Legal Tip 126: Structuring a development Part I

Discussion in 'Legal Issues' started by Terry_w, 23rd Apr, 2016.

Join Australia's most dynamic and respected property investment community
  1. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

    18th Jun, 2015
    Structuring a development

    When developing land and building there are many things to consider when structuring. There is no one answer to how best set things up as there will be too many variables.

    Developing tends to be very risky. Risks can come from several areas some of which are:

    - Cash flow crisis, often caused by delays
    - Falling values
    - Poor workmanship
    - Injury

    Having a company own the land can provide a barrier between the development and the persons behind it. Companies limit liability. For example, there may be a dispute with the builder. If it ends up in court it would be far better for the company to be suing the builder than yourself.

    Structuring the company is important too. Banks, and others want personal guarantees, usually from all directors and sometimes from shareholders as well. To limit the risk of your personal assets being exposes you would want to limit the number of directors and who the director(s) will be – hopefully, you had previously structuring your personal affairs so you own little personally.

    Should the company own as Trustee or in its own right? This also depends on a few things. Are you planning to sell or keep? Which state is the land located in?

    If you intend to keep then you will need to worry about land tax issues. Land tax law varies from state to state.

    If you will sell, land tax is less of an issue because it may only be a one-off event.

    Developing is usually taxed as revenue rather than capital gains. So there will be no 50% CGT discount available. The biggest drawback of a company is the lack of the 50% CGT discount, but that won’t apply here anyway. Companies have another advantage of being able to retain income, pay 30% tax and then pay the tax out as a dividend at a later date. This could be timed to when the beneficiaries are on a low income so there could be tax savings or even tax refunds from the franking credits.

    The shares of the company should be owned by the trustee of a discretionary trust for both asset protection and tax minimisation.

    If a trust owns the development then the profits can be distributed to a bucket company and retained in a similar fashion. For this reason, a trust is generally preferred as it adds the additional possibility that it can bypass the company and pay a beneficiary directly. The advantage of a trust is that income retains its character. So income comes out as income to the beneficiaries, capital gains as capital gains (if there were any). But a company transforms income into dividends – which have different tax consequences sometimes. An example would be if there was a capital gain in a trust this could be distributed to a beneficiary who had a capital loss so that the loss could offset the gain. However when a company has a capital gain it would come out as a dividend, and not a capital gain, so it could not be offset by the loss. This is not such an issue with developing, but it could be if the property is retained and held onto.

    Either way, you might have a large profit which may end up, in part at least, into a company. Getting it out can be a problem as it will mean tax is payable. Borrowing it from the company can also cause it to be deemed as a dividend and tax to be payable – or a high rate of interest would need to be charged by the company.

    One way around this is for the next development to be done using the cash in the company.

    The same company that holds the cash should not do the next development because of asset protection reasons. A new company should be set up and company A should lend company B the money to get started. A written loan agreement should be entered into and ideally a mortgage be taken over the land of the second project (behind the bank). This way if the second project fails company A would be a secured creditor and would take priority over unsecured creditors.

    Similar to the first project. Funds will be needed to kick it off. These funds can be lent by a related party family member who can take security behind the bank.

    Where there are more than 1 group of people doing the development then there are other issues to consider. A discretionary trust would not work because there would be no guarantee the profits would be split evenly (being at the trustee’s discretion).

    Two groups could structure in the following ways:
    - Company with 2 separate discretionary trusts owning shares,
    - 2 discretionary trusts with company trustees owning the land as tenants in common,
    - A unit trust with company as trustee and 2 separate discretionary trusts owning the units,
    - One group just lending money and not taking an ownership interest.

    The unit trust can work better than a company in some instances as it is a private arrangement and can keep the unit holders secret. A company’s shareholders are publically searchable. Units of the trust may also be able to be transferred to an SMSF at a later date, whereas shares of a company cannot because of tax issues this creates.

    Where some homes want to be kept by the parties then they will probably want to end up owning one or more in their own names/entity rather than jointly like the project. This will involve the transfer of titles and will result in a taxable event being triggered and stamp duty being triggered. This may be able to be avoided, or minimised with careful planning up front though.

    All the above has assumed that the land is to be purchased in the future. Where the land is already owned then it may not be possible to implement the ideal structure because of the stamp duty and the CGT consequences of changing ownership midway.

    Planning the control of trusts and companies is also very important, especially bucket companies with large sums of cash and also, trust property with large amounts of equity. When you die or lose capacity you want to make sure the right people take over these entities. A trust falling into the hands of a relative could mean your direct family misses out as the trustee will have full discretion on how to distribute income and capital (subject to the deed) and the relative will likely be a beneficiary and so could appoint to himself or to his family at the expense of your family.
    Merlin, SmileSydney, DoubleD and 2 others like this.
  2. Terry_w

    Terry_w Structuring Lawyer and Finance Broker - all states Business Member

    18th Jun, 2015
    EN710 likes this.