Australian Property Custodian Holdings Pty Ltd v Commissioner of State Revenue

IN THE SUPREME COURT OF VICTORIA	Not Restricted
AT MELBOURNE COMMERCIAL AND EQUITY DIVISION VICTORIAN TAXATION APPEALS LIST
No. 10194 of 2007
AUSTRALIAN PROPERTY CUSTODIAN	Plaintiff
HOLDINGS PTY LTD
v
COMMISSIONER OF STATE REVENUE	Defendant

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JUDGE:	Mandie J
WHERE HELD:	Melbourne
DATE OF HEARING:	1 October 2008
DATE OF JUDGMENT:	24 October 2008
CASE MAY BE CITED AS:	Australian Property Custodian Holdings Pty Ltd v Commissioner of State Revenue
MEDIUM NEUTRAL CITATION:	[2008] VSC 429

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DUTIES – appeal from Victorian Civil and Administrative Tribunal - transfer of dutiable property – dispute as to unencumbered value of dutiable property – whether Tribunal made errors of law by taking into account prospective lease between purchaser and vendor at above market rental – appeal allowed

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APPEARANCES:	Counsel	Solicitors
For the Plaintiff	Mr R Berglund QC	Madgwicks
with Dr N Orow
For the Defendant	Mr P Solomon	State Revenue Office
HIS HONOUR:

Introduction

The plaintiff, Australian Property Custodian Holdings Pty Ltd (“the taxpayer”), seeks leave to appeal, and (if leave is granted) appeals[1] from a decision of the Victorian Civil and Administrative Tribunal (“VCAT” or “the Tribunal”) that affirmed a determination by the defendant, the Commissioner of State Revenue (“the Commissioner”) pursuant to the Duties Act 2000 (“the Act”).
[1] Pursuant to s. 148 of the Victorian Civil and Administrative Tribunal Act 1998 (Vic).
The taxpayer purchased a property in Geelong upon which was erected a retirement facility known as “Tannoch Brae Retirement Village” – the building comprised four wings, containing 50 beds, connected to a central services block. The property was sold to the taxpayer by Primelife (Geelong) Pty Ltd (“Primelife”) under a contract of sale dated 1 November 2002. The purchase price was $3M but the Commissioner contended that the dutiable value for the purposes of the Act was $5.5M (subsequently reduced to $5.25M).
Duty is charged on the “dutiable value” of the “dutiable property” the subject of the “dutiable transaction”[2], all as defined by the Act.
[2] Section 18 of the Act.
In this case, the “dutiable property” is the estate in fee simple[3] in the Geelong property and the “dutiable transaction” is the transfer[4] of that estate in fee simple by Primelife to the taxpayer.
[3] Section 10(1)(a)(i) of the Act.
[4] Section 7(1)(a) of the Act.
Section 20(1) of the Act provides:
The dutiable value of dutiable property that is the subject of a dutiable transaction is the greater of –
(a) the consideration (if any) for the dutiable transaction .. ; and
(b) the unencumbered value of the dutiable property.
Section 22(1) of the Act provides:
The unencumbered value of dutiable property is the amount for which the property might reasonably have been sold in the open market –
(a) in the case of a transfer of dutiable property on a sale of the property – at the time the contract of sale was entered into;
…

free from any encumbrance to which the property was
subject at that time.

The ultimate dispute between the parties was whether the amount for which the property might reasonably have been sold in the open market, at the time the contract of sale was entered into, exceeded the consideration for the transfer.
Facts and procedural history
It will assist an understanding of the rival contentions of the parties if the background facts are summarised together with an account of the procedural history of the matter.
The taxpayer purchased the property pursuant to a contract of sale dated 1 November 2002 for the sum of $3M payable in full on a specified date[5] or such other date as mutually agreed. It was not suggested that the contract of sale had any particular conditions of relevance to the question of duty.
[5] Curiously, the date specified was 31 October 2002.
However, at the time of entering the contract of sale, the parties made a further agreement entitled the “Tannoch Brae Sale of Rights Agreement” (“the sale of rights agreement”). There was an additional party to this agreement, namely Primelife Corporation Limited, as a guarantor. The sale of rights agreement recited that Primelife was the owner of the Business conducted on the land, that the taxpayer “has purchased” and Primelife “has sold” the land upon which the Business was operating and that Primelife had agreed to sell to the taxpayer and the taxpayer had agreed to buy from Primelife “certain rights connected with the Business .. and to provide for the entering into of the Tannoch Brae PLC Lease” (“the Lease”).
The sale of rights agreement provided that Primelife sold to the taxpayer and the taxpayer purchased from Primelife “the Rights” for the purchase price (defined as the sum of $2.5M). “The Rights” thereby purchased for $2.5M were defined as the entitlement to acquire the Business on the terms of the agreement and the entitlement to the benefit granted to the taxpayer under the Lease including the entitlement to the “Tannoch Brae Annual Fee” (defined as the rent under the Lease).
The sale of rights agreement provided for the parties to do a number of things on or before its completion date. Primelife was obliged to grant a company charge in favour of the taxpayer over certain rights relating to accommodation bonds and the like, and also over the “Business assets,” and provision was made, inter alia, for payment of the purchase price and execution and exchange of parts of the Lease.
Annexed to the sale of rights agreement was the form of lease to be entered into between the taxpayer and Primelife. Of present importance, the term of the Lease was 25 years from 5 November 2002 to 4 November 2027 and the initial rent payable was $522,500 per annum, with provision for five-yearly rent reviews together with certain options for renewal.
The transfer of land was executed on 4 November 2002 and the Lease was made on 5 November 2002.
By Notice of Assessment dated 1 September 2003, the Commissioner assessed the transfer of land for duty in the sum of $302,500 reflecting a dutiable value of $5.5M.[6] A Notice of Objection to this assessment was given, dated 28 October 2003. The grounds of objection included grounds that the unencumbered value was not more than $3M and that the Commissioner had wrongly included in the consideration paid for the transfer the sum of $2.5M paid pursuant to the sale of rights agreement.
[6] The assessment was issued to State Trustees Limited but the parties agreed that the involvement of that entity should be disregarded as having no relevance to the issues to be decided.
By Notice of Determination dated 27 February 2004, the Commissioner disallowed the objection and determined that the dutiable value of the dutiable property transferred by the transfer of land was $5.5M. The reasons for the determination by the Commissioner at that stage were stated to be, in substance, that the consideration paid for the transfer was $5.5M, namely the total of the two payments under the contract of sale and the sale of rights agreement respectively.
The taxpayer appealed to VCAT and, at a directions hearing on 8 August 2007, the Commissioner was given leave to amend its grounds of disallowance by adding a further ground as follows:
“The objection to the assessment is disallowed on the ground that the dutiable value of the dutiable property is the unencumbered value of the property … which is $5,250,000 being the amount for which the property subject to the lease agreement might reasonably have been sold in the open market at the time the contract of sale … was entered into on 1 November 2002 …”

(emphasis added)

In effect, the Commissioner’s justification for the assessment of dutiable value moved from reliance upon the total consideration passing under the two agreements to reliance upon an assessment of the value of the property “subject to the lease.” This new approach was supported by a valuation that had earlier been obtained by the Commissioner that was in due course put in evidence before the Tribunal. This was a document entitled “Overview report” by a valuer, Mr Kevin Bice, dated 18 March 2005. The document is entitled “Overview report” because it refers to two earlier valuations, one by Mr Bice dated 5 July 2002 and one by a Mr Les Brown of “M3property Strategists” dated 13 August 2002. It appears that these valuations were based upon the existence of the Lease, that is, the property was valued upon the basis of an existing 25 year lease at an annual rent of $522,500 per annum.
In his overview, Mr Bice noted that his earlier valuation had assessed a fair market rental of $338,000 per annum based on $130 per registered bed per week whereas Mr Brown’s valuation had adopted a market rent of $377,000 per annum based on $145 per bed per week. Mr Bice said that he thought that the higher figure was achievable at October 2002 while noting that Mr Brown’s valuation process was “to adopt a capitalisation rate which recognises the guarantee by a substantial aged care listed entity (Primelife Corporation Limited) which was not the case in our assessment.”
Mr Bice then said: “We have conducted the following exercise in order to estimate value. We have adopted the market rental of $377,000 p.a., which capitalised at 9.5% recognising the Primelife guarantee, equates to $3,968,421.” Mr Bice then did a calculation on that part of the rent which he considered to be above market rental and reached a conclusion which he said was “supportive” of Mr Brown’s valuation of $5.25M.
After conducting a further analysis to establish the internal rate of return (still based upon the existence of the Lease), Mr Bice expressed his conclusions as follows:
“We mention the following clause on Page 33 of the M3 Report, which
confirms their valuation is of the freehold component.
“subject to the qualifications and assumptions contained within the body of this report, I assess the market value of the freehold interest of Tannoch Brae Residential Aged Care facility Geelong, subject to execution of the lease agreement (as described), exclusive of GST, for first mortgage security purposes at the date of inspection to be …”
The valuation essentially has a core component of the capitalised rental on a market basis, together with a higher yield treatment applied to the overage rental component …
We have therefore concluded that the value parameter of $5,250,000 outlined within the M3 Property Strategists reports is reasonable, albeit slightly bullish due to the rental factor at the high end of the range and the sub 10% yield … Accordingly, we confirm our analysis of the M3 Property Strategists report dated 16th October 20025, to be a reasonable depiction of the freehold component value subject to the specified lease at $5,250,000.”
When the matter came before the Tribunal, on 20 November 2007, counsel for the Commissioner sought leave to amend the ground that had been the subject of leave granted by the Tribunal’s order of 8 August 2007. The Commissioner sought and obtained leave to delete the words “subject to the lease agreement.” Counsel for the Commissioner explained this amendment by saying that the taxpayer took the point that there was no lease agreement as at 1 November 2002 and said that:

“We don’t rely upon there being one, we rely upon the prospect.”

Thereafter, the Commissioner proceeded before the Tribunal solely upon this amended ground of disallowance (and not upon its original grounds set out in the Notice of Determination). The Commissioner no longer relied upon the existence of the Lease. Despite that, the Commissioner relied upon the valuation (or the overview) of Mr Bice which was based upon the existence of the Lease.
Before the Tribunal, the taxpayer relied upon expert evidence from another valuer, Mr Dan Magree (also of M3property Strategists). In his valuation, Mr Magree said that the Lease subsequently entered into between the taxpayer and Primelife was “one factor which may be considered relevant to take into account if it is, in my opinion, a Lease that reflects the true potential value of the property transferred.” However Mr Magree then said that the Annual Fee in the lease equated to a rental of approximately $200 per bed per week and that such rental was significantly higher than the market rental for the property which indicated rates between $114 and $145 per bed per week. Accordingly, Mr Magree said that it was his opinion that the Annual Fee in the lease did not represent a market rent and overstated the true potential value of the property. By capitalising the market rental, Mr Magree concluded that the unencumbered market value of the property at 1 November 2002 was $3.07M.
Both valuers were cross-examined in the proceeding before the Tribunal but nothing emerged from their evidence of present relevance.
Reasons of the Tribunal
In its reasons, after outlining the facts, the Tribunal noted the rival contentions of the parties.
The Tribunal said that the taxpayer submitted that the property was not the subject of any lease as at the relevant date and that the valuation of $3.07M reached by Mr Magree was therefore applicable and that the valuation of Mr Bice was dependent upon the existence of the Lease. The Tribunal noted that the taxpayer submitted that the Lease was entered into after the contract of sale, was for a rental above market and that, in making a valuation for the purposes of the Act, particular or peculiar arrangements entered into between the parties were to be disregarded – regard should only be had to reasonable and normal terms and conditions applicable in the open market.
The Tribunal then recorded the Commissioner’s submission that, in accordance with Spencer’s[7] case, it had to be assumed that the hypothetical vendor and purchaser were perfectly acquainted with the land and all circumstances affecting its value and that, in that regard, “the existence of a lease on favourable terms to a freehold owner was a most relevant and important matter to consider for valuation purposes.” The Tribunal noted that the Commissioner contended that the lease should be “treated as something that was in prospect in which a person [being] the hypothetical vendor or purchaser would be cognisant of as at 1 November [and] should therefore be regarded as relevant to fixing the appropriate unencumbered value.”
[7] Spencer v Commonwealth of Australia (1907) 5 CLR 418.
The Tribunal then said that although the proceeding was in form a valuation case it was not a valuation case in the traditional sense. Mr Bice had valued the freehold subject to a specified lease and Mr Magree’s valuation had excluded consideration of that lease. The Tribunal said that “[u]ltimately however, what is between the valuers and between the parties is the propriety or otherwise of factoring in the 5 November 2002 lease.”
In the course of referring to a number of authorities, the Tribunal emphasised the existence of the sale of rights agreement and the subsequent Lease and then said:
“In a case such as Spencer’s case which was one of compulsory acquisition the provision for sale on purchase must be hypothetical otherwise no valuation could be obtained at all because it would be open to the person the subject of the compulsory acquisition to say “there can be no sale price because I would never sell.” Where a valuation is being undertaken for the purposes of assessing duty on a transfer or conveyance ex-hypothesi, the vendor is not only willing to sell. In fact he has sold. The need to resort to a hypothetical sale therefore is less obvious than it is in a case such as Spencer’s. What is between the parties here is the degree to which one extends the hypothetical to the exclusion of the actual. According to the [taxpayer] one assesses the duty on this transfer not upon the basis of what actually happened and what the parties knew and contemplated would happen but on the basis of what might have occurred in a hypothetical sale.…
The Commissioner says that what actually happened is relevant and a hypothetical purchaser being cognisant of the intention of Primelife .. to take a lease on the favourable terms to the freehold owner would reflect this in the price he would pay and a hypothetical vendor would reflect it in the price he would ask ..
In my view, hypothetically well informed vendors and purchasers of the subject property on 1 November 2002 would be aware of the willingness of Primelife to take the 25 year lease on the apparently favourable term. It is notorious that commercial properties are typically valued by reference to their rental income both actual (passing) rent and reversionary rent.”
The Tribunal then referred to the decision of the High Court in Commissioner of State Revenue v Pioneer Concrete (Vic) Pty Ltd[8] and the decision of this Court in The Palace Hotel (Hawthorn) Pty Ltd v Commissioner of State Revenue[9] and said that:
“Pioneer does not require one to disregard the rental income actual or potential of a piece of real estate in carrying out a valuation of its unencumbered value …Here…the lease was no more than a realisation of an advantageous opportunity known both to the actual vendor and purchaser and inevitably known to any hypothetical vendor and purchaser and operating as an enhancement to the unencumbered value of the land. … Having regard for valuation purposes to the imminence of the 5 November lease does not transform the subject matter of the transfer from an unencumbered fee simple to the conveyance of a reversion expectant upon termination of a long lease.”
[8] (2002) 209 CLR 651.
[9] (2004) 8 VR 439.
Grounds of appeal
In its proposed Notice of Appeal, the taxpayer says that the following questions of law are raised on the appeal:
1. Whether in determining the unencumbered value of the dutiable property in accordance with the provisions of section 22 of the Duties Act 2000 regard can be had to special arrangements that exist or which may exist either at the time of the execution of the relevant transfer of land or subsequent to that execution between the actual vendor and actual purchaser which might enhance the value of the property the subject of the transfer.
2. Whether on the evidence before the Tribunal it was reasonably open for the Tribunal to classify the transfer of land forming the subject of assessment as a transaction being a sale and lease back and to disregard the effect of the sale of rights agreement.
3. Whether the decision of the Tribunal was one to which no reasonable decision-maker would have come.
The taxpayer seeks to rely on the following grounds of appeal:
1.          The Tribunal erred in law in taking into account the specific factors and actual arrangement that existed between the Appellant and the vendor of the land. The Tribunal should have determined the value of the dutiable property on the basis of a hypothetical vendor and purchaser without regard to the special conditions upon which the Appellant purchased the land taking into account the possibility of leasing the premises on the basis that the lease would be on reasonable terms and conditions and not above market rent.
2.          The Tribunal erred in law in characterising the transfer forming the subject of assessment as being in substance a sale and a lease back and determined that liability to duty attached to transactions rather than documents. The Tribunal should have found that liability to duty attached to the instrument of transfer and disregarded the other documents executed by the parties at the time and subsequent to the transfer.
3.          In the alternative, the Tribunal erred in law in taking into account the effect of a lease executed by the appellant subsequent to the execution of the transfer.
Submissions

As will be seen, the parties were not in real dispute as to the applicable law but rather as to how it was to be applied in the circumstances.
The taxpayer submitted that, in affirming the Commissioner’s decision, the Tribunal took into account the specific factors and actual arrangement that existed between the taxpayer and the vendor of the land, in particular the Lease entered into after the execution of the transfer. The taxpayer submitted that the value of the dutiable property had to be ascertained in accordance with s. 22(1)(b) of the Act and in accordance with the principles in Spencer’s case and not having regard to any particular or special features of the actual transaction or arrangements between the vendor and the purchaser. The taxpayer submitted, citing Commissioner of State Revenue v Pioneer Concrete (Vic) Pty Ltd (“Pioneer Concrete”),[10] that the purpose of making the inquiry hypothetical was to isolate the value of the estate or interest to be transferred from factors that were extraneous to the purpose for which such a value was to be ascertained and that special or particular conditions stipulated or agreed to by a particular vendor or purchaser were irrelevant. The Tribunal should have disregarded the Lease which, for reasons peculiar to the vendor and purchaser, was for a rent greater than the market rent. The Tribunal was entitled to take into account the potential rental value of the land, i.e. the market rental, but the evidence was that the rental in the Lease exceeded the market rental and depended upon the special arrangements entered into between vendor and purchaser in the sale of rights agreement.
[10] (2002) 209 CLR 651, 667 per Gleeson CJ, Gummow, Kirby and Hayne JJ.
The Commissioner also emphasised the application of the principles in Spencer’s case. The Commissioner submitted that the hypothetical prudent purchaser must be taken to have been “cognizant of all circumstances which might affect its value”.[11] In that regard, the Commissioner submitted that both actual and prospective tenancies were matters of which the hypothetical purchaser would be cognisant and which the hypothetical purchaser would take into account.[12] The Commissioner submitted that the prospect of the terms of the Lease to be entered into was therefore relevant to be taken into account and that the Tribunal was not in error in so concluding. The Commissioner submitted that there was no legal error involved in the Tribunal’s conclusion that:
“In my view, hypothetically well informed vendors and purchasers of the subject property on 1 November 2002 would be aware of the willingness of Primelife to take the 25 year lease on the apparently favourable term.”
[11] See Spencer v Commonwealth of Australia (1907) 5 CLR 418, 441 per Isaacs J; also citing ISPT v Melbourne City Council [2008] VSCA 180 at [38]; Deputy Federal Commissioner of Taxation v Gold Estates of Australia Ltd (1934) 51 CLR 509, 515; Kenny & Good v MGICA (1999) 199 CLR 413 at [50] per McHugh J; Vopak Terminals Australia Pty Ltd v Commissioner of State Revenue (2004) 12 VR 351, 376 per Ormiston JA.
[12] Citing Palace Hotel (Hawthorn) Pty Ltd v Commissioner of State Revenue (2004) 8 VR 439, at [18] -[23] per Harper J.
Reasons
It is clear, in my view, that there could have been no error of law if the Tribunal had merely taken into account evidence of prospective tenancies in making a finding as to the amount for which the property might reasonably have been sold in the open market. Nor could there have been any error of law if the Tribunal had made such a finding upon evidence from expert valuers based upon the letting prospects of the property. However, that is not what happened before the Tribunal.
The expert valuation evidence before the Tribunal fell into two categories. On the one hand, there was a valuation of the property transferred on the basis that it was subject to the Lease – a basis that had been expressly and correctly disavowed by the Commissioner. On the other hand, there was a valuation that took into account the market rental that the property might attract but disregarded the Lease because the rent therein was substantially higher than a market rental.
The reasoning of the Tribunal was not supported by the valuation evidence. Rather, the conclusion of the Tribunal, as quoted in para [36] above, comprised the undeniably rational proposition that hypothetically well-informed vendors and purchasers would take into account the prospect of a 25 year lease on favourable terms as to rent. But, in my view, that proposition was not apposite having regard to the whole of the evidence as to the transaction entered into between the taxpayer and Primelife because the taxpayer had agreed to pay a substantial sum, in part, in order to procure that Lease. There was not a simple prospect of a 25 year lease on favourable terms as to rent as the Tribunal stated – there was a prospect of a 25 year lease on such terms but only in exchange for a substantial payment. The position was thus not analogous to the position that would have existed had the property been subject to the Lease at the time of the sale.
Given that the particular arrangement between the taxpayer and Primelife involved the payment of a substantial premium for a lease with rental well above market and that there was no evidence explaining this arrangement, the whole arrangement including the proposed Lease was simply irrelevant to the question for what amount the property could be reasonably sold in the open market.
For the foregoing reasons, I consider that the Tribunal erred in law by taking into account the prospective Lease and that the decision of the Tribunal was one that no reasonable Tribunal could have reached.
Pursuant to s.148(7) of the Victorian Civil and Administrative Tribunal Act 1998, the Court is empowered on an appeal to affirm vary or set aside the order of the Tribunal or to make any order that the Tribunal[13] could have made in the proceeding or to remit the proceeding. In the present matter, there being no evidence to support the value espoused by the Commissioner and the only other evidence being that the value of the property was $3.07M,[14] I would propose to order as follows:
1.          Leave to appeal granted.
2.          Appeal allowed.
3.          Decision of Tribunal set aside.
4.          Vary the Commissioner’s determination and assessment by substituting a dutiable value of $3.07M and that the assessment of duty be reduced accordingly (the revised duty should form part of the order).
[13] The Tribunal, on a review, is empowered to confirm, reduce, increase or vary the assessment or decision – see s.111 of the Taxation Administration Act 1997 (Vic).
[14]             See para [24] above.
I will hear the parties on the question of costs.

[2008] VSC 429

24 October 2008