Articles

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.

Owner builder insurance

The current domestic building warranty insurance regime came into force 20 years ago and it remains largely a mystery to most property lawyers.

Donald Rumsfeld was referring to weapons of mass destruction when he made his infamous comment about “knowns, known unknowns and unknown unknowns” but he may just as well have been referring to the owner builder warranty insurance scheme that has plagued Victorian conveyancing lawyers for 20 years. Whilst insurance is generally a matter relating to the quality of a property and not a matter going to title, it is the draconian consequences of getting the insurance situation wrong that makes this issue one of the great disasters of conveyancing. Quality issues do not generally create a right of avoidance but failure by the vendor to comply with the owner builder insurance obligations does allow the purchaser to avoid, an outcome that can have disastrous consequences for the vendor’s adviser.

Known

What is known about the scheme is that an owner builder who performed building works in the 6.5 years prior to the sale is required to include a Condition Report in relation to those works in the contract and (if the works exceeded $16,000) obtain warranty insurance. It is important to note that the obligation to provide the Condition Report is absolute and does not depend upon the cost of the works.

Known unknown – what works?

But knowing that the scheme applies to building works creates the first unknown – what building works trigger the obligation?

Section 137B(2) Building Act creates the requirement if a vendor “constructs” a building and the definition of “construct” (s.137B(7)) includes repair or alteration of the building. Clearly adding a room, for instance, would be construction and the requirement arises. But what about essentially cosmetic works that might involve work that could be described as “home handyman work”, such as retiling a bathroom or moving a doorway? Where do we draw the line?

A convenient threshold might be to differentiate between works that require a building permit and works that do not, although that arbitrary line is itself somewhat problematic. Essentially, substantial works require a permit and cosmetic works do not. But the Act, by contemplating an obligation even when a building permit has NOT issued, makes it clear that the requirement does relate to non-permit works and so we must presume that this unknown is in fact any and all works undertaken on the home – any repairs or alterations no matter how minor.

Unknown unknowns – when?

Harder still is the problem of determining when the works were performed.

By s.137B(7) the Act provides a series of alternatives for determining when the 6.5 year period, known as the “prescribed period”, commenced. Starting from the contract date, the vendor must look back either:

  1. 6.5 years and see whether an occupancy permit or certificate of final inspection was issued; or
  2. if not, then look back 7 years to see whether a building permit was issued; or
  3. if neither of the above, then look back 6.5 years to see whether the owner has certified that construction had commenced.

Works performed during any of those periods trigger the requirements. The first two alternatives are based on an objectively determined event but the third is a very subjective basis for determining the prescribed period and adds to the prevailing sense of unreality that surrounds the vendor’s obligations in relation to owner builder insurance.

Off the plan duty concessions

Duty concessions available for off the plan sales need to be understood by both vendors and purchasers.

Vendors selling off the plan properties often emphasis the potential for “huge stamp duty savings” and, indeed, duty is calculated on such transfers at a concessional rate, making them appealing to potential purchasers.  But unless the parties understand the extent of the concession the purchaser may be disappointed and the vendor potentially liable for misrepresentation.

The duty concession is available wherever the contract anticipates building work being performed during the course of the contract on the basis that duty is calculated on the value of the property as at the contract date and is not payable on the value of any building works constructed between contract and settlement. The concession is available whether the property is a stand alone home, a unit in a small development or a lot on a multi-storey plan of subdivision.  It is also available, on a proportional basis, provided that any construction is to be undertaken, with the full concession available if total construction takes place during the contract, diminishing to no concession if construction was complete as at the contract date.

Calculating duty is an important task for the solicitor for the purchaser but can only be undertaken on the basis of information provided by the vendor in the form of an Off the Plan Statutory Declaration that provides the basis for calculating dutiable value.  The vendor’s obligation to provide this document arises from GC.10.1(a)(ii) of the standard contract that requires the vendor to do all things necessary to enable the purchaser to become registered.  The purchaser is unable to register the Transfer until duty is assessed and duty cannot be assessed in relation to these transactions without the Declaration.

The vendor may choose to use the Fixed Percentage Method or Alternative Method to calculate the cost of construction.  Unless the contract requires the vendor to adopt the Alternative Method, the vendor will generally adopt the simpler Fixed Percentage Method.  The percentage of the contract price allocated to construction is:

single dwelling    45%       multi-dwelling    60%       high rise    75%

If construction has not commenced as at the contract date then the concession will be calculated by reducing the contract price by the amount equal to the full construction cost calculated by reference to the Fixed Percentage and then calculating duty on the reduced consideration.

If the contract price is $600,000 and the contract is signed prior to commencement of construction then duty is calculated as follows:

Single dwelling $600,000 x 45% = $270,000 construction cost
minus $270,000 (100% construction cost)
dutiable value = $330,000
multi-lot (up to 3 storey)  $600,000 x 60% = $360,000 construction cost
minus  $360,000 (100% construction cost)
dutiable value =  $240,000
high rise (4 storey & above)  $600,000 x 75% = $450,000 construction cost
minus  $450,000 (100% construction cost)
dutiable value =  $150,000

If construction is 25% complete when the contract is signed then the cost of post contract construction will be reduced to 75% of the construction cost.  The deduction from the contract price will therefore be less, resulting in a higher dutiable value and higher duty as the percentage of post contract construction deceases.