5 Ways To "Fudge" Up Your Construction Project
This post was originally published on the blog of Melbourne based law firm R.B. Flinders. RBI has worked with R.B. Flinders to solve complex legal & solvency issues with clients.
When a client says they want to undertake a construction project or property development, the first question that comes to mind is: have they bitten off more than they can chew?
Yes, we acknowledge that this initial question is somewhat pessimistic, but it comes from a place of justified concern.
The construction industry is a battlefield. What initially seems like a straightforward project, overtime, transpires into a complex beast of burden of risk, contractual disputes and unforeseen costs and delays.
Sorry to paint a picture of doom and gloom, but it is important for any budding developer or business wanting to undertake a project to be aware of what can go wrong.
As lawyers, we have been involved in all stages of the life cycle of construction projects. Some of them have been relatively painless, others, well, let’s just say they have not gone according to plan.
To set out some of the things that can go wrong, we have compiled a high-level check list of "what not to do" from a legal perspective. Or another way to politely put it: five ways to "fudge" up your construction project.
1. Getting the structure wrong
There are many different ways to structure a project. You can undertake a project as an individual, through a partnership, a joint venture, development agreement or any of a number of structures. A trap that many fall into is not giving enough thought to the intricacies of the structure that is put in place and what it means for risk exposure and tax outcomes.
For instance, you might want to undertake the development through a joint venture agreement. Why? Because the project is a one-off undertaking and you are not intending to carry on a business. The expenses of the project can be shared amongst the other joint venturers and there is no joint and several liability like in a partnership structure. In addition, a joint venture can often mean that stamp duty and tax are not triggered early in the project. However, even if the agreement governing your project is called a "Joint Venture Agreement" its form and terms may actually be more like a partnership and the court has the power to reclassify it as one.
This would give rise to:
- Joint and several liability of participants (that means you may be responsible for the liabilities of the other parties in the project);
- Stamp duty may be triggered and deemed payable. For example, if a second landowner joined the Joint Venture (and it is found to be a partnership) stamp duty would be triggered on the transfer of the ‘partner’s interest’; and
- Capital Gains Tax (CGT) liability will arise, whereby an interest in a partnership is considered a CGT asset.
2. Thinking you can ‘deal with GST later’
Every development is unique and will have a different GST strategy in place, however the one thing every development has in common is that the best GST treatment will be in place from the beginning of the project.
The first consideration will be the breakdown of commercial and residential property. Generally, commercial developments are considered a taxable supply and subject to GST. For residential projects, they are only subject to GST if they are classified as a taxable supply under s 9-5 of A New Tax System (Goods and Services Tax Act 1999 (Cth) (GST Act).
Now, did you know that there are GST-free going concern concessions available under the GST Act? Did you know that there are further concessions available under the margin scheme, where GST is calculated on 1/11th of the margin of the sale? More importantly…do you know if you are eligible?
It is clear that there is significant up-side to the yield of a project by ensuring that you implement the best GST treatment possible.
However, as we have seen before, taking the view that you can ‘deal with GST later’ can result in both paying the full rate of GST unnecessarily on a purchase and rendering the project ineligible for margin scheme concessions on subsequent sales of the developed site.
3. Paying more than you need to
As we all know, developments are expensive and this means that timing, specifically when funds are available and when payments are due, is critical. If funds aren’t available to meet cash flow demands when they arise, you have a problem. This is why proper management of Duties and CGT is a key concern.
Just as there are many ways to structure a project, there are equally as many ways to deal with land. Some of the more common arrangements we see include:
- Percentage sales to developers;
- Staged sales;
- Option Agreements; and
- Direct sales by the landowner to end buyers.
These diverse arrangements allow for CGT and Duty liability to be brought forward to the beginning of project, staged in increments or even delayed until very close to the end of a project. Of course, as either a Landowner or a Developer each arrangement has its own degree of risk. The best arrangement for any given project will come down to the relationship of the parties, their commercial drivers and appetite for risk.
Ultimately, if you are comfortable with the parties and smart about your structure, you can keep more money in your account and out of the State Revenue Office’s during the life of the project.
4. Site Due Diligence
With land development, unfortunately what you see is often not what you get and there is nothing worse than investing in a site only to find out that as far as a development is concerned…it’s worthless.
Restrictive covenants are a common example of this and appear throughout residential areas to, amongst other reasons, protect a neighbourhood character and guide the long term development of the area. One of the primary issues is that covenants run with the land meaning that if you have an unfavourable covenant, you’re generally stuck with it, unless you have the time and resources to fight to change it.
Another common issue that arises far too often is what lies below the surface. Whether it be rock or contamination, you can be sure that the bottom line of the project will suffer and you want to be as protected as possible. The previous petrol station owner may have ‘promised’ to clean up the land, however how far does this get you when you commence construction only to find out an expensive clean up job is waiting just under the surface for you?
All of the above, your due diligence and water tight agreements can be addressed, as long as you deal with them at the beginning of the project.
5. Assuming the project won’t take long
So you have the perfect site. The group structure, land arrangement and funding are all in place, now all you need to do is get a permit from Council, which is child’s play, right? WRONG.
Time and again we have seen the best laid plans, even those supported by Council along the way, frustrated when for ‘reasons unknown’ Council refuse to grant a permit. So, where do you go from here? Assuming you have a well-planned and appropriate development, this is where you take the matter to the Victorian Civil and Administrative Tribunal (VCAT).
However, no matter how meticulously planned or highly ResCode compliant your development may be, the matter will likely take 10-12 months from when you make your application to when you receive a decision.
Further, even if you are successful at VCAT, if there is any merit whatsoever to council’s refusal (and there’s always something) there is little to no chance that you will receive any of your costs…and you certainly don’t need a lawyer to tell you that litigation isn’t cheap.
We have only chosen five main ways to "fudge" up a construction project. There are many more. However this all can be alleviated and managed if you get the correct advice from the outset and make sure you get the framework for your development right from the get go. The documentation underpinning the development, whether it be the head contract, leases and subcontracts (to name a few), need to be drafted and reviewed to ensure you are minimising risk and getting the most from your project.
Essentially, in any project, you need to strike the right balance of:
- Risk exposure
- Asset protection
- Flexibility; and
- Minimising tax and duty.