Andrews v Kocalidis (No.2)
[2010] VCC 1616
•24 November 2010
| IN THE COUNTY COURT OF VICTORIA | Revised |
Not Restricted
AT MELBOURNE
CIVIL DIVISION
COMMERCIAL
GENERAL DIVISION
Case No. CI-08-05458
| JOHN ANDREWS | Plaintiff |
| v | |
| ANDREW KOCALIDIS (aka KAY) | Defendant |
| and | |
| ANDREW KOCALIDIS (aka KAY) | Plaintiff by Counterclaim |
| v | |
| JOHN ANDREWS | Defendant by Counterclaim |
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| JUDGE: | HIS HONOUR JUDGE GINNANE |
| WHERE HELD: | Melbourne |
| DATE OF HEARING: | 11, 13 and 15 October 2010 |
| DATE OF JUDGMENT: | 24 November 2010 |
| CASE MAY BE CITED AS: | Andrews v Kocalidis (No.2) |
| MEDIUM NEUTRAL CITATION: | [2010] VCC 1616 |
REASONS FOR JUDGMENT
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Catchwords: CONTRACT – joint venture – distribution of joint venture property – whether sale of property should be ordered – valuation of property -- taxation liability of joint venturers – whether proceeds of sale of property would attract GST – whether distribution to joint venturer should be reduced because of tax deductions available.
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| APPEARANCES: | Counsel | Solicitors |
| For the Plaintiff | Mr R L Moore | McNab, McNab & Starke |
| For the Defendant | Mr J J Isles | George M Livaditis |
| HIS HONOUR: |
1 Some issues remained for determination in this proceeding following the delivery of judgment on 4 August 2010. They included:
• Issue one: should the property at 55 Foch Street, Box Hill South be sold at auction, or should Mr Kay be ordered to pay a portion of its value to Mr Andrews? • Issue two: the value of the property; • Issue three: what is the updated amount of the contributions by the parties towards the joint venture? • Issue four: should the Court take into account the taxation consequences to Mr Kay and Mr Andrews of receiving the proceeds of the sale of the property or a share of its value? 2 The parties desired, and were permitted, to call evidence concerning the valuation of the property and the taxation liabilities that they might incur as a result of the distribution of the surplus or net equity in the property. There was also evidence from both Mr Andrews and Mr Kay concerning its current condition.
Issue One: Should the property be sold or should Mr Kay be ordered to pay a portion of its value to Mr Andrews?
3 On 15 October 2010, I granted Mr Andrews leave to amend his Statement of Claim to reintroduce a claim for the sale of the property. The Statement of Claim, as originally pleaded, included such a claim, but it had been deleted when an Amended Statement of Claim was delivered on 14 September 2009. In that amended pleading, Mr Andrews had sought as remedies, declaratory relief as to the existence of the joint venture, damages and alternatively, equitable compensation.
4 A frequent means of distributing the assets of a partnership upon dissolution is for the assets to be sold.1 That approach is also applicable to the distribution of the assets of a failed joint venture.2
Submissions of the Parties
5 Mr Kay argued against the sale of the property and submitted that the Court should assess equitable compensation rather than ordering a sale. His counsel referred to the judgment of Gibbs J in Lucas v Lucas3 that:
“The court has a discretion to determine in any case whether, on the dissolution of a partnership, the ordinary course should be followed, or whether that course should be departed from to meet the circumstances of the particular case.”
6 Mr Kay argued against a sale because of the costs involved, the small amount of equity that would be paid to Mr Andrews, because Mr Andrews had breached obligations that were imposed on him under the joint venture agreement and because the provisions of the Sale of Land Act 1962 would prevent Mr Kay from lawfully bidding at the sale of the property. He also argued that Mr Andrews’ evidence concerning the value of the property was unsatisfactory, in particular because of the failure to recall Mr Cocks, a valuer, who had given evidence for Mr Andrews at the trial concerning this issue.
7 Mr Andrews submitted that:
(i)
the auction of the property was the clearest way to establish its value and avoided the Court ascribing an arbitrary value to it;
(ii)
the Court should decline to order a sale only in exceptional circumstances;
(iii) the value of the property was greater than Mr Kay contended;
1
Fletcher ‘The Law of Partnership’ (9th ed.) p.252
cf Muschinski v Dodds (1985) 160 CLR 583 at 623
[1962] Qd R 205, 212 (iv) the Court had not found that Mr Andrews’ conduct had brought the joint venture to an end;
(v) the property was still a joint venture asset;
(vi) a registered proprietor such as Mr Kay, could make disclosed vendor bids at the sale of the property;
(vii) sale costs were negotiable and should be shared.
Conclusion on Issue One
8 I have given consideration to the fact that the usual order following the dissolution of a partnership, or a joint venture, is for a sale of assets. A court will usually only authorise one partner to purchase the interests of the others at valuation, when it is satisfied that the results of such a sale will be more beneficial to the would be purchaser’s co-partners than the sale of the business as a going concern by public auction.4
9 Mr Andrews declined the opportunity to become registered proprietor of the property. Nevertheless, I have decided that the property was joint venture property.
10 However, I do consider that this is a case in which I should permit Mr Kay to purchase Mr Andrews’ interest in the joint venture property for the following reasons.
11 First, I received extensive evidence about the sale value of the property from both parties at the trial and during the further hearing in October. This reflected the fact that, until I allowed the amendment to the Statement of Claim, neither party was seeking the sale of the property. I am therefore in a position to fix the value of the property. If I order a sale of the property, that extensive evidence will be to no avail.
Fletcher, ‘The Law of Partnership in Australia’ (9th ed) p. 252 and Wedge v Wedge (1995) 12 WAR 489
12
Second, there are the costs that will be incurred in respect of the sale of the property. These are likely to include expenses such as the engagement of an independent solicitor. There is some authority that in an action for partition, where a sale is ordered, leave to bid will not be given to the party having the carriage of the sale.5
13
Third is the fact that I have determined that Mr Kay is entitled to receive the great proportion of the joint venturers’ net equity or surplus in the property.
14
Fourth is the difficulty in ordering a sale, where, if Mr Kay is permitted to bid, he may be the highest bidder. Mr Kay is the registered proprietor of the property. If Mr Kay is permitted to bid and is the successful bidder, then no sale, at least of any legal interest, will occur. Rather Mr Kay would have to pay to Mr Andrews his share of the purchase price. The auction in those circumstances would fix the value of the property, in circumstances where I have already received extensive evidence and submissions about that issue.
15
Fifth is the desirability in finalising the entitlements of the parties, not least because the Planning Permit expires on 12 January 2011.
16
I am in a position to determine the value of the property on the basis of the evidence and thereby what sum, Mr Kay, must pay to Mr Andrews in respect of his interest in the property.
Issue Two: The Value of the Property
17 The parties proceeded on the basis the Court should adopt a value of the property reflecting the evidence led in October 2010. 18 Mr Andrews called Mr P Buchanan, a Certified Valuer with particular experience in inner metropolitan Melbourne. He provided a valuation as at 23 September 2010 of $1,350,000 as an “as is” current market valuation, with a
Robinson, ‘The Property Law Act Victoria’, page 479
town planning permit in place for the erection of three 2-storey townhouses. This valued the property at $1,420 per square metre, based on an area of 951 square metres. His evidence was that the land was worth $1,100,000 or $1,150 a square metre, without the Planning Permit. He considered that the property’s highest and best use was as a development and that the house added no value to it.
19 Mr Buchanan adopted a Gross Realisation Value model, working back from the value of the property with the three units constructed. The valuation allowed for development and holding costs, transaction costs and a profit and risk component. He considered that the Gross Realisation Value figure, once the units were constructed, was $2,450,000. He adopted a development cost taken from the ‘Rawlinson’s Guide’, of $1,400 per square metre for a medium level fit-out of the units. The Gross Realisation method produced a sale price of $2,450,000, from which were deducted stamp duty, development, holding and selling costs, which totalled about $1,147,500, leaving a value of the property, with Planning Permit, of about $1,350,000.
20 Mr Buchanan referred in his report to the sale of five two-storey town houses in Box Hill South in 2010 at prices between $775,000 and $860,000 without planning permits. He also provided evidence of the sale of nine properties in Box Hill South in 2010, without planning permits, to develop town houses at prices between $615,000 and $1,735,000.6 He referred to a Doncaster property which had obtained a high price. In respect of the properties referred to by Mr Brindley, who gave evidence on behalf of Mr Kay, he stated that 40 Foch Street, which had sold for $1,161 a square metre, and 23 Hamel Street, which had sold for $1,175 a square metre, were most relevant. He gave evidence that he had found no comparable sale of a block of land with a planning permit to construct three two-storey town houses. He considered
Mr Buchanan also referred to the sale of two vacant sites for $2,080,000, which had been sold without planning permits for unit development.
that the property would inevitably be sold to a developer.
21 Mr Kay recalled Mr D Brindley, a Certified Practising Valuer and a former President of the Real Estate Institute of Victoria and the Real Estate Institute of Australia, who had given evidence at the trial. Mr Brindley sought to establish the market value of the property, which was best determined by direct comparison. He valued the property at $946,000 excluding GST, or less than $1,000 per square metre. He reached his valuation based on a comparison of sales of residential properties, some with permits and some without. At trial he had valued the property at $1,044,000, although there was uncertainty whether that price included GST. Mr Brindley considered that the Planning Permit added about $140,000 to the value of the property.
22 Mr Brindley expressed the opinion that the Gross Realisation Valuation method was not satisfactory and was a hypothetical development method. He gave evidence that there were differences between the properties that Mr Buchanan had referred to by way of comparable sales, and the subject property. Mr Brindley considered that, once constructed, the two-bedroom unit would sell for between $650,000 and $670,000 and the two three- bedroom units for between $700, 000 and $720,000. The combined sale price of the three units would be approximately $2,000,000 to $2,100,000.
23 Mr Brindley considered that the property, with the Planning Permit, had a value of $2,100,000 to $2,150,000. If Mr Buchanan’s construction costs were accurate, a developer would lose money. Normally a developer would expect to obtain a 30 per cent profit. Marketing costs of the units would be one percent and agent’s selling fees would be 1.5 to 2.5 per cent, plus GST.
24 Mr Brindley gave evidence that the property market was showing signs of retraction. He agreed that he had not seen any comparable property in 2010, save for one in Box Hill North. He also agreed that none of the properties he had considered, which were sold in 2010, achieved a value of less than $1,000 per square metre. He was unable to explain why the value of the subject property was less, save to say that it was a matter of opinion.7 However, he did state that the property was less desirable than some comparable properties, because it has a line of sight to some factories.
Submissions of the Parties
25 Mr Andrews submitted that Mr Brindley’s valuation should be rejected because it was significantly out of step with comparable sales in Box Hill South, and gave insufficient value to the plans and Planning Permit that existed in respect of the property.
26 Mr Kay criticised Mr Buchanan’s use of the Gross Realization, or hypothetical subdivisional methods of valuation. He referred to authority8 that the hypothetical subdivision method was more prone to error because of the number of variables requiring consideration. It was an inappropriate method of valuation, when the property would not necessarily be sold to developers. Mr Buchanan’s costings produced a break even result at best and perhaps a loss and no builder/developer would buy the property on that basis.
Conclusion on Issue Two
27 I adopt a value of the property between those given by Mr Buchanan and Mr Brindley. Mr Buchanan’s valuation is based on working back from a Gross Realization Value. It gains some support from comparable sales. However, I do not adopt that method of valuation, because it does depend on hypothetical costs.
28 While Mr Brindley’s valuation did not depend on the Gross Realization Value, it appears to underestimate the value of the property by reference to comparable sales. The evidence from comparable sales, indicated sales in
Transcript (“T”) 1558
Turner v Minister of Public Instruction (1956) 95 CLR 245 and Derring Lane Pty Ltd v Fitzgibbon (2007) 16 VR 563
2010 above $1,000 per square metre, even for properties without planning permits for the construction of units, whereas Mr Brindley’s valuation put the figure at less than $1,000.
29 In my 4 August 2010 judgment, I adopted $114,000 as the value added by the Planning Permit.
30 I consider that the appropriate valuation of the property with a planning permit is $1,100,000. In adopting that figure, I have taken into account the risk that the Planning Permit will not be renewed in 2011. Mr Buchanan had not taken into account that risk, whereas Mr Brindley had.
Issue Three: What is the updated amount of the contributions by the parties towards the joint venture?
31 I set out in my judgment of 4 August 2010 that the contributions of the parties to the joint venture were, as at December 2009, Mr Andrews - $24,473.31 and Mr Kay - $463,780.81.
32 Mr Kay gave evidence that his contributions were either to fund the repayments or to pay the mortgage. They included mortgage payments, payments for interest and development costs.9
33 By the further hearing in October 2010, Mr Kay’s contribution had increased by $12,858 to $476,638.81. The amount owing under the mortgage was $249,789. Mr Andrews’ contributions remained unaltered.
34 Mr Andrews accepted that Mr Kay had paid these costs and expenses.10
35 In my judgement of 4 August 2010, I stated that:
“The net profit was the sum remaining after Mr Andrews had been reimbursed for the costs incurred in obtaining planning and building permission, and the cost of building the project, together with his margin, and Mr Kay reimbursed for the purchase price and interest on
T 1672, 1678
T 1761, 1788
borrowings to purchase the property and undertake the construction.”11
36 However, the joint venture did not proceed.
Issue Four: Should the Court take into account the taxation consequences to Mr Kay and Mr Andrews of receiving the proceeds of the sale of the property or a share of its value?
37 A number of issues were argued about the relevance of the taxation consequences for Mr Andrews and Mr Kay of the orders that the Court might make. I will deal with each, although some had no effect once I decided not to order a sale of the property.
38 As a general proposition, I consider that I should not have regard to the taxation consequences for Mr Kay and Mr Andrews of receiving a share of the proceeds of sale of, or of the value of, the property. That consideration does not enter into the determination of the appropriate distribution of the joint venture property. In any event, the taxation consequences will depend on a range of variables, which are not presently known.
Goods and Services Tax
39 An issue arose as to whether any Goods and Services Tax would be paid by Mr Kay on the proceeds of the property if it were sold. If it were, the allied question was, whether the amount of tax should be deducted from the net equity, or surplus notionally remaining in the property, for the purposes of distribution to the joint venturers. Although I have decided not to order a sale, as this was one of the issues argued, I will state my conclusion on it.
40 By a combination of provisions in the GST legislation, A New Tax System (Goods and Services Tax) Act 1999,12 the liability to GST turned on whether the property was “residential premises” within s.195-1. That term is defined:
"residential premises" means land or a building that:
Paragraph [148]
ss.9-5, 40-65 and 195-1
(a) is occupied as a residence or for residential accommodation; or (b)
is intended to be occupied, and is capable of being occupied, as a residence or for residential accommodation.”
41 The parties focused their submissions on paragraph (b) of the definition.
42 Mr Andrews called Mr S O’Flynn, Taxation Director with Moore Stephens accountants, to give evidence as to the taxation liability, including GST, that the distribution of the joint venture property might attract. Mr O’Flynn, in his witness statement, assumed that the property was uninhabitable and thus not considered a residential or commercial property. The effect of this assumption was that because of s.9-5 of the GST legislation, the proposed sale of the property would be considered a taxable supply and would therefore attract GST.
43 Mr Kay, who is an accountant, also gave evidence about this issue. He stated that if the property had had the physical characteristics that enabled it to be occupied or, to be capable of occupation, as a residence and was intended to be so used, then he would have moved into it himself sometime after early 2007, rather than continuing to pay rent elsewhere, or alternatively, he would have sought to rent the property to a tenant. Accordingly, he argued that the sale of the property would constitute a taxable supply and attract GST.
44 Evidence was given about whether the property, which has been uninhabited since February 2007, was capable of being occupied as a residence or for residential accommodation, and therefore, whether it was “residential premises” within the meaning of the legislation. Mr Kay gave evidence about a number of aspects of the property that he contended made it uninhabitable. He stated that the kitchen, bathroom and toilet facilities needed to be replaced and that it required new stumping and carpets. The services had been disconnected, one by “meter abolishment”. Carpet and floor boards needed to be replaced. Mr Kay had not visited the premises recently.
45 Mr Andrews gave evidence that he visited the property every two to three weeks. He stated that, although some services had been disconnected, there was running water and a functioning kitchen and toilet. Whilst the house might require significant cleaning and some refurbishment, it was habitable.
46 The definition of “residential premises” in sub-paragraph (b) also raises the issue of the intended use of the building.
Submissions of the Parties
47 Mr Andrews submitted that the intent referred to in sub-paragraph (b) of the definition of “residential premises” must be that of the buyer of the premises, as the vendor has no intention of occupying them. In any event, Mr Kay could simply require the purchaser of the property to pay any GST that fell due.
48 Mr Kay submitted that the net equity or surplus should be reduced by one- eleventh to take account of the GST that would be payable if he sold the property.
Conclusion on GST
49 I prefer Mr Andrews’ evidence as to the condition of the premises, as he has regularly visited it.
50 Whether the elements of sub-paragraph (b) of the definition of “residential premises” will be satisfied depends on decisions to be taken by Mr Kay and the purchaser, in the event of the sale of the property. The circumstances that may apply at the time of any such sale are uncertain. I therefore consider that I should not make any allowance for liability to GST.
Other Taxation Issues
51 Mr O’Flynn’s written and oral evidence addressed in considerable detail the appropriate accounting method of calculating and distributing the joint venture profit.
52 I have already decided the means by which the distribution of the net equity should occur. The task of distributing the net equity in assets following the failure of a joint venture is different from the task of determining the taxation liability of joint venturers following the distribution of the profit.
53 However, I will summarise Mr O’Flynn’s evidence about the appropriate treatment of joint venture profits. He identified three scenarios or approaches.
54 Under scenario one, the estimated joint venture profit was calculated in accordance with taxation law. It was based on capital costs, with each party responsible for its respective holding costs and contributions. This was the scenario most commonly adopted. No account was taken of the taxation liability of individual joint venturers, who could claim their own taxation deductions for holding costs and for amounts that they were required to pay to other joint venturers.
55 Scenario two calculated the joint venture profit by taking the net capital contributions of the joint venturers, less the taxation benefit of tax deductions, that each could claim. Under this scenario, interest and other costs would be excluded from Mr Kay’s capital contributions, as these recurring costs were deductible by him personally.
56 Scenario three calculated the joint venture profit based on gross capital contributions, less the taxation benefit of tax deductions claimable by each joint venturer. Under this scenario, interest and other costs would be included in Mr Kay’s capital contribution. Mr O’Flynn expressed the opinion that it would be reasonable to add back the taxation benefit, at Mr Kay’s marginal tax rate, of the recurring costs, as he would receive a tax deduction for those costs, yet Mr Andrews would not.
57 Mr O’Flynn emphasised that, unlike a partnership, the income of joint venturers would be separately assessed based on the distribution of income that they received. He considered that scenario one was the appropriate methodology in this instance. He did not consider that mortgage repayments, interest and holding costs should be brought into account. Development costs, the interest, the rates and taxes were deductible during the course of the development.
58 Mr O’Flynn considered that if scenario three were applied, Mr Kay could obtain the benefit of taxation deductions for his interest payments and these should be included in the calculation of the net residual equity. Under scenario three if adopted, Mr Kay’s recurring costs would be deducted from the joint venture profit. The gross capital contributions of the parties should be reduced by the amount of the taxation benefits available to them by deductions, calculated at the top marginal tax rate of 46.5 per cent. In the case of Mr Kay, the available deduction would be $80,124, referrable to the interest payments he had made. In the case of Mr Andrews, the figure would be $11,380.
59 Mr Kay, in his witness statement, expressed the view that he would be liable for tax in the year of disposal of the property. The determination of the net residual equity in the property would be the same whether the property was taken in a realized or unrealized state.
60 The parties did not dispute that the interest payments made by Mr Kay should be taken into account in determining the net equity, or surplus remaining in the joint venture asset. However, the question raised by Mr O’Flynn’s evidence, which had not been debated at the earlier trial, was whether the advantage of tax deductions, that Mr Kay would receive because of the interest payments, should be brought into account in calculating the net equity in the property available for notional distribution to the parties. Mr Kay is yet to claim those deductions. Mr O’Flynn considered that Mr Kay could re-open previous taxation returns to claim as deductions the interest payments on the funds provided to enable the purchase of the property.
Submissions of the Parties
61 Counsel for Mr Andrews submitted that I should bring these deductions into account on the basis advanced by Mr O’Flynn. He argued that both parties would be liable for tax on the amount of the joint venture profit distributed to them. He disputed that Mr Andrews would be paying tax at the top marginal rate. Mr Kay would be able deduct the amount that he paid to Mr Andrews.
62 Counsel for Mr Kay argued that no taxation deduction for interest payments should be taken into account because, if his taxable income was reduced by the interest payments of $180,000, his income would increase by that amount. Once the top marginal tax rate of 46.5 per cent was applied, Mr Kay would be liable for the same amount in additional tax as the taxation deductions. The two amounts would cancel each other out. His taxation liability would increase by the same amount as he would receive by claiming the tax deductions in amended taxation returns.
Conclusion on Taxation Deductions
63 The task for the Court, as I explained in the reasons for judgment given on 4 August 2010, is to ascertain the net equity in the joint venture property. This is a different task from the calculation of the taxable profit from the joint venture, which was the question that Mr O’Flynn considered. By reference to the decision of Muschinski v Dodds,13 I stated that the first rule for distributing the net proceeds was that to the extent that the joint funds allow, the joint venturers are entitled to the proportionate repayment of their capital contributions to the abortive joint venture.14
64 As stated, it is clear that the remaining mortgage debt is to be brought into account in determining the net equity.15
65 The question is whether the interest payments of Mr Kay on loans that he obtained to fund the purchase of the property should be deducted for the
(1985) 160 CLR 583
Paragraph [189]
Cf Baumgartner v Baumgartner (1987) 164 CLR 137 at 150 and cf ss.43 and 48 of the Partnership Act 1958
purposes of calculating the net equity, or surplus, in the property.
66 Mr Kay did argue at trial that his interest payments were a form of capital contribution, in the sense that if he had not made them, he and Mr Andrews would have had to contribute greater sums to the joint venture. However, the interest payments are not readily described as capital contributions. They were a cost of financing the purchase of the property.
67 Nevertheless, I consider that the interest payments are an item that should be taken into account in calculating the net equity of the joint venturers in the property. In a real sense they are a form of advance to the joint venture. By analogy with the distribution of partnership assets on final settlement of accounts, advances, as distinct from capital contributions, are brought into account. 16
68 If I were wrong in that conclusion, I would increase Mr Kay’s share in the net equity to reflect the amount of interest payments that he had made.
Amounts to which the Parties are Entitled
69 I calculate the entitlements of the parties as follows:
Value of the Property $1,100,000.00 Amounts to be deducted from the value of the property: - Balance of Mortgage: $249,789.00 - Joint Venture contributions: Mr Andrews $24,473.51 Mr Kay $476,636.50 __________
Total deductions: $750,899.01 -$750,899.01
_________
Net equity, or surplus, in the property: $349,100.99 =========
Partnership Act 1958, s.48; Fletcher (op cit) pp. 280-281; ‘Lindley & Banks on Partnership’ (18th ed) pp. 735-736
70
Mr Andrews is entitled to 20 per cent of that sum, which equals $69,820.00, plus his expenses of $24,473.51, totalling $94,293.51.
71
Mr Kay is entitled to retain the property and is liable for the outstanding debts, subject to paying that sum to Mr Andrews.
72
Subject to providing the parties with an opportunity to check these arithmetical calculations, I propose to order that Mr Kay pay to Mr Andrews within sixty (60) days, the sum of $94,293.51 plus any applicable interest, in respect of Mr Andrews’ interest in the joint venture property. This payment will extinguish Mr Andrews’ interest in the joint venture property.
73
If that payment is not made, I will reserve liberty to apply to enable Mr Andrews to apply for a sale of the property.
74
Mr Andrews is obliged to pay to Mr Kay the sum of $15,000, plus any applicable interest, in respect of the counterclaim.
75
I will give the parties an opportunity to consider the calculations set out above and hear them in respect of those calculations, costs and any associated matters.
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