Victoria cannot tax its way to prosperity

Of course, imposing higher taxes is not the only way to generate additional revenue. Reducing taxes can stimulate new activity and increase collections.

In economics, the Laffer curve is often used to demonstrate the relationship between tax imposts and tax revenue. Imposts that are too high suppress activity and lower revenue, while imposts that are too low are a missed revenue opportunity. The art is in finding the optimal tax base and rate.

With this in mind, a key feature of the 2024-25 Victorian budget is the proposed abolition of duty on certain non-residential property and the introduction of an annual commercial and industrial property tax (CIPT). The reforms start on July 1. But is this the right measure to relieve the pressure on property investors and businesses?

A comparison with NSW highlights the disparity in the existing property taxes that apply in both states.

To illustrate, assume a trustee of a unit trust buys a tenanted retail store in both Sydney and Melbourne. In each case, the price is $3 million and the unimproved land value is $1 million.

For non-residential property, the top duty rate in NSW is 5.5 per cent (excluding foreign investor surcharges). The rate applies to transactions exceeding $1,168,000 (the threshold is indexed annually).

Victoria’s 5.5 per cent rate applies to transactions exceeding $960,000. A 6.5 per cent rate applies to transactions exceeding $2 million. The thresholds are fixed. The NSW duty cost is $148,005 and in Victoria it is $175,000 (18 per cent higher).

On $1 million, the Victorian land tax for a trust is $8163. This increases to $48,163 if all unitholders are foreign (due to the absentee owner surcharge, or AOS).

Victoria has some AOS exemptions, but not for passively leased property. NSW does not impose land tax surcharges on non-residential property.The NSW land tax is nil if the trust is a “fixed trust” or $16,000 if it is a “special trust”.

NSW permits land tax costs to be passed on to retail tenants as an outgoing, subject to limits. Victoria prohibits this.

WGT is unique to Victoria

Assume the trustee decides to borrow $2 million to fund the purchase in Victoria. It issues a property linked note to an investor. Interest is calculated based on the Melbourne store rents.

Victorian duty laws deem property linked notes to be an “economic entitlement”. The noteholder is taken to acquire an interest in the land triggering duty (up to $110,000 on $2 million). Those rules are unique to Victoria.

Assume the land is subsequently rezoned and the unimproved value increased $500,000 to $1.5 million for both stores. Windfall gains tax (WGT) would apply in Victoria at a rate of 50 per cent on that increase.

The trustee could defer the $250,000 liability, with interest, for 30 years or until the next sale (if earlier). WGT is also unique to Victoria.

In August 2024, an unrelated investor purchases 50 per cent of the units in the trust. The acquisition triggers “landholder duty” in NSW and Victoria. On $1.5 million (50 per cent of market value in each state), the duty is $65,555 in NSW and $82,500 in Victoria.

In Victoria, the unit acquisition would also cause the trustee’s WGT deferral to end. The trustee would need to pay $250,000, plus accrued interest, albeit the trustee may have no prior knowledge of the transaction.

The unit acquisition will also bring the Melbourne store into the CIPT net in Victoria. CIPT will apply, in addition to land tax, at a rate of 1 per cent on the unimproved land value. In this example, it would apply to 100 per cent of the land from January 1, 2035 (albeit only 50 per cent of the units were purchased).

Duty may not apply to a future sale once the property is in the CIPT net. That removes a material upfront cost, but CIPT has its own winners and losers.

For example, assume an office tower and an industrial site in Victoria both have a price of $30 million. The unimproved land value for the office tower will typically be much higher (potentially double) than that of the industrial site. While the duty on the purchase of both properties is the same (based on price), the annual CIPT may be much higher for the office tower than the industrial site (based on unimproved value).