Adjustment of rent

Rental properties present challenges at settlement and care must be taken when adjusting rent and dealing with a security deposit.

The starting point is GC. 15 of the standard contract. But for an “adjustment” condition in the contract, no adjustment of the purchase price would occur and the parties would simply have to accept that rent is in arrears or advance. But an adjustment condition allows the parties to adjust rent as at the settlement date on the basis that the vendor is entitled to the rent up to the settlement date and the purchaser is entitled thereafter.

No formal assignment of the landlord’s rights is required as s. 141 Property Law Act confers upon the owner from time to time the right to recover rent due in respect of the property. Whilst it is common to enter into a Deed of Assignment or Transfer of the tenant’s rights under a lease, no such formality is required in the case of the transfer of the landlord’s rights to a new owner.

In the unusual situation where rent is paid up to the day of settlement, no adjustment between the parties is required. Where rent is paid in advance, the vendor must allow to the purchaser the amount of the prepayment beyond settlement day. Rent is deemed to accrue from day to day (s.54 Supreme Court Act) so rent is to be reduced to a daily rate and the rent for the number of days pre-paid is to be adjusted against the vendor. If rent is payable monthly, the monthly rent is multiplied by 12 and divided by 365 to give a daily rate. If rent is payable weekly, the amount is divided by 7 to give a daily rate.

Rent in arrears tends to present greater difficulties, not so much for the purchaser but for the vendor. In the absence of a Special Condition in the contract, the vendor cannot require the purchaser to allow to the vendor by way of an adjustment any rent due, but unpaid, at settlement. If the rent is in arrears, no adjustment is required. It is for the vendor to seek to recover arrears from the tenant and the vendor is aided by s. 56 Supreme Court Act in this regard. This section provides that if the purchaser recovers arrears from the tenant, then the landlord is entitled to the arrears that relate to the pre-contract period. However a purchaser might not be inclined to issue proceedings against the tenant and the vendor would be wise to include a Special Condition requiring the purchaser to do so.

Alternatively, the vendor might issue proceedings against the tenant for arrears BEFORE settlement, as the vendor has the right to rely on the terms of the lease until settlement.

Security Deposit 

A lease will regularly provide for the payment by the tenant of a security deposit to be held by the landlord to secure the performance of the tenant’s obligations under the lease. It is important that the purchaser makes arrangements for the transfer of this security deposit as the tenant will be entitled at the end of the lease to have the purchaser (as landlord) account for that security deposit. If the vendor holds that security deposit in the form of a cash bond, then adjustment may be achieved by the vendor allowing as an adjustment in favour of the purchaser the amount of the bond and the purchaser depositing that amount in an account under the control of the purchaser. Section 24 Retail Leases Act requires the landlord to hold the security deposit in an interest bearing account on behalf of the tenant and interest must be considered when undertaking this adjustment.

The tenant may satisfy the security deposit requirement by providing a bank guarantee. This presents particular difficulties upon the sale of the freehold. The guarantee will be made out in favour of the vendor and such guarantees CANNOT be assigned. Banks will only make payment to the NAMED beneficiary, so a NEW guarantee must be put in place to take effect from the date of settlement. This creates logistical difficulties, particularly if the lease does not include a clause requiring the tenant to provide a replacement guarantee in the case of a sale.

Adjustment of rates

An essential task in a conveyancing transaction is the adjustment, between vendor and purchaser, of liability to pay rates. Whilst this task is never simple, it is even more complicated in a rental situation where the lease may transfer responsibility to pay rates and outgoings to the tenant. Additionally, the entitlement to rent needs to be apportioned.

The first inquiry is to establish who is responsible for payment of the rates pursuant to the lease.

If the landlord/vendor is responsible for payment, then adjustments are made in the normal way:

if the rates are paid, the purchaser will allow the prepayment to the landlord;

if the rates are unpaid, the purchaser will draw a cheque from the settlement proceeds in payment of the rates and adjust on a “rates paid” basis. By this method the vendor pays the rates up to settlement the purchaser pays from settlement.

If the tenant is responsible for payment:

if the rates are paid, no adjustment is required;

if the rates are unpaid, the purchaser is entitled to be satisfied that any arrears of rates are paid at settlement.

This conventional way of adjusting on a “rates paid” basis means that the vendor pays pre-settlement rates and the purchaser pays post-settlement rates, but both parties may take the view that they would prefer that the tenant pays.

In respect of arrears of rates, the purchaser is entitled to insist upon deduction and payment of arrears at settlement and it is no answer by the vendor to this contractual entitlement that the tenant is responsible for payment. That is a matter between landlord (the vendor) and tenant and does not reduce the purchaser’s right to adjustment.

In respect of current rates, the purchaser is entitled to adjustment up to settlement day even if the current rates are not due and payable. If adjustment is on a “rates paid” basis the purchaser will effectively pre-pay the rates until the end of the current assessment. Whilst the purchaser will be entitled to recover those rates from the tenant pursuant to the lease, the purchaser might prefer to adjust on an “unpaid basis” where the rates are adjusted to the day of settlement only. This requires the vendor to pay (by deduction) rates until settlement but leaves responsibility for payment of future rates to be determined in accordance with the lease.

The vendor in this situation is exposed to a loss. Pursuant to the sale contract the vendor has had to pay any arrears, including part of any unpaid current assessment by way of adjustment of the purchase price. Whilst the vendor, as landlord, had rights under the lease to recover rates from the tenant, that right passes to the purchaser at settlement – s.141 Property Law Act.

The vendor therefore needs to issue recovery proceedings against the tenant before settlement, or include in the contract of sale a Special Condition addressing this situation. This might be an undertaking by the purchaser to repay to the vendor the amount of current rates deducted by the purchaser when and if, the tenant pays those rates or it might authorise the vendor to issue proceedings against the tenant in the name of the purchaser to recover unpaid rates. That the parties are entitled to contract out of the consequences of s.141 Property Law Act was established by Ashmore Developments P/L v. Eaton [1992] 2 Qd R 1.

Great care needs to be exercised in drafting such a Special Condition, as is evidenced by Brinca Property Management P/L v Yeo & Rambaldi [2015] VMC 35.

Withholding tax

All sales of real estate over $2 million made after 1 July 2016 will be presumed to be made by a foreign resident and therefore be liable to a 10% withholding payment unless the vendor obtains a Clearance Certificate from the ATO.

The ATO is concerned that foreign residents are not paying capital gains tax and has introduced a ‘withholding payment’ regime obliging purchasers to withhold and pay to the ATO 10% of the purchase price on account of the vendor’s CGT liability. To better understand this measure, I attending an ATO Information session.

I was greeting in the foyer by Person ONE who directed me to a line where, eventually, Person TWO checked my photo ID. and then directed me to an adjoining line where, eventually, Person THREE asked me to sign in. He then directed me to Person FOUR who invited me to take a seat in the foyer. Eventually Person FIVE invited me to join a group being escorted to the lift and we were shown into a lift, only to find that that lift did not stop at the right floor, so we returned to ground, changed lifts and, eventually, found ourselves on the eighth floor where we were meet by person SIX, who escorted us to the seminar room. We were advised that sanitary and sustenance facilities were available but that we would need to be escorted to those facilities by one (or perhaps more) of the large cast of escorts standing at the back of the room. As the level of participation of the escorts in those sanitary and sustenance activities was not disclosed, I spent a very uncomfortable 2.5 hours not willing to find out.

Despite the need for prior registration and this rigorous security campaign, there were not enough copies of the papers available for the 100 odd people in attendance – that does not bode well for all of these $200,000+ payments that are going to be pouring into the ATO from 1 July.

The most important aspect of the withholding regime is for vendors and purchasers to understand that ALL $2m+ transactions are subject to the tax UNLESS the vendor obtains, and provides to the purchaser, a Clearance Certificate. In the absence of a Clearance Certificate, the purchaser must deduct 10% of the purchase price and remit it to the ATO immediately after settlement. Failure to do so will make the PURCHASER liable to the ATO for the amount.

The key to the vendor obtaining a Clearance Certificate will be the vendor’s current registration with the ATO as a Australian resident tax payer. This places a premium on early consideration of the consistency between the name of the registered proprietor and the registered tax payer. If the vendor has tax records that PRECISELY match the title registration then a Clearance Certificate will issue on-line. This is expected to be 80% of the time. However, if there is a discrepancy between the name on the title and the name of the tax payer, the application goes off-line and delay will be inevitable while the vendor provides the ATO with additional documentation to align the registered proprietor with a registered Australian resident taxpayer.

Clearance Certificates will be available on-line from 27 June 2016, are valid for 12 months and may be used in respect of more than one property. Authentication is problematic.

If the purchaser does not receive a Clearance Certificate then the purchaser is obliged to remit the withholding payment and does so by completing a Purchaser Payment Notification on-line and receiving a Payment Reference Number allowing for payment on-line, at a Post Office or by mail. The ATO will issue payment confirmation to both the purchaser and the vendor.

Of enormous practical importance is the question whether the 10% withholding is to be 10% of ‘the price’, a relatively simple calculation, or is GST to increase the withholding and will adjustments effect the withholding? As presently advised, it appears that a flat 10% of the contract price will be acceptable but hopefully a Ruling will be available before 1 July.