Over the years, options have been used by property developers, speculators, marketers and investors to defer, reduce or avoid paying stamp duty on conditional or speculative property transactions.
A call option over land is the right to require someone to sell you their land for a price at some future date. A put option over land is the right to require someone to purchase land you own.
Put options and call options are often combined in the same transaction, called ‘put and call’ option agreements. Essentially, these are agreements to enter into a contract for the sale of land at some point in the future if either of the parties to the option agreement wishes it. The holder of the call option is the potential purchaser and the holder of the put option is the potential vendor. If the purchaser chooses not to exercise the call option then the vendor can exercise the put option to compel the purchaser to purchase the land.
Stamp duty on grant of options
Stamp duty liability is not triggered by the grant of an option. It is triggered only when the option is transferred or sold or when the option is exercised:
- A person acquiring a call option by transfer or sale from the option-holder (the person to whom the landowner granted the option) pays duty on the price paid for the option (note: the price for the option, not the land).
- A person exercising an option to purchase land pays duty on the price paid for the land.
By “price” we include both monetary or non-monetary value given for the option. For arms-length commercial transactions this is all the money paid or payment-in-kind that is given for the option. For sales at an undervalue (usually where the parties are related), the duty will be calculated on the the market value of the option. The market value of an option depends on variables such as the value of the property, the scarcity of the property and duration of the option. As a rule of thumb, the value of an option will be the difference between the price payable for the land on exercising the option and the market value of the optioned property.
Use of options
Because the mere grant of an option does not trigger stamp duty, options are used in the following scenarios:
- to secure development rights over a potential site without having to pay stamp duty or buy the land unless the developer can assemble the site and obtain development consent;
- to defer stamp duty where a development may not be completed before the deadline for payment of duty on contracts for sale (15 months from exchange for off-plan residential developments and only 3 months from exchange for off-plan commercial developments);
- to secure purchase rights over a property and lock in a price but defer duty to a future tax year;
- to gain the exclusive right to market lots for sale for a specific period of time;
- to permit flexibility in choosing the actual entity that will purchase the property; and
- as sale guarantees to a developer if a buyer cannot be found on the open market.
Call Option Assignment Duty
A person acquiring a call option over land from an option-holder must pay stamp duty as explained above. But, if the call option is part of a put and call option agreement then the option-holder selling the call option must also pay stamp duty. This duty is called ‘call option assignment duty’ and is a kind of vendor duty. The duty is calculated on the sum of the price received for the option and the price payable on exercise of the option. In other words the vendor of a call option under a put and call arrangement will pay stamp duty on the full value of the land and not merely the option value.This is explained in the example below.
- Alan grants a call option to Bob. Neither Alan or Bob pay any duty in relation to the grant of the option. Bob then sells the option to Carole. Carole pays duty on the price she pays for Bob’s option.
- Same facts as above, but when Alan granted a call option to Bob, Bob also granted a put option to Alan. So Bob has the right to buy the land from Alan and Alan has the right to sell the land to Bob. Bob then sells his option to Carole. Bob (not Carole) pays duty as if he was the purchaser of the land even though he is the seller of an option!
Despite its name, call option assignment duty captures not only assignments and transfers, but also sales effected by way of nominating a third party to exercise the option or purchase the land.
Say Alan is a landowner and Bob is a developer. Bob wants to buy some inner-city industrial land from Alan on condition Bob can obtain a rezoning of the land to residential use. Alan and Bob enter into a put and call option agreement for the sale of Alan’s land at $2 Million with an option period of 1 year. Alan grants a call option to Bob for a nominal fee of $10. Bob grants a put option to Alan also for $10. Bob can exercise his call option at any time within the year, but Alan cannot exercise his put option unless and until the land is rezoned. No stamp duty is paid at this point.
Six months later, Bob obtains the rezoning. He decides to realise his profit now and sells his call option to another developer, Carole, for $500,000. Carole exercises the call option to purchase the land from Alan.
- As vendor of the call option under a put and call agreement, Bob pays stamp duty calculated on $2.5 Million ($2 Million + $500,000).
- As purchaser of the call option, Carole pays stamp duty on $500,000.
- As purchaser of the land on exercising the option, Carole pays stamp duty on $2 Million.
Of course, Bob is not in his right mind if he knowingly incurs such a stamp duty liability on land he will not be purchasing. If Bob has confidence in his ability to get the land rezoned and wants the flexibility of on-selling the option, he does better by purchasing a stand-alone call option from Alan for real money that will be counted towards the purchase price on exercising the option. Bob could then sell the option to Carole without incurring any stamp duty liability.
And, until now, it would have been possible for Carole to avoid stamp duty on the purchase of a stand-alone call option. Typically, an option agreement contains a nomination procedure whereby Bob may nominate a third party like Carole to exercise the option or purchase the land. Properly drafted and structured, such a nomination can take effect as a novation of rights that is not subject to stamp duty even if a substantial amount of money changed hands for the nomination.
The State Revenue Legislation Further Amendment Bill 2014
We say “until now” because legislation is wending its way through the NSW State Parliament that will impose stamp duty liability on the purchaser of a stand-alone call option even if the sale is structured as a nomination.
The State Revenue Legislation Further Amendment Bill 2014, once enacted and in force, will impose duty on nominations of options granted after the legislation is enacted. The purchaser of a call option will have to pay stamp duty when ownership of the option changes regardless of whether the sale of the option is structured as a nomination, novation, transfer or assignment.
Duty payable on the nomination will be calculated on the price payable for the option nomination (and see our comments earlier in this post on what we mean by “price”).
Duty on transfers of land following exercise of a call option
The duty chargeable on the purchase of land that occurs as a consequence of the exercise of an option is calculated on the purchase price grossed up by the price paid for the option by the purchaser (whether for its grant, transfer, exercise or otherwise) with a credit given for any duty paid on acquiring the option. In other words, you add together all the money paid by the purchaser (Carole) for the option (acquired from Bob) and the land (acquired from Alan on Carole exercising the option), calculate the duty on that total amount and then deduct any duty paid by Carole on acquiring the option from Bob.
The legislation specifically mentions that the grossing up formula applies to any money paid for the grant of an option. This means duty is payable on price paid for the grant of an option but the liability to pay that duty does not arise until the option is exercised at which point duty is payable on both the price paid for the grant of the option and the land price.
Another benefit to the taxman is to capture an uplift in the value of the land when that uplift is realised on the sale of an option from the option holder to a third party (i.e. when Bob sold the option to Carole in the example given above). Previously, the Office of State Revenue would have had to detect and challenge the land price as not capturing the total value of the land at the later stage of when the option is exercised and the purchaser presents a contract for sale to the Office of State Revenue for stamping.
The practical effect of these legislative changes is explained in the following scenario.
Alan grants Bob a call option to purchase property at $2 Million for an option fee of $200,000. The terms of the option agreement provide that the option fee will be credited towards the purchase price of the property. Bob and Carole enter into a nomination deed in which Bob novates his rights to Carole and agrees to nominate Carole to exercise the call option and purchase the property in return for Carole reimbursing him the $200,000 paid to Alan.
Stamp duty consequences under the new legislation
- On acquiring the option from Bob, Carole must pay duty on the $200,000 paid for the option. The amount of duty payable is $5,500.
- On exercising the option to purchase the land for $2 Million, Carole must pay duty calculated on the total of $2 Million for the land price plus $200,000 for the option) less the duty paid on acquiring the option. Duty on $2.2 Million is $106,500 less the $5,500 already paid leaves a balance payable of $101,000. So the total duty paid by Carole will be $106,500.
Other effects of the new legislation
The grossing up/credit given formula results in a higher tax liability than if duty was paid on the land price with no grossing up or credit because the gross up is taxed at a higher marginal rate (being added onto the purchase price). For example, duty of $95,500 is payable on the land price of $2 Million and adding the $5,500 paid for the option leaves a total duty payable of $101,000.
[Rates are those published on the website of the Office of State Revenue on 8 August 2014.]
Effect of new legislation on put options
One uncertainty is the stamp duty payable on the exercise of a put option. The new legislation imposes the new formula “in respect of a transfer of land in New South Wales that occurs as a consequence of the exercise of an option to purchase land” [emphasis added].
Is a put option an “option to purchase”? If not then the duty payable by a purchaser under a contract for sale created by the exercise of a put option would be calculated in the normal conveyancing manner so in certain circumstances the landowner might be encouraged to exercise their put option in order to a achieve a better tax outcome for the purchaser.
In any event, those dealing in options should factor in the cost of stamp duty when selling call options.
For further information, please contact Andrew Kleiman.
This publication is intended only to provide a summary of the subject matter covered. It does not purport to be comprehensive or to render legal advice. The publication reflects the law at the date the publication was written which may differ at the date the publication is being read. No reader should act on the basis of any matter contained in this publication without first obtaining specific professional advice.