The general common law rules around what is, or is not, consideration will need to be considered in respect of each of those payments to determine the duty liability.

However, one of the most important aspect of this is that from 19 May 2022, the grant of all options over New South Wales land will need to be lodged for stamping, even if the call option fee is nominal only. This may mean that the cost of compliance for a taxpayer will in many cases, far exceed the amount of duty payable, which in the case of nominal consideration would be duty of $10 only.

Nominating a nominee

Some call options are drafted so that the grantee has the right to nominate a nominee to exercise the option. Typically, the nominee is required to pay the grantee an amount of consideration to reimburse the grantee for the amount of the call option fee which was paid by the grantee to the grantor. The NSW Duties Act deems this to be a transfer of the option which is a dutiable transaction. The duty liability is calculated by applying the rate of duty (top rate of 5.5%) to the greater of the consideration for, or unencumbered value of, the option. The duty in this instance will be payable by the nominee.

If, however, the option is part of a put and call option arrangement, then the nomination for consideration would also give rise to call option assignment duty. This duty liability is calculated by applying the rate of duty (top rate of 5.5%) to the greater of the consideration for, and unencumbered value of, the land which is the subject of the option, and would be payable by the grantee.

Exercising the option

The exercise of an option, which is essentially the acceptance of an irrevocable offer from the grantor, constitutes a contract for the sale of land (being an agreement for transfer of dutiable property). This is a dutiable transaction under the pre-existing provisions. The duty liability is calculated by applying the rate of duty to the greater of the consideration for, or the unencumbered value of, the land.

The NSW Duties Act requires that the consideration in these circumstances (ie. the creation of a contract pursuant to an exercise of option) includes any consideration that was provided for the grant of the option. However, it is not unusual for the parties to agree for the consideration payable under the contract for sale to be reduced by the consideration that was paid for the option. That contractual term would need to be taken into account for the purposes of calculating the duty on the contract for sale.

For the purposes of ascertaining the unencumbered value of the land, as a general proposition the consideration agreed upon for a sale of land between unrelated parties acting on arm's length should reflect the unencumbered value of that land. However, in the context of an option, the consideration for the sale of land was agreed upon when the option was entered into and, in practice, is usually already inserted into a copy of the contract of sale which is annexed to the option agreement. As the duty liability arising on the agreement for the sale of land arises at a different time, there is a possibility that the unencumbered value of the land may have changed since the time that the option agreement was entered into. This tends to be usual in land-banking types of arrangements. Where the unencumbered value of the land has changed substantially, a valuation report may be required to support the duty calculation. In this regard, the Chief Commissioner in his guidance note has made it an evidentiary requirement that a taxpayer provide a valuation report for any land which is the subject of an option which is exercised more than 12 months after the date on which the option was granted.

If the person exercising the option is the nominee, or otherwise a transferee of the option, a credit will be available to reduce the duty liability by any duty which was already paid by the nominee or transferee in respect of the nomination or transfer. However, this credit is not available where the option was never transferred or taken to be transferred. That is to say, the duty paid on a grant of an option is not credited against the duty payable on the contract that is created pursuant to the exercise of the option. This differentiates NSW from Queensland which has always provided a credit.

Settlement of the property

The transfer of the land will generally attract concessional duty of $10 on the basis that it is in conformity with the contract for sale.

Option lapses because it is not exercised

Where an option to purchase land is not exercised before the by the option end date, the only duty liability which should arise in the overall transaction should be the duty on the grant of the option (if the option was granted on or after 19 May 2022). No further duty liability should arise upon expiry of the option on the basis that there is no further transaction causing the grantee to cease to have an equitable interest in the land.

However, if the grantor and grantee of an option to purchase land agree between themselves to terminate the option earlier than the initially agreed option period, this may be a transaction resulting in a change in beneficial ownership of the dutiable property. Likewise, if the grantor and grantee of an option to purchase land agree to extend the period during which the option may be exercised, this too may be a transaction resulting in a change in beneficial ownership of the dutiable property. However, the duty payable in these scenarios would depend on whether any consideration is paid for the early termination of the option or the extension of time for the exercise period and whether these “arrangements” can be valued.

A typical transaction involving an option for the grant of an easement

The following section describes the duty implications at each step the grant of an easement pursuant to an exercise of an option for the grant of an easement.

Entering into the option

The grant of an option for the grant of an easement creates an equitable interest in land for the grantee of the option. However, the interest in land arising for the grantee is attributable to an option over dutiable property, which is specifically excluded as an item of dutiable property. The option itself is also not an option to purchase land. On that basis, there is no creation of dutiable property in this instance, as distinct from the grant of an option to purchase land. Therefore, this grant of an option for an easement over land should not be a transaction which results in a change in beneficial ownership of dutiable property under section 8(1)(b)(ix). This should be the result regardless of whether a payment has or has not been made or the grant of that option.

For the same reason, extending the option exercise period will also not be a dutiable transaction.

Exercising the option

The actual exercise of the option will result in the grant of an easement.

If the grant of the easement is for consideration, then this will be a transaction that results in a change in beneficial ownership of dutiable property because an easement is an interest in land. The duty liability is calculated by applying the rate of duty (top rate of 5.5%) to the greater of the consideration for, or the unencumbered value of, the easement.

If the grant of the easement is for no consideration, then that would be an excluded transaction and would fall outside the scope of section 8(1)(b)(ix) of the NSW Duties Act.

However, an excluded transaction may result in a change in beneficial ownership of dutiable property if it is part of a scheme or arrangement that, in the Chief Commissioner's opinion, was made with a collateral purpose of reducing duty otherwise chargeable.

Where consideration has been paid for the option to grant the easement (which was not a dutiable transaction – see above), and no consideration is paid for the grant of the easement itself, this should result in no duty liability.

However, if there was no option for an easement and consideration is paid for the grant of the easement, then a duty liability does arise under the NSW Duties Act. As such, there is a possibility that the Chief Commissioner may view the use of the option as a scheme or arrangement made with a collateral purpose of reducing the duty otherwise chargeable. Therefore, the parties should be prepared to show some commercial imperatives which required the use of an option arrangement.

Option which is not exercised

Where an option for the grant of the easement is not exercised before the option period expires, no duty liability should arise. While the grantee may cease to have an equitable interest in the land which was created by the option, this interest is not dutiable property due to section 11(1)(l)(ii).

For the same reason, even if the grantor and grantee of an option to grant an easement agree between themselves to terminate the option earlier than the initially agreed option period, or to extend the period during which the option may be exercised, no duty liability should arise.