By Russell Cocks, Solicitor

First published in the Law Institute Journal

Last month I wrote about owner-builders and suggested that the only issue that causes property lawyers greater concern is GST. Perfectly on cue, changes have been made to the operation of the margin scheme within the GST regime and these changes are bound to cause heartache and pain, particularly in the hip-pocket nerve.

The margin scheme is a legitimate method by which developers of land are able to minimise the impact of GST on their activities. The ATO accepts that GST is not meant to be a tax on land, but rather a tax on the proceeds of activities involving land. In its simplest form the margin scheme allows a developer (someone who is conducting a profit-making enterprise) to pay GST on the ‘profit’ or marginal increase in value of the real estate activity that the developer is conducting. Thus a developer who buys a property for $1m and sells it for $2m is able to pay GST on the ‘margin’ of $1m rather than the sale price of $2m. This applies whether the developer simply holds the land and resells it, which is an enterprise in itself, or the developer undertakes a more intensive enterprise, such as constructing homes on the land, and then selling.

Like all benefits, the margin scheme has qualifications. The rule that to rely on the margin scheme ‘the seller must have purchased on the margin scheme’ is widely known. In such circumstances the vendor will have remitted GST on its margin to the ATO and the purchaser does not receive a tax invoice and is not able to claim the GST back. The ATO has got and kept its pound of flesh and it is (momentarily) content. However this rule whilst an easily remembered mantra, is not strictly correct. In fact, the qualification is a little more generous than that and the margin scheme may be used if the purchase was on the margin scheme OR on a no-tax basis.

Thus a purchase from a vendor not liable for GST, or the purchase of a going concern or farm (both non-taxable) will entitle the purchaser to adopt the margin scheme when reselling. The ATO accepts that it is not entitled to a share of such sales, although it waits hungrily for a piece of the action from the next transaction.

The corollary of this rule is that the margin scheme is not available on re-sale if the purchase was on a full tax basis. In such cases the ATO will have received GST on the transaction but the purchaser will have received a tax invoice and claimed the GST back. Thus the ATO have gained no net benefit out of that taxable supply and eagerly awaits the next transaction to recover its entitlement. The margin scheme is available for successive transactions (with successive owners paying tax on their margin) but once someone hops off the merry-go-round and sells on a full tax basis, the music stops and the margin scheme is no longer available.

However, as often happens, some ‘smarties’ have apparently been rorting the system and so the rules have changed for everyone. One ‘rort’ was to insert a GST-free transaction (such as going concern) between a full-tax supply and a margin scheme supply, thereby ‘reopening’ the margin scheme that had been closed by the full-tax supply. A sells to B on a full tax basis (no net GST to the ATO) then B ‘converts’ the asset to a going concern and sells to C (no GST to the ATO). When C re-sells the development (now no longer a going concern as it is complete) instead of C paying GST on the sale price, the ATO only receives GST on C’s margin as C had purchased a going concern and is therefore entitled to apply the margin scheme. The value that B added to the development escapes GST. The new rules require C to ‘look back’ to the transaction through which B acquired the property (from A) and only entitles C to apply the margin scheme if A was also entitled to do so.

A second rort relates to calculation of the margin itself. Again, the modus operandi is to insert a GST-free transaction, such as a going concern, between two margin scheme transactions. The first transaction from A to B is conducted on the margin scheme and B then ‘converts’ the asset to a going concern before selling (GST free) to C. C (under the old rules) was entitled to apply the margin scheme to the subsequent sale of the completed development. The value that B added to the project escaped GST. Again the amendments adopt the ‘looking back’ obligation and require C to ‘look back’ to the first transaction (A to B) and to adopt A’s sale price in determining C’s margin. In that way the value that B added is taxed.

These amendments came into effect on 8 December 2008 and no doubt the ‘smarties’ will have already moved on to find other loopholes in the Act. Fortunately the amendments only apply to “new supplies”, being a supply (on the margin scheme) of a property that was itself acquired after 8 December 2008. However such transactions will begin to take place much quicker than anyone expects and an appropriate inquiry process must be established.

Inevitably the unprepared will unintentionally allow their clients to enter transactions that come back to bite them at tax time and the Legal Practitioners Liability Committee will no doubt have to walk along behind the elephant swinging its shovel.

Tip Box

Whilst written for Victoria this article has interest and relevance for practitioners in all states.

By Russell Cocks, Solicitor

First published in the Law Institute Journal

Property law is an inherently conservative branch of the law. The contest between strict legal principles and the application of equity seems to have occupied an inordinate portion of the last two centuries, with the common law principle of caveat emptor still being the starting point of any analysis of purchaser’s rights. When added to the equally dominant preference in favour of certainty of contract, it can be seen that a purchaser alleging a breach of contract by the vendor generally starts behind the eight ball. A defect in title might justify complaint, but these are rare. The more common defect in quality rarely justifies avoidance of the contract and claims based on implied terms founder on the rocks of certainty.

But the consumer (of encyclopedias or real estate) has found an ally in the last 25 years as Parliament has responded to the common law’s intransigence by creating rights and remedies that seek to equalize the imbalance of power between vendor and purchaser. The Trade Practices Act has been the saviour of the downtrodden consumer but, due to the Commonwealth’s limited power, this weapon was confined to disputes with corporate foe. The corresponding Fair Trading Acts in the various state jurisdictions were generally viewed as the poor cousin of the Trade Practices Act, but a recent High Court decision may have changed the landscape forever.

Houghton v Arms [2006] HCA 59 involved a commercial dispute between a consumer and a corporation based on the Trade Practices Act, but the corporation had gone into liquidation, so the claimant faced a pyrrhic victory. The claimant therefore sought to claim against two individuals who had negotiated the contract on behalf of the corporation. These individuals were not directors of the corporation but mere employees, albeit in senior positions in a relatively small organisation. This claim could not be based on the Trade Practices Act, as these defendants were individuals, and so the claim was made pursuant to the Fair Trading Act. The High Court held that the Fair Trading Act effectively mirrored the Trade Practices Act and, provided that the individual defendants had been acting in ‘trade and commerce’, that they would be equally liable (with the corporation) for the misrepresentations. The claim had been lost at first instance on the basis that mere employees were not engaged in ‘trade and commerce’ (merely engaged in their contract of employment) but the High Court took the view that the employees were indeed engaged in trade and commerce in the fulfilment of their employment duties. The extraordinary aspect of the case was that the Chief Justice delivered a unanimous judgment on behalf of all five judges (neither Kirby J. nor Callinan J. sat) and the whole judgment occupies just 9 pages and 48 paragraphs. It is a case study in judicial brevity.

The recent willingness of courts (Statewide Tobacco Services Ltd v Morley (1990) 2 ACSR 405) to lift the corporate veil has been a worrying trend for directors who have sought refuge behind this (now flimsy) artifice. Houghton v Arms means that mere employees may now ‘carry the can’ for corporations, although this liability is a personal one based on the Fair Trading Act, rather than a vicarious liability transmitted from the corporation.

In the context of common or garden variety conveyancing, not only will corporate vendors be held accountable for misleading or deceptive conduct, so too will their employees. This may be particularly significant for individual estate agents (who are undoubtedly acting in trade and commerce) and the employees of development companies who sell land and/or apartments to the public. It may have a particular significant in terms of what such participants in the conveyancing process don’t say, as much as what they do say. Misrepresentation by silence is unknown to the common law, but a usual suspect in a trade practices environment. Now, not only corporate vendors and agents will be liable for their failure to disclose, so too will their employees.

Is it too much to expect that this may lead to the mythical world of ‘truth in advertising’?

Tip Box

Whilst written for Victoria this article has interest and relevance for practitioners in all states.

By Russell Cocks, Solicitor

First published in the Law Institute Journal

The law requires us all to do, and not do, a lot of things. Specifically in relation to ownership of real estate, various statutory requirements impose duties on home owners and those engaged in the business of building homes. Indeed, failure to comply with those statutory obligations can result in the imposition of penalties for non-compliance. But the existence of those legal obligations and sanctions for breach do not normally impact on the relationship between vendor and purchaser, which is essentially governed by the fundamental legal principle of privity of contract.

That a vendor has not complied with a statutory obligation or has in fact breached such an obligation remains a matter between the vendor and the statutory authority and does not give a purchaser any right to insist upon the vendor fulfilling that statutory duty. A vendor might be obliged to put only recyclable material in the green bin but regularly uses that bin for non-recyclable rubbish. This may make the vendor a social pariah at the local kindergarten and expose the vendor to a penalty, but it does not impact on the relationship between the vendor and purchaser should a contract of sale be entered into. Likewise, the failure by the vendor to comply with statutory duties relating to pool fencing or installation of smoke alarms is a matter exposing the vendor to sanction, but does not give the purchaser the right to insist upon the vendor complying with those obligations during the course of the contract and prior to settlement.

The purchaser would only have such a right in one of two situations:

• if a statute provides that failure by the vendor to comply with the statutory duty entitles the purchaser to avoid – as is the case with s 11 Sale of Land Act 1962 in respect of failure to have adequate body corporate insurance; or
• if a notice has been served in relation to the breach requiring the vendor to remedy the breach. Condition 15 of Table A gives the purchaser the right to insist that the vendor comply with such notices prior to settlement. However this right only applies in relation to notices served pre-contract, and any notice served post-contract burdens the purchaser.

The obligation for a home owner to have an occupancy certificate or certificate of final inspection in relation to building works performed on the property arises from ss 38 and 39 Building Act 1993. The objective is to ensure that works on properties achieve a certain standard of completion and safety and the failure to obtain a certificate upon completion of works may result in a statutory penalty and, for participants in the building industry, may lead to loss of registration. But the absence of a certificate does not undermine the vendor’s ability to sell the property or give a purchaser any right to insist that a vendor obtain a certificate prior to settlement.

The one exception is in the case of a new home or apartment purchased off-the-plan. In such circumstances it is possible to argue that, on the basis of the contractual obligation to deliver vacant possession, a purchaser is entitled to expect that the purchaser will have the legal right to occupy the premises and that the vendor is thereby obliged to obtain a certificate to that effect. This argument respects the fundamental principle of privity of contract: see McDonald v Balaam P/L (1996) ANZ ConvR 447.

Similar arguments apply in relation to builder warranty insurance certificates. Registered domestic builders are obliged to have warranty insurance and a vendor selling a property with the benefit of such insurance might use that fact as a positive marketing attribute. But no law requires a vendor to provide the certificate of insurance, either prior to contract, in response to an inquiry during the contract, or at settlement. Some vendors choose to do so, but a purchaser does not have a right to insist upon the vendor providing those certificates. The purchaser does have a right to request a certificate from the insurer (whoever that might be) but only after the purchaser becomes the owner: see ministerial order 2003 S98.

Owner-builders who sell might have an obligation to obtain insurance and disclose particulars of that insurance in the vendor statement, but that is as a result of a specific obligation in s 32(1A) of the Sale of Land Act 1962, and failure to do so gives the purchaser a statutory right to avoid. This obligation only applies to owner-builders and has no application where the warranty insurance was issued to a registered builder.

Failure to have adequate pool fencing, working smoke alarms, certificates relating to occupancy, certificates relating to warranty insurance and indeed the fact that properties might have fill, be liable to flooding or contain asbestos, are merely defects in quality. In the absence of specific statutory intervention, such defects fall within the principle of caveat emptor (buyer beware) and are the purchaser’s problem. To purchasers who complain about such matters I say, ‘Would you like the vendor to repaint the bathroom too?’

Tip Box

Whilst written for Victoria this article has interest and relevance for practitioners in all states.

By Russell Cocks, Solicitor

First published in the Law Institute Journal

Property lawyers of a certain vintage have been much influenced by two ‘parks’ and may, from time to time and no doubt due to their vintage, get those parks confused.

The first in time and perhaps in memory is Ellenborough Park, a park in London that is the subject of the case cited as Re Ellenborough Park [1956] Ch 131, which concerned the proprietary nature of easements. The second is MacArthur Park, a park in Los Angeles and the subject of the song of the same name written by Jimmy Webb and recorded by Richard Harris in 1968. Both Re Ellenborough Park and MacArthur Park have also been the subject of review and revisits from time to time, with the law following the traditional path of developing a line of authority and the song suffering from the desire of others to impress their own style on an icon, the disco version released by Donna Summer in 1977 being perhaps the worst example of the latter.

Exploring the concept of confusion a little further, lawyers of all vintages often confuse the legal principles associated with easements with those of their closely related legal ‘cousin’, covenants. Re Ellenborough Park explored the proprietary nature of easements, confirming that a correctly established easement is indeed a proprietary right, as opposed to a mere personal or contractual right. Covenants are likewise recognised as proprietary rights and thus enforceable against ‘all of the world’, as opposed to mere contractual rights that are only enforceable against contracting parties.

Interest in covenants in recent years has principally arisen in a negative way – how to get rid of them. Covenants are essentially private town planning instruments and the nature of modern society has been to transfer the role of town planning from the private to the public domain. Hence there is a tension between the private proprietary rights created by the recognition of the proprietary nature of covenants and the ambitions of town planners who seek to create a modern, integrated metropolis utilising existing infrastructure.

This tension leads to mini-battles on street corners between pro-development forces and their opposition, who are intent on preserving the essentially anti-development nature of private covenants.

Greenwood v Burrows (1992) V ConvR 54-444 is generally regarded as the starting point for any analysis of the extent of proprietary protection for covenants in Victoria. That case concerned an application for removal or variation of a covenant pursuant to s 84 Property Law Act 1958 (Vic.) and it is fair to say the case adopted a pro-covenant standpoint and established a high threshold for any applicant seeking removal or variation. This view prevailed until Stanhill P/L v Jackson [2005] VSC 169, when Morris J. signalled a change in attitude. This new approach adopted a pro-planning policy, with recognition that individual proprietary rights might need to be subject to the greater good that was to be achieved by the implementation of an overarching planning policy. However the joy of the pro-planners was short lived as Fraser & Ors v Di Paolo & Anor [2008] VSC 117 and Vrakas v Registrar of Titles [2008] VSC 281 returned to the hardline proprietary rights approach and rejected removal or variation applications.

However, the worm may have turned again, or at least popped its head above the ground. Koller v Rice [2011] VSC 346 is a judgment of Dixon J. that permits the variation of a ‘single dwelling’ covenant to allow for a second dwelling. Single dwelling covenants are probably the most common covenant that is the subject of these applications to remove or vary, as that covenant strikes at the fundamental public planning aspiration of developments that seek to utilise existing infrastructure. By definition, if one dwelling already exists on the land such as to bring into play the operation of the covenant, then the land has the benefit of infrastructure and ought to be further developed.

Dixon J., whilst recognising the proprietary nature of the covenant, also noted:

The State Planning Policy framework encourages development within the existing urban fabric to take full advantage of transport facilities, infrastructure and community facilities.

After an analysis of the recent cases and an adoption of the principles set out in Vrakas (which had refused the application), Dixon J. concluded that this was a suitable case to allow for a dual occupancy development on a site that had been intended to be limited to a single dwelling, notwithstanding the objection of an adjoining neighbour.

Two facts of this case can be seen to strongly favour the variation:

1. the proposal was a simple increase from one dwelling to two;
2. it was a corner block and thus lent itself to separate entry for the second dwelling.

Whether the case signals a revival for the pro-planners or simply another false dawn remains to be seen.

Tip Box

Whilst written for Victoria this article has interest and relevance for practitioners in all states.

By Russell Cocks, Solicitor

First published in the Law Institute Journal

A covenant, in the widest sense, is merely an agreement, or a term or condition of an agreement. Thus contracts include covenants, mortgages include covenants, and leases include covenants. But considered in the context of real estate, covenants have a particular meaning; being agreements that relate to the use of land. In this respect covenants epitomize the distinction between a contractual right, that only binds the parties to the contract and a proprietary right, that binds all the world.

This promotion of covenants from a mere contractual right to the lofty heights of a proprietary right came relatively late in the history of English (and Australian) law. It was not until the mid-19th century that the law recognised that a contractual agreement between two landowners could bind a third party (indeed, all third parties). Initially these agreements constituted the earliest attempts at town planning and despite the fact that government has essentially taken over that role, there is no doubt that private covenants still have a role to play in Australian property law. Most commonly in practice a covenant will be encountered that will restrict the use of a particular piece of land, typically by restricting how the land may be used (no quarrying), the number of dwellings that may be constructed on the land (not more than one), or the method of construction of buildings on the land (brick or brick veneer). It can be seen that the objective of such covenants was to maintain the ‘standard’ of housing developments and covenants were typically used by subdividers for this purpose. However times change, and the ideal housing development of the 1940s or 50s may not satisfy the needs of a modern society intent on high density development in areas presently serviced by infrastructure, such as around railway lines.

Thus lawyers are often consulted by a client whose land is presently affected by a covenant and who wants that covenant removed or varied, or by a client who is considering purchasing land affected by a covenant and wants advice as to the possibility or removal or variation. This might be as simple as a client who wants to know whether a ‘no quarrying’ covenant prevents the construction of a swimming pool (it doesn’t), to a client who wants to construct a number of units on a property affected by a ‘single dwelling’ covenant.

If the proposed use of the land is prohibited by the covenant there are four avenues open for removal or variation of the covenant.

Agreement

The owner of the land benefiting from the covenant may agree to its removal or variation. This will require formal documentation and registration at the Land Titles Office pursuant to s 88 Transfer of Land Act. This is a relatively simple process where there is one benefiting owner, or a small number of benefiting owners, but is impractical where many surrounding owners share the benefit, which is common in subdivisional covenants.

Court

Property rights are amongst the most fundamental rights in society and the courts have traditionally been a bastion in relation to those rights. A person affected by a covenant is entitled to apply to the court for removal or variation of the covenant pursuant to s 84 Property Law Act and whilst the courts have traditionally been loath to undermine the rights of the benefiting landowner, recent judicial pronouncements have been less proscriptive and more inclined to consider the push for higher density housing in areas serviced by existing infrastructure.

Municipal council

As town planning contracted from an exercise dabbled in by developers to an integral function of government, municipal councils became the central point of government focus. Subject to state government supervision, municipalities are at the coalface of planning and are invested with the power, amongst other things, to vary or remove private covenants. However pressure from lobby groups, such as Save Our Suburbs, has resulted in considerable restrictions being placed on the exercise of this power. This has resulted in a general tendency of municipal councils to refuse applications and force the applicant to appeal to VCAT, where a reasonably pro-development bias prevails.

Planning scheme

The final possibility, albeit virtually impossible, is for the planning scheme that governs the location of the land that is affected by the covenant to be amended to allow for removal or variation of the covenant.

The law in relation to covenants, and their removal or variation, is another example of why the practice of conveyancing is anything but a ‘form filling-in’ exercise. Lawyers need to be pro-active in meeting their client’s needs in this area and be ready to provide quality advice. None of the above methods of removing or varying a covenant are easy, but they are all about providing your client with high quality service for a fair reward.

Tip Box

Whilst written for Victoria this article has interest and relevance for practitioners in all states.