Vendor Finance and Tax

Discussion in 'Accounting & Tax' started by lixas4, 18th Jul, 2020.

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  1. lixas4

    lixas4 Well-Known Member

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    I am looking at a development site where there is a possible option to purchase based on vendor finance. I am curious as to the tax outcome for the vendor as it will affect their decision to proceed under this type of purchase.

    My understanding of vendor finance is that at settlement the ownership of the property is transferred from the vendor to the purchaser, but instead of the purchaser paying for the property in full, part or all of the purchase amount is leant from the vendor to the purchaser, and a mortgage is placed on the title to secure the vendors interest.

    My query is in relation to the vendors tax treatment. At the point of sale the vendor will be taxed on capital account, then if interest is earned from the vendor finance then this will be taxed as income.

    Is the above correct?
     
  2. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    There are many forms. Usually title only passes on payment in full. An installment contract.

    Vendor would usually be taxed on the date of signing the contract.

    If title passes you are really just borrowing from the vendor.
     
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  3. Mike A

    Mike A Well-Known Member

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    the vendor might not be taxed on capital account. you mention it is a development site so depending on what activities the vendor has undertaken already will determine whether it is on capital or revenue account to them.

    the vendor needs to get tax advice and provide all facts to determine whether it on revenue or capital account for them.
     
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  4. lixas4

    lixas4 Well-Known Member

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    They have prepared a concept plan, and recieved preliminary engineering advice, which they are using for marketing purposes. No planning permit for the site.

    Apparently if they sell it now as is, they will be taxed under capital account.

    The agent mentioned today they would consider other purchasing arrangements if they keep the capital account tax treatment. But they won't consider a development management agreement.

    Firstly, i am trying to work out what all the different types of vendor finance are and how they work, and how they affect the vendor.
     
  5. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    There are basically 3 types of vendor finance
    a) Vendor lends the deposit to the purchaser and title changes hands on a standard settlement
    b) instalment contract where the purchaser pays a deposit and then the rest in installments, potentially over 30 years with title only passing on the last payment
    c) a lease option where the purchaser purchases a lease on the property with an option to purchase it at a certain amount and rents it until then - sometimes with part of the rent being credited to the purchase price.
     
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  6. lixas4

    lixas4 Well-Known Member

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    Great, thank you for explaining Terry, heaps easier to understand then reading the results i got from google!

    So for option a) vendor will likely be taxed on the purchase amount under capital account, and income account for interest earned on deposit borrowing.

    B) this one i am interested in exploring how it would work for a development site.

    Lets say its a 4 stage land development site. We would pay a deposit which would be funded by us, as well as the permits, engineering, presales. Then at construction we would also need to self fund as we wont own the property and there is no property to secure construction funding against. After the end of stage 1 we settle on the sales but we dont own the land, the vendor does, so the vendor would be settling on the land sales relating to stage 1, and i guess a good part of the settling money would be the first installment payment to the vendor. Then repeat for stage 2 onwards.

    Would the above scenario affect the vendors tax treatment? Would they still be under capital account? It seems very similar to a development management agreement setup but without the profit split
    .
     
  7. Mike A

    Mike A Well-Known Member

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    going to be GST issues for you under that arrangement. thats a complex arrangement and i've seen it done once before. we engaged a tax lawyer to deal with the income tax and GST issues for both parties. the contracts are critical to the entire arrangement and determines the outcome for tax and GST purposes.
     
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  8. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    The vendor should get their own tax advice, I couldn't say whether they would be taxed on revenue or capital account. They might be operating a business for example. I think it is also possible to be taxed overtime as the installments are paid.
    But this is complex stuff and not very common so specialist advice is needed.
     
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  9. lixas4

    lixas4 Well-Known Member

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    Yes its quite interesting in how it would work. Using the installment example above, the goal would be to somehow seperate the settlement payments for the different recievers, ie, my portion would be income/gst, but hopefully the vendors under capital/no gst. Not sure how this would work or even if its possible.

    I ask because if that setup was slightly changed and under a development agreement with a profit split, and the landowner was seen as hands off the development (like the vendor finance scenario above), then the vendor could potentially be taxed under capital account.

    Have the ato provided any guidance on development sites and vendor finance that you know of? I found a great guidance note they prepared for development agreements, which luckily we took a hard copy of, as they pulled it off their website (attached).
     

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  10. Terry_w

    Terry_w Lawyer, Tax Adviser and Mortgage broker in Sydney Business Member

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    Yes there was an ATO ID or TR on installment contracts - dating from about 20 years ago.
     
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  11. Elives

    Elives Well-Known Member

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    i'd suggest if in vic to do instalment contract not option as stamp duty is only payable on i believe settlement date not contract date also set up the instalment not with interest payment if it's their ppor instead of 300k purchase price and interest rate have it 350k and 100% principal payments this would then be tax free for vendor
     
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  12. Paul@PAS

    Paul@PAS Tax, Accounting + SMSF + All things Property Tax Business Plus Member

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    Yes very complex. I have seen many surprised to be asked to pay at least 7% + upfront as the GST is payable upfront and duty also. Some backyard developers may skip the GST issue. Remember, its the BUYER who has the obligation to remit GST they withhold from the vendor. So if they get it wrong you can become liable.

    GST at settlement). The instalment basis has a special process as indicated in link
     
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