NSW Vendor duty & the principal place of residence exemption – a beast of deception …

By Luis Batalha

Of the many exemptions available from vendor duty, the principal place of residence exemption is likely to be the one most commonly used by ordinary vendors. However, its sheer complexity and over-engineering will undoubtedly lead to it being misunderstood. The purpose of this discussion is to shed light on the scope of the exemption and (hopefully) reduce the level of misunderstanding.

Introduction

The NSW Government announced its introduction of vendor duty on 6 April 2004. The Act introducing the new duty, the State Revenue Legislation Amendment Act 2004 (Act), was passed shortly after on 14 May 2004 and received assent on 24 May 2004. The starting point of the new duty is the imposition on sellers of land related property. Absent the availability of an exemption, duty is payable. Of significant importance to ordinary Australians is the principal place of residence exemption. It is on that exemption that this discussion focuses.

Vendor duty – an overview

For contracts signed on or after 1 June 2004, the new Chapter 4 of the Duties Act 1997 (NSW) (Duties Act) charges duty that vendors and transferors, rather than purchasers, are liable for (new sec 151(1)).

Vendor duty is payable at the flat rate of 2.25% on the dutiable value (not the profit or gain) on the sale or disposal of certain properties (sec 157 and sec 160(1)). This can be contrasted to the position under capital gain tax (CGT), where the tax is only imposed on gains calculated in accordance with the statutory provisions (see sec 100-35 of the Income Tax Assessment Act 1997 (Cth) (ITAA 97)).

Duty is payable on properties regardless of when they were purchased (Schedule 1, transitional provisions clause (2)). That is, in contrast to CGT (see, for example, sec 104-10(5)(a)), for instance, vendor duty applies to properties whenever purchased (including properties purchased before 1 June 2004).

Land-related property

Vendor duty is only payable on “vendor duty transactions” of “land-related property” (sec 145(1)). Section 149 defines “land-related property” as either:
(a) land in NSW; or
(b) a land use entitlement; or
(c) an interest in NSW land or a land use entitlement, except to the extent that:
i. it arises as a result of the ownership of a unit in a unit trust scheme and is not a land use entitlement; or
ii. it is, or is attributable to an option over land-related property.

Vendor duty transactions

Vendor duty is only charged on a limited category of dutiable transactions. Specifically, the duty is only payable on the following 3 types of transactions of land related property:
  • agreements for sale or transfer;

  • transfers; and

  • declarations of trust (sec 146(1)).
These are referred to in the Act as “vendor duty transactions” (sec 146(2)).

Vendor duty exemptions

Consistently with the NSW Government’s intention to charge vendor duty primarily on sellers of investment properties, the Act sets out a number of different exemptions from vendor duty. However, it is important to emphasise, that unless one of the exemptions applies, vendor duty is payable. In other words, the starting point of the provisions is not the imposition of vendor duty on investment properties, but rather the imposition of vendor duty on all land related property – subject to the availability of an exemption or concession expressly stated in the Act. In this discussion, we focus only on one of the exemptions – namely the principal place of residence exemption in sec 162B(1).

The principal place of residence exemption

Although similar terminology has been chosen, the principal place of residence exemption for NSW vendor duty purposes is far from identical to the equivalent exemption in the capital gains tax (CGT) context: refer Subdivision 118–B of the ITAA 97.

Use and occupation – the 3 tests

To begin with, for vendor duty purposes, a residence will only be a “principal place of residence” of a taxpayer if it satisfies 1 of the following 3 tests:
  • 2 year test – under this test, a residence is automatically a principal place of residence if it has been continuously used and occupied by the person for residential purposes for a period of at least 2 years; or

  • 3 out of 5 years test – under this test, a residence is automatically a principal place of residence if it has been used and occupied by the vendor for residential purposes for a total period of at least 3 years in the last 5 years; or

  • less than 2 years, at the Commissioner’s discretion – under this test before the exemption will be available, the vendor needs to satisfy the Commissioner that the residence has been the vendor’s principal place of residence since they became its owner. The test applies if the vendor became the residence’s owner less than 2 years before the date on which a liability to vendor duty would arise (sec 162B(3)).
Also, for a property to be a principal place of residence under all 3 of the above tests:
  • the property must have been used solely for residential purposes and not for any other purpose; and

  • during the period of use and occupation, there must not have been any other property that the person used as a residence; and

  • importantly, income must not have been derived from the property during the period of ownership (sec 162C(1)(c)). This prohibition, however, would appear to be subject to the special rules (discussed below) dealing with the principal place of residence exemption.
By contrast, the requirements that need to be met for the CGT main residence exemption are more flexible. Specifically, there is no set period of use that needs to be met before a residence will be treated as the taxpayer’s main residence (sec 118-110 of the ITAA 97).

Definition

The phrase “principal place of residence” is defined exhaustively in sec 162A(1) as “the one place of residence that is, among the one or more places of residence of the person within and outside Australia, the principal place of residence of the person”. In other words, a person can only have 1 principal place of residence in the whole world.

Transitional provision

In determining the period of use and occupation of a property for the purpose of the 3 tests discussed above, pre-1 June 2004 use and occupation counts (clause (1) of the transitional measures dealing with the application of exemptions from vendor duty).

The Commissioner’s overarching discretion

Independently of the 3 tests of use and occupation being met, under sec 162B(4), the Commissioner is given a wide discretion to treat a particular property as the principal place of residence of a vendor if the Commissioner is satisfied that it is “fair and reasonable” for the exemption to apply in the particular case.

The wide discretion in sec 162B(4) seems to apply even in those cases where none of the tests in sec 162B(3) are met. It will be interesting to see under what circumstances the Commissioner will exercise the discretion.

It may turn out that in determining whether a property is a vendor’s principal place of residence, the NSW Commissioner will have regard to the same factors as the Federal Commissioner has regard for sec 118-110 CGT purposes. That is, the factors set out in Taxation Determination TD 51 (paragraph 2):
  • the place of residence of the vendor's family;

  • whether the vendor has moved their personal belongings to the dwelling;

  • the address to which the vendor has his or her mail delivered;

  • the vendor's address on the Electoral Roll;

  • the connection of services such as telephone, gas and electricity; and

  • the vendor's intention in occupying the dwelling.
No doubt, the above factors are likely to prove influential in the exercise of the NSW Commissioner’s discretion not only under sec 162B(4), but also under sec 162B(3)(c) (ie the last test of use and occupation examined above).

***

Example

Facts

Tom bought an apartment on 31 December 2003 and has been living in the apartment since then. He has changed his details on the electoral roll to show the new address. Tom is a single father and lives in the apartment with his daughter Tina. All electricity lines and telephone lines to the household are connected. Due to recent financial difficulties, Tom is planning to sell the apartment on 29 August 2004.

Question

Will Tom be liable to vendor duty on the sale of the apartment?

Answer

At the time Tom sells his apartment he would have only been living in it for less than 2 years. Accordingly, Tom will not be automatically entitled to the principal place of residence exemption (as he does not meet either of the tests in sec 162B(3)(a) or (b)). While Tom’s occupation of the apartment pre-1 June 2004 counts in calculating his total occupation period (clause (1)), that period of occupation is not sufficient for him to meet the 2 year test.

However, Tom’s situation may be one where the Commissioner may choose to exercise his discretion under either sec 162B(3)(c) or sec 162B(4). Indicators that the apartment is Tom’s principal place of residence include the fact that his daughter lives with him, the change in address on the electoral roll and the fact that electricity and telephone connections have been attended to.

***

Apportionment for land partly used as a main residence

Section 162G sets out 3 different methods of apportionment to ensure that where a property is used partly as a residence and partly for non-residential purposes only the portion not used as a residence is liable to vendor duty. However, to qualify for an apportionment under sec 162G the Commissioner must be satisfied that:
  • the land is used and occupied by the vendor as their principal place of residence; and

  • the exemption would apply if the land had not been used for purposes other than residential purposes.
The apportionment for the land is determined by applying the following formula:

(dutiable value of land transferred – land’s “exempt proportion”) x 2.25%

The “exempt proportion” calculation varies depending on how the dwelling is used and occupied by vendor:

If the dwelling is: Then the exempt proportion is:
a single dwelling = 1 – apportionment factor
a flat = (1 – apportionment factor) x floor area of flat divided by total floor area of all flats on land
any other case = such portion as the Commissioner considers fair and reasonable in the circumstances

The “apportionment factor” is either:
(a) the apportionment factor stated as a fraction in the Register of Land Values for respect of the land value of the land; or
(b) in all other cases, such other apportionment factor as the Commissioner considers fair and reasonable in the circumstances.

***

Example

Facts

Yung owns a dual purpose 2 storey property. He lives upstairs in the residential part of the property, but leases out the premises downstairs for retail purposes. The total area of the property is 200 square metres, 100 square metres upstairs and 100 square metres downstairs. Yung is currently planning to sell the entire property, but is concerned that he will be subject to vendor duty on the total sale price of the property – being $500,000.

Question

Will Yung be liable to vendor duty on the sale of the property? If Yung is liable to duty on what amount will the duty be calculated?

Answer

From the present wording of the legislation, it would appear that this is a situation intended to be covered by the apportionment sec 162G. The outcome of the application of that section is that a portion of Yung’s land should be exempt from vendor duty. As floor area may be considered a reasonable basis of apportionment in this instance (sec 162G(3)(c)), vendor duty should be payable on only 50% (ie 100/200 square metres) of the dutiable value of the property on sale. That is, the vendor duty payable should be $5,625 (ie $250,000 x 2.25%).

***

Is there a limit on the land covered by the exemption?

For CGT purposes, the main residence exemption extends only to land that is adjacent to the residence, to the extent that it is used for private or domestic purposes and in total, the property does not exceed 2 hectares (sec 118-120 of the ITAA 97). Interestingly, there is no such limitation on the equivalent exemption from vendor duty. It will be interesting to see whether such a limitation will develop through legislative change or administrative practise.

Time apportionment

The reference point for calculating the liability to vendor duty is the time when the transaction happens. Therefore, provided either of the occupation tests in sec 162B(3) is met at that time, it does not matter that sometime earlier the property was used for investment purposes.

***

Example

Facts

Rose bought a property in 1990. From 1990 until hearing about the vendor duty on 6 April 2004 she used the property as an investment – deriving rental for the entire period. From fear of having to pay vendor duty, Rose moves into the property on 20 April 2004. She has been living in the property since, but is now contemplating selling the property in December 2004.

Question

Will Rose be liable to vendor duty on the sale of the property? If Rose is liable, will there be an apportionment for the period she used the property as an investment property?

Answer

Much like Tom in the earlier example, around December 2004, Rose would have only been living in her property for less than 2 years. Accordingly, Rose will not be automatically entitled to the principal place of residence exemption (as she does not meet either of the tests in sec 162B(3)(a) or (b)). While Rose’s occupation of the house pre-1 June 2004 counts in determining her total period of occupation (clause (1)), that period of occupation is not sufficient for her to meet the 2 year test.

However, if Rose’s situation is one where the Commissioner exercises his discretion under either sec 162B(3)(c) or sec 162B(4) then a full exemption is available.

While it may be thought strange, it would appear from the wording of the legislation that the fact that Rose used the property entirely for investment purposes for a substantial period of time (which was in fact longer than the period of residential occupation) is not relevant for the purposes of determining her entitlement to the principal place of residence exemption.

***

Special rules on principal place of residence exemption

The Act sets out a series of rules on the principal place of residence exemption dealing with:
  • land on which there is a residential occupancy other than the vendor’s (sec 2);

  • land used for incidental business purposes (sec 3);

  • the sale of a former principal place of residence (sec 4);

  • absences from a former residence (sec 5);

  • the death of a resident (sec 6);

  • life estates following the death of a resident (sec 7); and

  • situations where couples separate (sec 8) (Part 2 of Schedule 2 to Schedule 4).
These rules apply by reason of the deeming in sec 162E that expressly states that Schedule 2 (where the rules are set out) has effect.

Special rule 1: land on which there is one other residential occupancy

A property will be a principal place of residence even if there is on the land 1, but not more than 1, “excluded residential occupancy” (sec 2(1)).

An “excluded residential occupancy” is defined in sec 2(2) as:
(a) 1 room;
(b) 1 suite of rooms (not being a flat) each room of which all occupants of the suite are entitled to occupy;
(c) 1 flat;
(d) 1 suite of rooms (not being a flat) each room of which all occupants of the suite are entitled to occupy, and 1 room;
(e) 1 flat and 1 room; or
(f) 2 rooms, each of which is separately occupied.

The exemption is available even where income is derived from the excluded residential occupancy (sec 2(3)). Interestingly, and by contrast to sec 3(3) (discussed below), the section does not indicate how it interacts with the earlier sec 162C(1)(c) which denies land the status of residential land if income is derived from the land. Also, there is no mention either of how the section interacts with the apportionment provision in sec 162G.

***

Example

Facts

Marco rents out to Eliza one of the rooms at his house. Eliza pays Marco $200 a week for the renting of the room. Marco plans to sell his house on 24 June 2004.

Question

Will Marco be liable to vendor duty on the sale of his house?

Answer

No, Marco will not be liable to vendor duty on the sale of his house as it is his principal place of residence (sec 162B(1)). The fact that one of the rooms is rented out to Eliza makes no difference to his entitlement to the principal residence exemption (sec 2(2)(a)). This is the case even though Marco derives income from renting a room to Eliza (sec 2(3)).

***

Special rule 2: land used for incidental business purposes

The principal place of residence exemption applies:
  • if not more than 1 room is used primarily for business purposes; and

  • the business is primarily conducted from elsewhere (sec 3(1)); and

  • whether or not income is derived from the business use on the land (sec 3(2)).
Meaning of word “primarily”

The operation and scope of this special rule depends on the meaning given to the word “primarily” in the 2 contexts in which it appears. As the word is not defined in the Act it is likely that it will take on its ordinary meaning.

One meaning of the word “primarily” is “at first or originally” (Re Parker Pen (Australia) Pty Limited and Export Development Grants Board (1983) 67 FLR 234). The Collins Dictionary defines the word “primarily” as “principally; chiefly; mainly”. In Taxation Ruling TR 2001/7, on the meaning of personal services income, the ATO notes that the word ''mainly'' implies that more than 50% of a particular activity is of the sort concerned (paragraph 25).

The question whether a building, 66% of which was occupied as a residence and the remainder used as a general store, was used ''principally and primarily'' as a residence, was considered by the Full Court of South Australia in Gray v Mercantile Mutual Insurance (Aust) Ltd (1995) 8 ANZ Insurance Cases 61-241. According to the majority judgment in that case, the test to be applied in determining the primary use of a residence is not merely a quantitative one but involves the degree or intensity of use of the building as a place of residence so that it can fairly be said that the premises as a totality were mainly so used. The majority added that in applying the criterion it was necessary to consider not only the objective but also the subjective features of the case.

The remaining judge said that the test to be applied should be an objective one in which a broad commonsense approach should be adopted.

It will be interesting to see whether the OSR and NSW Courts will take a similar approach in interpreting the special rule in sec 3.

Interaction with sec 162C(1)(c)

Section 3(3) makes express provision giving it priority over sec 162C(1)(c) which denies residential land status to land used to derive income.

***

Example

Facts

Wanda is an artist and runs an arts and crafts store from a retail outlet near her house. She has also set aside a room in her house where she completes some of her own artwork to sell at the store. She derives income from the artwork she does on the weekends from her house. Wanda now plans to sell her house on 16 July 2004.

Question

Will Wanda be liable to vendor duty on the sale of her house?

Answer

No, Wanda will not be liable to vendor duty on the sale of her house. The principal place of residence exemption will be available even if one room at her house is used mainly for business purposes. Where, as here, the business is conducted from elsewhere, the business use at the house is disregarded (sec 3(1)). Also, Wanda will obtain the benefit of the exemption even if she is deriving income from the artwork she does at her house (sec 3(2)).

Special rule 3: concession for sale of former principal place of residence

If the Commissioner is satisfied that the property has been occupied by the vendor as their main residence for a period ending within 6 months of the potential liability to duty, that use and occupation is taken to continue until the date of liability (sec 4(1)). However, during the 6 month period, no income can be derived from the use or occupation of the land (sec 4(3)).

In addition, the Commissioner may in a particular case extend the period of 6 months if satisfied that there is good reason for doing so (sec 4(4)).

Section 4 is similar, but not identical, to a CGT provision under its main residence exemption (see sec 118-140 of the ITAA 97). In particular, the CGT provision, allows not 1, but 2 dwellings, to be simultaneously treated as the taxpayer’s main residence where the taxpayer is moving between the dwellings.

***

Example

Facts

Serge purchased a house in 1998. He has been living in the house since he bought it. On 16 June 2004, he put the house on the market and decided to live with his parents until he obtains a good price for the house.

Question

How long can Serge stay with his parents before he will be liable to vendor duty on the sale of the house? Can Serge rent out the property during his absence?

Answer

Absent the Commissioner’s exercise of his discretion, Serge will have until 16 December 2004 (6 months) to find a suitable buyer for the house, otherwise he will be liable to vendor duty (sec 4(1)). Also, to be entitled to the exemption from vendor duty, Serge cannot during his absence rent out the property (sec 4(3)).

***

Transitional provision

If a vendor’s occupation of their residence has ceased not more than 6 months before 1 June 2004, then the occupation is treated as having ceased immediately before 1 June 2004. In other words, a vendor will have until 30 November 2004 in which to sell a property if they ceased occupying it before 1 June 2004 (clause 41(5)).

Special rule 4: concession for absences from former residence

If the Commissioner is satisfied that:
(a) a former residence was used and occupied by the vendor as their principal place of residence for a continuous period of at least 2 years; and
(b) that period of use and occupation ended no more than 6 years before the vendor duty transaction occurs, the vendor is taken to continue to use and occupy the former residence as their main residence during the period after that actual use and occupation ends (sec 5(1)).

However, the maximum period allowed is 6 years starting at the end of the most recent actual occupation period of at least 2 years (sec 5(2)).

During the 6 year absence, it would seem that the person is not allowed to derive income from the property (sec 162C(1)(c)). This is in clear contrast to the position under CGT, where income is expressly allowed to be derived during the 6 year absence (sec 118-145(2) of the ITAA 97). The OSR, however, takes the view that income can be derived in the 6 years.

Only 2 year test dealt with

Unfortunately, the special rule in sec 5 only deals with those situations involving the 2 year residency test and ignores the other 2 (or possibly 3) tests of residency set out in sec 162B(3) (for example, the 3 out of 5 years residency test).

***

Example

Facts

Nikita purchased a flat in August 1997. She lived in the flat until October 2000 when she decided to go on a working holiday to Paris. While working in Paris, Nikita has not been renting out her property. Nikita is now planning to return to Australia sometime soon – but at this stage is uncertain about the precise date of her return. Upon her return to Australia she plans to sell her flat.

Would the answer be any different if Nikita rented out the property while in Paris?

Question

By when does Nikita need to return to Australia and sell her house to ensure she will not be liable to vendor duty?

Answer

Nikita should be back in Australia by no later than October 2006 to ensure that she will not be liable to vendor duty (sec 5(1)).

If Nikita rents out the property during her absence she will not be entitled to the exemption from vendor duty (sec 162C(1)(c)).

***

Special rule 5: concession on death of resident – fee simple

If a vendor is any of the following persons:
  • the legal personal representative of a deceased; or

  • a beneficiary under a will of a deceased; or

  • a beneficiary on the intestacy of a deceased;
and the transaction relates to the main residence of the deceased immediately before their death, then an exemption from duty will be available (sec 6(1)).

However, the exemption will not be available if a period of 12 months expires after the grant of probate or letters of administration to the legal personal representative or the deceased’s interest in the land vests in a person other than the legal personal representative or beneficiary – whichever is earlier (sec 6(2)).

Transitional provision

If a grant of probate or letters of administration happens before 1 June 2004, then it is taken to happen on 1 June 2004 (cl 41(6) of transitional provisions on application of exemptions).

Meaning of word “immediately”

The operation and scope of special rule 5 will depend on the interpretation given to the word “immediately”. As the word is not specifically defined in the Act it is likely that it will take on its ordinary meaning.

It has been said that the word immediately implies “prompt, vigorous action, without any delay” (R v The Justices of Berkshire (1879) 4 QBD 469 at 471) or “without any other intervening occurrence” (R v Horseferry Road Metropolitan Stipendiary Magistrate, ex p Siadatan [1991] 1 All ER 324 at 329). Adopting these interpretations, it would seem that if the deceased moves out of his home a few days before death, then the entitlement to the exemption for a vendor beneficiary will be lost. Such a literal interpretation of the wording of the section would significantly narrow its scope of operation. Accordingly, it is preferable if a broader interpretation is given to the term “immediately”.

Transfer of land from deceased to beneficiary

As an aside, it should be noted that the transfer of land related property from a deceased to their legal personal representative or a beneficiary under their will is not liable to vendor duty. This is the case regardless of whether the property is the deceased’s principal place of residence (due to interaction of existing sec 63 and sec 162X which deems certain exemptions in Chapter 2 to apply to vendor duty).

***

Example

Facts

Bruno’s mother passed away at her home on 1 April 2004. Under her will, she left Bruno her residence. Bruno plans to rent out the residence until the end of 2004 and sell it early in 2005.

Question

Will Bruno be liable to vendor duty on the sale of the house? Is the answer different if Bruno’s mother died after having lived with him at his house for the last 2 months of her life?

Answer

Bruno will not be liable to vendor duty on the sale of the house in 2005. In fact, if probate was granted before 1 June 2004, Bruno will have until 31 May 2005 (12 months after the commencement of the provisions) to sell the house (sec 6(2)(a) and clause (4)).

If, however, Bruno’s mother was not living in the house “immediately” before her death, then the exemption from duty will not be available to Bruno.

***

Special rule 6: concession on death of resident - life estates

If a land owner dies and the land is used by another person as a result of a life estate created by the will of the deceased, the sale by a beneficiary or the legal personal representative will be exempt from duty (sec 7(1)). However, the exemption will only be available until a period of 12 months passes after the termination of the life estate (sec 7(2)).

Unlike the provision dealing with the concession in the case of a fee simple, the provision dealing with a life estate does not appear to require the deceased to be living in their residence immediately prior to their death (sec 7(1)).

Special rule 7: concession for couples who separate

After a couple separates:
(a) the use and occupation of the land by the “former spouse” is taken to be the use and occupation of the land by the vendor; and
(b) the exemption applies in the same way as it would apply if the former spouse were the vendor in the transaction.

A person is the “former spouse” of another person if the Commissioner is satisfied:
(a) the person is or was legally married to the other person and the marriage has been dissolved or annulled, or in the opinion of the Commissioner, has broken down irretrievably; or
(b) the person was in a de facto relationship with the other person and the Commissioner is satisfied that the relationship has been terminated.

Under this rule, the spouse may also have their own principal place of residence and be entitled to the exemption (sec 8(3)).

Restrictions on main residence exemption

50% interest requirement

The principal place of residence exemption is only available where at least 50% of the ownership interest in the residence is held by one or more natural persons who reside in the home as their principal place of residence (sec 162B(5)).

Only one residence per family

Only one place of residence may be treated as the principal residence of all members of the same family (sec 10(1)). Also, it would seem that each family may only have 1 residence every 2 years (sec 10(2)).

A “family” comprises:
(a) a person and his or her spouse (if any) (sec 10(3)(a)). A person is a spouse of another person if they are legally married or they are living together as a couple in a de facto relationship (sec 10(4)); and
(b) any dependent child or dependent step-child of the person and his or her spouse (or of either of them) who ordinarily resides with the person or their spouse (sec 10(3)(b)). A person who is the child or step-child of another person is a dependent child or a dependent step-child if the person is under 18 years of age and is not legally married (sec 10(6)).

Conclusion

Of all the different exemptions available from vendor duty, the principal place of residence exemption is likely to be the one most widely used by vendors. Unfortunately, however, due to its complex nature, it is also the exemption most likely to be misunderstood. Given the manner in which the exemption has been portrayed by the media and to a lesser extent the tax press, it would seem that its breadth is greater than it actually is. This may catch out the uninformed, the unwary, the ill-advised or simply the ignorant. Often having a document stamped consistently with a statutory declaration would seem to be the end of the matter. However, in time, once the Office of State Revenue engages in audit activity of the new vendor duty, the position may become a particularly dangerous one for vendors who have not examined the statutory provisions closely. The danger lies in the potential duty penalties that may apply as well as the significant repercussions relating to the false swearing of a statutory declaration.


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