ACLN - Issue # 52 37

Property Development Joint Ventures Risks,Financing and Taxation Issues

- David Colenso, Partner,Deacons Graham & James, Brisbane.

This article focuses on property development jointventures. Selection of a joint venture structure is oftendistracted or even driven by tax efficient considerations.Participants can lose sight of the woods for the trees ­passing over the original motives and benefits for the jointventure by emphasising tax above all other issues. Theoriginal purpose for the joint venture must remainparamount in selecting the structure and vehicle. Riskand financing issues should be primary considerationswhile taxation remains secondary.

This article explores these considerations and:• analyses the myriad of risks facing property

development joint ventures;• looks at ways to eliminate or minimise those

risks;• addresses the critical finance issues; and• highlights particular tax features and

consequences.

1. OVERVIEW

1.1 Joint ventures may take many forms. Mostcommentators will point to the 3 broad categoriesof joint venture:(1) a separate legal entity ("Vehicle"), such as an

incorporated joint venture company withshares owned by the Participants;

(2) a legal relationship recognised by law("Structure"), such as a partnership (commonlaw or limited liability) or a trust (unit ordiscretionary);

(3) a purely contractual relationship which, initself, is not a separate legal entity and doesnot fit into the accepted legal definition of trustor partnership relationships. They aregoverned by the joint venture agreement whichcreates the contractual relationship between theParticipants.

Essential to all of these categories is the coming

together of at least 2 businesses or investors("Participants") for a common business purpose.

1.2 This article discusses why Participants enter into aproperty development joint venture and some of therisks which will be encountered. More importantly,it also addresses ways in which those risks can beeliminated, minimised or apportioned between theParticipants and other outside parties by appropriatestructuring and documentation.

2. WHY HAVE A JOINT VENTURE?

2.1 MotivesMost joint ventures arise from an idea, opportunity,

risk or a time when a Participant can see a benefit in joiningwith another Participant to further a common businessgoal. Often those original reasons for getting together inthe first place are forgotten or pushed to the backgroundby issues such as tax.

"Firstly, it is essential to look at what the 'mission'and objectives of the business venture are. Thisseems a very obvious first step, but unfortunatelyoften not thought through and clearly articulatedin the enthusiasm of starting a venture. If it is notclearly defined, the steps that follow can bemisdirected".l

Discussed below are some of the original motivesand benefits for the formation of property developmentjoint ventures and how those motives can dictate theappropriate Structure of the joint venture.

2.2 FinanceMany ofAustralia's large (and not so large) property

developments in recent years have shown a willingnessby many companies to consider joint venture arrangementsas a suitable means of financing them. Innovativeexamples include the $520 million Collins Exchange officetower at 333 Collins Street, Melbourne.2 After the

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spectacular crashes of property developments anddevelopers in the late 1980's, financiers placed evengreater scrutiny on asset backing and balance sheets.Under lenders' prudential guidelines now, the balancesheet of a developer or builder on its own may not besufficient to raise the required finance for a major project.The assistance of a financier may be needed - one who isprepared to fund the project on the basis that it is given anequity share in the project and not merely assume a securedlender's position in the project.

2.3 Spreading Financial RisksClearly a joint venture is one possible way of

spreading financial risks to enable financial institutionsto participate in large projects while not exceeding theirprudential limits. Companies can spread the costs andrisks of a project while allowing a flexible combinationof technical, financial and market knowledge andstrengths. By spreading financial risks ajoint venture is ameans of achieving business and economic objectiveswhich ordinarily would be far beyond the capabilities ofone company operating alone.

Given the ever-changing property market, a jointventure permits experimentation in the high risk/highprofit end of a market without necessarily incurring anunlimited liability for a developer. Participants can "dipa toe in the water" of a new area of investment, aspeculative development or engage new technology ormanagement techniques without placing all their capitalat risk.

2.4 Off Balance SheetProperty acquisition and development incurs very

high debt during the early stages of acquisition of landand construction. That debt on its own may beunacceptable both to developers and financiers and couldaffect existing financial ratios of companies. Dependingon the ultimate structuring of a transaction, ajoint ventureis one way of ensuring that the project and subsequentlythe debt is "off balance sheet".3

2.5 Foreign InvestmentThe Foreign Acquisitions and Takeovers Act

("FATA") administered by the Foreign Investment ReviewBoard ("FIRB") provides a strong incentive for jointventure formation by foreign investors. Generally, thereis a 15% threshold on foreign investment in certaincompanies and even stricter control on foreign investmentin urban land.4 While FIRB is often willing to waive therequirements of the Act to encourage foreign investmentinto Australia, the restrictions have forced foreign investorsto involve Australian Participants in their ventures.

The FATA relies on a variety of tests to establishthe extent of foreign participation in ajoint venture throughboard and voting control. Those types of tests orconditions of approval imposed by FIRB have a greatimpact on the selection of a Vehicle. for the venture butalso on the selection of venture Participants and theultimate Structure of the joint venture itself.5

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2.6 Sharing ResourcesQuite often the only reason a developer needs other

Participants in a project is to achieve a benefit which thedeveloper is unable or unwilling to achieve single­handedly without complementary resources. Apart fromfinance, other considerations are:

(1) market knowledge and access;(2) industry intelligence;(3) development or building skills;(4) design or other trade skills;(5) site availability; or(6) industry contacts.

Invariably, each Participant in a joint venture hassomething special which may not be readily available inthe market - some special expertise, resources or marketposition which is both required by and often bestdeveloped in concert with other Participants. Essentially,"the combined resources of the Participants are intendedto be greater than the sum ofits constituent Participants."6

To ensure that resources (and not just ultimatelyprofits) are shared between the Participants in the jointventure, the Structure must be well planned to identifythe timing, nature, quality and other parameters of theresources and the extent to which they will shared by theParticipants in the joint venture development.

Documentation of the sharing of resources by theparticipants can be achieved by the following methods:

(1) secondment contracts for key employees ofParticipants to be seconded to the joint venture;

(2) licenses to the joint venture for the use oftechnology, confidential information or know­how which one of the Participants brings tothe joint venture;

(3) loan agreements where joint ventureParticipants are providing capital;

(4) enabling legislation where the government ora government authority is a participant;

(5) leases to the joint venture of property orfacilities owned by a Participant;

(6) partly paid shares in a joint venture companywhich would allow the joint venture to call onthe Participants' shareholders and theirfinancial resources if the joint venture requiredfurther capital;

(7) marketing agreements - particularly where aparticipant with market information orpenetration will market the joint venture'sproject; and

(8) management or operation contracts - usedwhere one participant will devote its skills forthe benefit of the joint venture.

2.7 Sharing RiskWhile the financial burden of a project may be too

great for one participant, similarly the desire to spread riskis another primary motive behind forming ajoint venture.Indeed, risk minimisation is one of the key roles whichmost consultants will play in a property joint venture.

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These range from lawyers who draft the joint venturedocumentation and construction contracts to advisers suchas building cost consultants, selling agents and financiers.7

At a very basic level, structuring may entailParticipants taking shares in a joint venture company inthe same proportion as their financial contribution to theventure. Essentially, if there is a loss or profit then it isshared proportionally to the equity contribution of eachshareholder.

However, the complexities of larger projects andthe demands of financiers dictate that the risk must notonly be apportioned but also the Participant best able tobear a certain risk does so - not forgetting that if aParticipant is unable to bear the risk then the otherParticipants will be vulnerable - the risk may crystalliseand will ultimately rest with someone.

In a nutshell:"successful structuring of a joint venture involvesidentifying the risks of the joint venture, allocatingthem to the Participants best able to bear them,allocating other risks to external parties who canmore efficiently bear them than the Participants,and documenting the manner in which those risksare allocated and borne".~

In part 3 of this article the author discusses thevarious categories of joint venture risks in propertydevelopment and methods to eliminate, allocate orminimise them.

2.8 A WarningWhile deserving of an article on its own, an

important point needs to made about structuring jointventures. Solicitors are most often called on to advise onand document joint venture Structures. Given the risksdiscussed in part 3 of this article, advising all Participantsposes an important and difficult matter for solicitors.Waimond Pty Ltd v Byrne9 illustrated that a solicitor canbe negligent in carrying out the instructions of the managerof a joint venture who held legal title to a property whenthat constituted a breach of trust, especially where thesolicitor failed to obtain instructions from the Participantswho were the beneficial owners of the land.

3. RISK

3.1 Identifying RiskIn analysing any property development all risks need

to be identified, addressed and, if possible, eliminated orminimised. The risks can then be allocated to theParticipant willing to accept them in order to achieve thevarious objectives of all Participants. In identifying therisks, Participants need to determine the likelihood ofoccurrence and, if they were to occur, their impact on theproject. In allocating the risks amongst the Participants itis essential to assess the ability of a Participant to undertakeor bear the risk. 10

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3.2 Financial RiskThe life of a property development project means

that there will be different financial risk profiles at variousstages of a project's life. Beginning with the primary riskof availability of finance through to take-out risk at theend of the project, financiers playa pivotal role indevelopment projects.

(1) SourceFinance is principally from 2 sources:(a) equity contribution from Participants

by:(i) shares in a joint venture Vehicle

(ordinary or redeemablepreference); or

(ii) debt (unsecured, secured orsubordinated); or

(b) third party debt (financiers, capitalmarket investors, underwritingagreements or loan facilities).

(2) Rate or Currency MovementLong term projects also face the uncertain risk

of movement in currency exchange rates andinflation. Depending on the size and needs of aparticular project, those risks can be hedged orminimised by currency swaps or sales contracts inforeign currency with CPI linked funding or indexedbonds. II

(3) Cost Over-runDuring construction of the project there is a

cost over-run risk. Will the actual cost of the projectbe as budgeted for in the feasibility? This risk canbe avoided by a fixed price construction contractand a fixed component of interest cost or an interestrate component in the finance facility. Somefinanciers may also require additional security orsupport in the form of bank guarantees or letters ofcredit to cover potential cost over-runs.

(4) Time Over-runDelay in construction of the project will pose

a time over-run risk. Not only will this result inincreased interest costs for the project but, at theother end, this will result in a delay in receipt ofrental income. Fixed price and fixed timeconstruction contracts will minimise this risk. It isalso usual for financiers to appoint their ownquantity surveyors to monitor the progress of adevelopment.

If there is less than 100% external financingbeing provided for a project, a cash flow deficiencycould result if a Participant providing equity orfinance cannot meet its obligations. OtherParticipants would be looking for cash offsetaccounts or a stand by finance facility to shore up aParticipant's obligations if required.

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(5) Take-outFinally, on completion of the project there is

a take-out risk. Will an investor be prepared topay the value of the project which the Participantshope it will achieve on the market? Will the residualvalue of the asset match the market expectations atthe time that the project is completed? Clearly theway to eliminate this risk is an end contract to buythe project or a take-out finance facility to replacethe often higher interest charged in a constructionfinance facility.

The take-out risk is minimised if theanticipated rental income of the project willgenerate sufficient cash flow to service its debt.Any shortfall would need to be serviced oralternative take-out finance arranged. This bringsinto consideration tenant risk - the strength of thetenant and its ability to meet its rent obligationsunder the lease.

The take-out risk has a constantly changingprofile. Changing construction market conditions,the various stages of a project's life, the competingneeds of the Participants and the constantlychanging perception of "value" in the propertymarket will all impact on a Participant's or afinancier's view of the level and acceptability ofthe risk. The Melbourne office market saw anexample of take-out risk with 6 major office towersall reaching completion around the same time inthe late 1980's - all competing for tenants in adepressed rental market with rising interest rates.Today, construction financiers are increasinglyrequiring take-out of construction debt oncompletion of the project by means of put options,property value insurance or pre-sale contracts.

3.3 Delivery Risk

(1) Construction Cost and Time Over-RunDuring the construction phase of a project the

burning question is "Can this be completed on timeand on budget?". The answer to this questiondepends heavily on the identity of the buildingcontractor and the provisions of the buildingcontract. The building contract can (and should)protect a developer from construction cost over-runsby providing for fixed price or "turn key" deliverycriteria. The risk of a contractor running overtimeon a project and delaying the rental income referredto above can be minimised by appropriate liquidateddamages clauses in the construction contract backedup with bank guarantees underwriting thecontractor's obligations. Construction costestimates are usually confirmed by quantitysurveyors for the developer and the financier.

(2) Contractor FailureFinancial failure ofcontractors was a common

feature of the property market crash in the late

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1980's. Many construction companies who alsotook on a development risk found that theconstruction cash flows were insufficient to covertheir rising interest commitments and the fallingmarket conditions. Today, contractors' performancebonds or guarantees are required by developers andtheir financiers. They have the added effect ofsquarely placing any industrial relations problemson the building contractor and not on the projectdeveloper or financier.

During construction, the risk of physicaldamage to the project can be covered by insuranceor force majeure clauses in the construction contract.

3.4 Participant FailureWhat happens if a Participant is unable to meet its

obligations to the joint venture? Participant failure is areal possibility - especially where equity contribution isrequired throughout the life of a development project. Thiscan range from a simple failure to meet a call for capitalwhen required to the receivership or liquidation of aParticipant. The joint venture agreement (or theshareholders agreement in the case of an incorporated jointventure company) can minimise the risk of failure to meeta capital call by forfeiture provisions or buy-out provisions.Other remedies I2 which may be considered in theStructure documentation are:

(1) termination by the innocent party;(2) the right to rectify;(3) loss of voting rights;(4) loss of profit rights;(5) dilution of interest;(6) compulsory sale; and(7) calling in of guarantees.

Obligations to the other Participants can be securedby cross charges or guarantees amongst the Participantsand obligations to outside financiers can be secured byparent company guarantees or security over the jointventure assets. I3

The consequences of participant failure are variedand need to be addressed against a background of equitableprinciples concerning:

(1) penalties;(2) relief against forfeiture;(3) preferences;(4) voidable dispositions;(5) the Corporations Law;(6) disguised charges; and(7) fiduciary obligations. 14

3.5 Political RiskProperty development projects are susceptible to

political or government risk and interference. Both Federaland State Governments have areas of responsibility whichcan impact on projects. Indeed, many large scaledevelopment or infrastructure projects involve the Stateor Federal Government in some way - either a.s a vendor,Participant, user, tenant, taxing authority or governing

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authority. All joint venture projects are subject tolegislative change - especially in taxation arenas. Whilethere can never be guarantees against changes in the taxregimes, the risk of additional tax or a variation of the taxtreatment of joint venture profit can be minimised byadvance tax rulings or determinations. Again, in thepresent political climate in Australia even those forwardrulings or determinations could never be assumed toremain unchanged for a long period of time.

Political change itself is a risk to propertydevelopment projects. Political parties and governmentshave differing agendas and "user pays" infrastructureprojects are highly susceptible to changes in governmentpolicies. The Sunshine Coast Toll Road is an example ofdiffering political persuasions altering the economicviability of a large infrastructure project. In somecircumstances political risk can be reduced by forcemajeure clauses in the joint venture agreement or theconstruction contract.

Government default itself cannot be ignored. Titleto land, government consents, planning approvals andgovernment facilitation or approval at all levels can beterminated, varied or revoked. What is the effect of defaultby the Government? Joint venture financiers would beanxious to ensure that their recourse to assets and contractsremain on commercially acceptable terms.

Enabling legislation may be required for a majorjoint venture project. Privatisation of utilities likeelectricity or gas generation or transmission, toll roads orcasino developments may require specific legislation toenable the project to proceed, or alternatively, to overrideexisting legislation which would prevent the project fromproceeding. The regulatory risk posed without supportinglegislation will, in many cases, mean that the project willnot proceed.

Where a project involves a risk that a governmentmay cancel the project, clauses in the joint ventureagreement allowing recovery of liquidated damages fromthe government concerned (if a Participant) may beappropriate to alleviate the risk concerns.

3.6 ConclusionAs discussed above, one of the prime motives for

forming a joint venture is to share or allocate risk:(1) among the joint venture Participants in return

for a share in the profits of the joint venture;or

(2) to external parties to the joint venture in returnfor a fee or payment.

Entitling Participants to a smaller share of the profitsis the simplest way of sharing risk among Participants.Of course, on many occasions that will not be a satisfactorymethod of apportioning risk, particularly where outsideparties are involved. Most risks can be minimised orallocated by way of a number of contractual, legislative,insurance, or financing methods.

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4. FINANCE

4.1 Identity of the BorrowerGiven the extraordinary range of joint venture

Structures and Vehicles, financiers of propertydevelopment joint ventures must identify and understandthe nature of the business of the joint venture and the risksreferred to above.15 The financier's requirements willdepend upon the identity of the borrower i.e. whether theentire project will be financed as a project or whether eachindividual Participant will separately finance its ownparticipation. The answer to that threshold question willdetermine a number of other essential finance agreementprovisions. 16

4.2 Joint Venture ObjectivesThe objectives of a joint venture or Participant in

seeking finance to fund a property development includeto:

(1) finance the acquisition of the land;(2) facilitate construction of the project;(3) obtain the most cost efficient source of

funds;(4) minimise recourse to the joint venture and

the Participants; and(5) retain ownership for the desired period.

4.3 Financiers' ObjectivesFinanciers ne<ed to consider the risks throughout the

life of a project and the changing nature of those risks astime goes on. Throughout the construction phase theywill want to ensure (as will the joint venture itself) thatthe project is built on-time, on-budget and to theappropriate quality required. Once that is achieved thefinancier will look at the tenant risk to ensure that theproject is leased to good quality tenants and that the projectcan generate sufficient income to service the level of debtthat the project has incurred. Of course, the debt servicingability of a project on completion will be a combinationof a variety of factors such as the project's borrowings,the effective interest rate and the level of income beinggenerated from the tenants. It is probably fair to say thatfinanciers will never be comfortable with all those risksprior to starting construction. Realistically they will lookto Participants for additional security or comfort. Whilefinanciers will assume some risk, their key objective is tominimise any down side that they may incur by financingthe project. Financiers will be looking at the risks, wherethey lie and the ability of the joint venture or a Participantto bear those risks. Again, an assessment of that risk willinclude the reputation, track record, financial standing andcapability of all major participants including the contractorunder the construction contract. Financiers are also vitallyconcerned with the structure of the joint venture and theadequacy and recourse that the project structure and theirsecurities will provide to them. I7

4.4 The Project as Borrower"In my experience legal issues arising from the

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financing of a joint venture tend to produce thehighest level ofdissatisfaction ".18

As mentioned above, financiers need to focus onthe threshold issue of whether a joint venture will befinanced as a project or whether each participant willseparately finance its own participation in the joint venture.

Obviously, where the joint venture is being financedas a proj ect, financiers can take some comfort indemanding security over the entire assets of the jointventure. Ideally, they will require a first registeredmortgage over the land coupled with security over theParticipants' shares or units in the joint venture Vehicle,their interests in the partnership or unincorporated jointventure and their other assets.

While liability of participants is essentially anegotiable issue with the financier, it is illusory forparticipants to believe that a company or unit trust structurestill provides limited liability.

"This advantage has been subjected to increasingattacks with the introduction ofprovisions in the ...Corporations Law which are aimed at piercing thecorporate veil to extend liability in certaincircumstances to directors personally." 19

While limited liability is clearly a primary objectiveof Participants in choosing a Structure and financingfacility, very few financiers will accept that they have norecourse to the Participants, their parent companies ordirectors if there is default or a breach of their prudentialrequirements.

4.5 The Participants as BorrowersOne of the reasons for forming a property

development joint venture is to share resources. Quiteoften one participant will have development orconstruction expertise while the other has no expertise inthose areas but has capital to provide to the joint venture.Each Participant will have a different borrowing capacityand credit profile. This means that participants can borrowmoney at different rates. Financiers of individualparticipants will look at:

(1) SecurityFinanciers will look at the Structure, Vehicle

and the security being offered by both the jointventure and the Participants. Whether or not thejoint venture is a partnership becomes a critical issueat this point.20

Financiers will scrutinize carefully the jointventure agreement to see whether it allows aParticipant to mortgage or charge its interest.Default by one of the Participants may allow afinancier to step into its shoes but this, in turn, mayonly deliver to the financier an ability to continuefunding the project to completion in order to obtainany realistic chance of receiving repayment. The"opportunity" to continue funding a shortfall is oftennot palatable as an option to the financier of a

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defaulting Participant. Cross charges or crossmortgages between Participants raise complicatedpriority issues with financiers of Participants.21

(2) The Relationship Between Financiersand other PartiesThe identity and reputation of the building

contractor and the terms of the building contractare of vital interest to financiers. A financier willshare a Participant's concern that the contractor isefficient, stable and solvent and that the constructioncost is fixed. This is even more critical if thefinancier agrees to continue funding the project afterdefault by a Participant or by the joint venture itself.As a first step, financiers will want to take securityover the Participant's interest in the constructioncontract so that the financier can remedy a defaultto allow construction to continue - so avoiding thehorrendous ill will and costs of delay, work ceasingand start-up.

Financiers will also scrutinise the strength ofa tenant, particularly where the project is a purposebuilt development involving say, an anchor retailtenant, casino or a hotel operator. Again financierswill usually require direct covenants with the majortenant to secure the financier's position in the eventof default.

The financier's right to step into theParticipant's shoes was illustrated in Brisbane'sDockside development. A corporate joint venturevehicle, Stencraft Pty Ltd was incorporated toundertake the large retail, hotel and residentialdevelopment. The Participants were GirvanCorporation, a property developer, FrickerConstructions, a building contractor and Westpac'sfinance company arm AGC as financier. As Girvanfollowed by Fricker collapsed, AGC was left notonly as financier of the project but also owner ofthe other participant's shares. With its other2 Participants in liquidation, AGC had no recourseto anything other than the project and the projectassets. It had to complete the unfinished portion ofthe project and sell it on.

Financiers' involvement in joint ventureproperty developments raises important projectmanagement issues. Financiers will want toapprove insurance arrangements, variations to theproject's plans and specifications, variations to theconstruction contract, development approval andbuilding approval. For multi-tenanted projects,financiers will also want to exercise a degree ofcontrol over the leasing by setting down a leasingpolicy to ensure that the tenancy mix is adequateand suitable to service the debt or provide therequired return on capital.

Financiers will control draw-downprocedures for progress claims in the constructionphase by appointing their own quantity surveyorsto certify that everything is in order.

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4.6 ConclusionFinanciers will look at the two distinct stages of

property development projects - the development phasewhen the project is being constructed and the operationphase when the project is operating and generating cashflow. Debt funding by outside financiers is more usualduring the construction phase because it is difficult toattract equity investment during this risky period. As aresult of this, most joint ventures will seek to raise debtthrough a number of means. Raising equity by debentureissue as opposed to a straight project finance debt facilityhas the advantage that it provides access to a longer termdebt. This allows matching of the funding liabilitiesagainst the project risks. Of course when a developmentis completed, tenanted and providing a cash-flow, it willbe easier to refinance it by way of equity raising.22

Finance is the lifeline of a property developmentjoint venture project. Financiers assume a critical role ineach major document and assume critical importance ineach major relationship. Practically speaking financiersbecome "a third eye" and, de facto (if not in reality) anadditional party to each important contract. Although theyhave a different perspective and risk analysis to theParticipants, the interests of financiers will impact on thenegotiation, documentation and the management of theproject.

5. TAXATION

of assets into the joint venture structure andon subsequent changes in interest.

"I subscribe to the view that the tail shouldnot wag the dog. Stamp duty can oftentempt parties to adopt bizarre structuresfor a project. Put simply, it is better not tosacrifice other structural advantages orimperatives to achieve a stamp dutysaving";24

(6) maximise the ease and minimise the cost ofsale of equity in a project;

(7) create a structure which facilitates access fornew Participants to be introduced into the jointventure;

(8) maximise flexibility to accommodate thechanging risk and investment parameters ofthe Participants - bearing in mind the ever­changing risk profile referred to in chapter 3;

(9) create a structure which is attractive to allownon-recourse financing and off-balance sheetfinancing; and

(10) maximise:(a) tax benefits (including depreciation

allowances) ;(b) access to tax benefits; and(c) the distribution of pre-tax income.

5.1 Introduction"Stated at the outset, the choice of the right jointventure vehicle should primarily be motivated bycommercial issues, one ofwhich may comprise theresultant taxation effect ofundertaking a transactionin a particular vehicle. "23

(2) legal relationship recognised by law ­a relationship where Australian law applies andimplies a number of legal rules governing therelationship between the Participants.Examples of this are partnerships, trusts andagency relationships. Participants in thesetypes of joint ventures may also form acompany to act as a Participant in the legalrelationship - most often this is a companywhich will act as a trustee or manager for thejoint venture. This is sometimes referred to asa "hybrid joint venture" where there is both a

(1) separate legal entity -where a separate legal identity is created andthe Participants hold investments in that equity.A company is the most typical form of this jointventure association.

5.2 Advantages and DisadvantagesThe taxation features and consequences of each joint

venture Vehicle or Structure are sufficiently broad enoughto warrant an article on their own. However, it isinteresting to briefly compare property joint ventureVehicles and Structures to hopefully narrow the scope ofthe exercise in selecting the appropriate structure for eachdistinctive property development joint ventures.

5.3 Types of VehiclesIn the introduction to this article I touched briefly

on the three broad categories ofjoint venture associations:

select a structure that best suits the investmentparameters and commercial objectives of theParticipants to facilitate mortgaging andcharging, project management, assetmanagement, control, default, sale of aninterest, valuation and ultimate exit strategies;create a structure which accommodates eachParticipant's requirements of land and shareownership, asset management, FIRBapprovals and financier's requirements;use a joint venture structure which is as simpleas possible - a rational approach is requiredto avoid an unnecessarily complicated andconvoluted structure;assess risk to limit the liability of theParticipants;minimise stamp duty at both levels - transfer

(2)

(3)

(4)

(5)

Tax is one of the myriad of commercial issues whichface joint ventures and Participants. By summarising someof the issues which need to be considered, the taxramifications of the various joint venture Structuresbecome easier to identify and consider. Participantsshould:

(1)

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trust and corporate structure overlaying therelationship between the parties.

(3) contractual relationship -a new entity is not created and the relationshipdoes not fit within the accepted legal definitionsof "trust" or "partnership". It is essentiallygoverned by the terms of the joint venturecontractual document which provides for asharing of profit, losses, expenses or paymentof remuneration to the Participants based onthe success of the joint venture.

5.4 CompanyIf a company acts as the joint venture vehicle it will

own the assets of the joint venture and the Participantswill only own shares in the company.25 It would be treatedas a separate entity for tax purposes and the rights of theParticipants are regulated by the Articles of Association,the Corporations Law and usually a shareholders'agreement between the Participants.

Tax ConsequencesA company is a separate tax payer for tax purposes.

Its profits can be distributed as dividends to theshareholders but the company itself is allowed the usualbusiness deductions for expenses and depreciation.26 Theindividual tax position of Participant shareholders isirrelevant to the company's tax position. Dividends paidfrom taxed profits may be "franked" to the extent thatcompany tax is paid on the profits. Franked dividendsmean that resident individual shareholders will ultimatelyreceive franking credits which will off-set income tax.

Advantages(1) As a separate single legal entity, it can hold

the joint venture assets in its own name. Thisfacilitates financing and, from a financier'spoint of view, simplifies taking security overthe joint venture assets.

(2) Each shareholder has liability which is limitedto the extent of unpaid capital in the sharesheld.

(3) The company structure is well recognisedwithin the Australian and foreign legal systemsand is envisaged by the tax treaties whichAustralia subscribes to.

(4) The Corporations Law and a voluminous bodyof case law creates a well regulated structureand management overlay on the corporateconstituent documents and agreements. Again,this provides for certainty among Participantsand outside parties such as financiers.

(5) Distribution ofprofit is flexible - assuming thatthe company remains solvent and profits areavailable for distribution,

(6) Transfer of shares and therefore transfer of aParticipant's interest is simple with minimalstamp duty consequences. However, care must

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be taken with "land-rich" companies under thevarious stamp duty regimes.27

Disadvantages(1) Tax losses arising to the company cannot be

assessed by the individual Participants - theyare "trapped" in the company and cannot begrouped or netted against other income of aParticipant shareholder. This is a majordistinction between a company Vehicle and apartnership or unincorporated joint venture.This is a primary tax consideration as manyproperty development joint ventures take yearsto derive sufficient assessable income to off­set against early losses.

(2) The imputation franking provisions mean thatcertain tax concessions cannot be passed on tothe Participants on a tax free basis. This isparticularly relevant in a property developmentjoint venture because of the effect it has on theindexation component of capital gains and thedepreciation allowance for buildingconstruction costs.

(3) Acquisition and disposal of shares must beconsidered under the capital gains taxprovisions of the Income Tax Assessment Act.Complex issues also arise on the winding upof a company.

5.5 Unit TrustA unit trust joint venture structure combines some

of the features of an incorporated joint venture with someof the features of an unincorporated joint venture.Although the beneficial interest in the trust property isrepresented by individual units similar to shares in acompany, the unit trust does not have a distinct legalpersonality. The trustee of the unit trust holds the assetsof the joint venture on behalf of the Participants. TheParticipants' ownership of units gives each Participant aninterest in the assets of the trust but not a divisible interestin any particular asset. The trust is both established andregulated by the trust deed. The unit trust joint venturecan be structured to avoid the prohibitive fundraising rulesin the Corporations Law provided that the trust satisfiesone of the exemptions under section 66.28

Advantages(1) The income of the unit trust is taxed in the

hands of the unit holders so Participants aretaxed according to their own tax regime. As aresult each unit holder will receive pre-taxincome so it can deal with that income in themanner which is most advantageous to it. Thisis particularly useful where some Participantsare taxed at concessional rates and some arenot.

(2) A unit trust is more flexible than a company ­it is not subject to the restrictive rules relatingto maintaining capital or assisting in the

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acquisition of interests in the Vehicle.29

(3) The trust deed affords flexibility forclassification of units in to different categoriesto reflect the different contributions to the jointventure of the Participants. The trust deed canalso cater for reclassification and redemptionof interests which is fundamentally easier in atrust structure rather than in a companystructure.

(4) While the transfer ofunits is simple and similarto the transfer of shares in a company, thedisposal or transfer ofunits is a separate taxableevent. On the one hand there are various taxincentives available to the unit holder such asaccelerated depreciation rates, investment anddevelopment allowance and these will diminishthe cost base of the units for capital gains taxpurposes. On the other hand, for shares, thosebenefits are retained in the company aspotentially unfranked dividends. As a resultthere is a trade-off for access to pre-tax incomeagainst a potential increase in capital gain ondisposal of units.

Disadvantages(1) Some foreign legal and tax regimes do not

recognise the trust structure - Japan is anexample of this. Many developers riding thewave of Japanese investment of Australia inthe 1980's found that the trust structureproposed was not understood or recognised bythe potential Japanese investor.

(2) Income losses in a unit trust cannot bedistributed to the unit holders. They are"trapped" and can only be carried forward tobe applied against future income from the trustrather than other income of the Participants.

(3) This "trapping" of losses usually dictates thatthe joint venture must be equity funded withany borrowings undertaken at the Participantlevel rather than by the joint venture asborrower. Obviously this means that jointventure assets must be made available assecurity for borrowings by individualParticipants.

5.6 PartnershipThe Commissioner has stated the criteria he will

use to determine whether partners are carrying on abusiness.30 He has also said in another ruling31 that hewill treat co-ownership of income producing property asa tax partnership. A partnership creates a number ofconsequences for the Participants. Joint liability, thecreation of partnership assets, subordination of loans byParticipants to the venture and the application of thevarious State Partnership Acts are usually matters ofconsiderable concern when documenting joint ventures.As a rule of thumb Participants in property developmentjoint ventures do not want to create a partnership and

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should take strenuous steps to avoid creation of apartnership. The unlimited liability of Participants in apartnership is obviously the greatest concern. It cuts acrossmany of the risk issues referred to above.

Advantages(1) A partnership is transparent for tax purposes ­

tax loss~s can "pass through " the pa.rtnershipto the individual Participants. This allowsparticipants with differing tax regimes to betaxed appropriately.

(2) The various state Partnership Acts aroundAustralia and a sound body of case law meanthat there is ample (and perhaps onerous)regulation of partnership relationships.

Disadvantages(1) Unlimited and joint liability for partnership

debts and acts of other partners usually negatesthe attraction of a partnership to propertydevelopment joint ventures. It createsunnecessary exposure by 1 participant to theactions of another participant.

(2) The various United States jurisdictions do notrecognise a common law partnership so it isarguably beyond the power of a U.S.corporation to enter into a partnership inAustralia.

(3) Transfer of interests in partnerships is a stampduty nightmare without careful attention topartnership documentation because legal titleto the underlying assets may also need to betransferred.

(4) The capital gains tax regime includes ataxpayer's interest in a partnership and treatseach partner's interest in each of thepartnership's asset as a separate asset. TheCommissioner's approach is set out in anincome tax ruling.32

5.7 Unincorporated Joint VentureThere is no income tax definition of an

unincorporated joint venture. While a partnership isdefined in section 6(1) of the Income Tax Assessment Actto mean an association of persons carrying on businessesas partners or in receipt of income jointly, it is welldocumented that this definition has two limbs. The firstone accords with the legal definition of a partnership andthe second is what is often referred to as a "taxpartnership" i.e. persons in receipt of income jointly. Thiswider definition makes it more difficult to avoid a taxpartnership and its consequences. Unless it is establishedthat Participants share in the product of the joint venturerather than the proceeds of sale or profits, a tax partnershipwill arise. Mining joint ventures where participants sharein the "product" or sayan infrastructure project wherethe Participants share in the electricity produced areexamples where a tax partnership may not arise.

The Act's definition of "partnership" covers not

ACLN - Issue # 52

only a common law partnership but also a consortiumwhere the Participants receive income jointly (but do notderive or realise profits jointly). Such a consortium willbe taxed as a "partnership" under the Act. If theconsortium does not share profits and does not receiveincome jointly, then it will be neither a common lawpartnership or a "partnership" for the purposes of the Act,so instead the partners will be treated as if the income hadbeen earned solely by them. In the latter case tax electionsas to depreciation and the like can be made by theParticipants separately rather than by the venture.33

Advantages(1) "Pass through" of income and losses to

participants.(2) Structuring can avoid unlimited liability and

the consequences of common law partnership.

Disadvantages(1) Detailed and complete documentation of the

entire relationship is required.(2) This structure would be difficult to use in

property developments because theParticipants have undivided interests in the landand need to jointly deaf with their undividedinterests in order to derive income.

(3) The actual operations of the joint venture mustreflect the strict terms of the agreement. Forinstance, if the Participants start acting jointly,receive income jointly and share profits thendespite the terms of the joint venture agreementthey could easily be found to be a commonlaw partnership with the liabilities which attachto that structure.

5.8 DepreciationGenerally speaking the tax depreciation rates for

plant are generous. However, where plant is affixed toland not owned by the owner of the plant, theCommissioner adopts a very strict view on the availabilityof depreciation of the plant. To claim tax depreciationthe user of the plant must own the plant so the affixing ofplant to the land could lead to a denial of depreciationdeductions to a tax payer who does not own the land. TheCommissioner adheres strictly to the general common lawview that items affixed to the land become part of theland and are therefore owned by the land owner. Propertydevelopment joint venture Participants need to considercarefully at what stage plant has become affixed and thiswill lead to considerations of common law tests of themethod of affixation, the period of affixation and whetherthe plant owner has a right to remove the plant from theland. In tax ruling TR94/D26 the Commissioner sets outhis views on the issue of ownership of fixtures fordepreciation purposes. The ruling is particularly relevantwhere tenants of property development projects havephysical possession and use of a tenant's fixture or wherethe tenant has a contractual right to remove the plant.

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6. CONCLUSIONEach of the issues raised in this paper will lead to

further investigation for each particular project, Vehicle,Participant and financier. There is no "boilerplate" whichcan be used between projects because of the very issuesraised in this paper.

Participants' motives, risks, finance and tax issuesall produce a pallet of colours to be considered. As ininterior design, one shade won't suit everybody.

FOOTNOTES

1 Alain Purnell "Joint Ventures - Forming aConsortium and Maximising DevelopmentOpportunities" in Australian Construction LawNewsletter Issue #7, October 1989, page 22.

2 For a case study discussion on the financing of thisproject, see "Joint Ventures in PropertyDevelopment" by Dianne Wilson, Business LawEducation Centre, 1989 pages 83-98.

3 For a detailed discussion of this topic, see M.Markovic "OffBalance Sheet Financing: The LegalImplications" (1992) 10 Company and SecuritiesLaw Journal, pages 35-60.

4 See sections 12A and 26A(2) of ForeignAcquisitions and Takeovers Act 1975.

5 See sections 8 and 11 of Foreign Acquisitions andTakeovers Act 1975.

6 Graeme Dennis "Joint Ventures - How to Select theRight Structure for your Project?" IIR Conferences,29 March 1995, page 2.

7 See Alan Magnus (Editor) "Joint Ventures inProperty: Structures and Precedents ", Sweet andMaxwell, London, 1993, page 39.

8 Graeme Dennis - referred to above, page 3.9 Australia and New Zealand Conveyancing Report,

May 1990, page 230.10 For elaboration of these risks and others, see Richard

Ladbury "Financing Resource Projects", AustralianLaw Journal. Volume 62, 1988, page 937.

11 For a detailed discussion of these types of financingarrangements see J. Martin "Project Finance" in"Handbook of Australian Corporate Finance"1989, Butterworths, Sydney, edited by Bruce atpage 329.

12 See Neil Roberts "Default Clauses in Joint VentureAgreements" in Australian Mining and PetroleumLaw Association year book, 1987, page 318.

13 For a detailed discussion of the relationship betweenfinanciers and Participants see Alan Millhouse"Financing Joint Ventures" in "Joint Ventures Lawin Australia" edited by W. Duncan, FederationPress, 1994, page 144.

14 This has been discussed at great length in manyarticles. See for example John Lehane "JointVenture Finance and some Aspects ofSecurity andRecourse" in Austin and Vann (Editors) "The LawofPublic Company Finance ", Law Book Company,1986, page 515 and Ken MacDonald "Joint Ventures

ACLN - Issue # 52

- Breakdowns and Repair Rights Upon Default",1983 A.M.P.L.A. year book, page 209.

15 An excellent analysis of financiers' risks in propertyjoint ventures is by Di Everett in "Joint Ventures: aProblem for Lenders" in Australian Banking LawBulletin, Volume 10, Number 10, June 1995,page 86.

16 For a detailed discussion of financing of jointventures see Alan Millhouse "Financing JointVentures" referred to above at page 125.

17 See Alan Millhouse at page 129 referred to above.See also Peter Fox "Default/Insolvency ­Enforcement - The Banker's Position", AustralianMining and Petroleum AssociationYearbook, 1991,page 85.

18 Michael Gray "Property Joint Ventures - FactorsRelevant to Structures ", in Australian ConstructionLaw Newsletter, Issue #11, April 1990, page 32.

19 Allan Millhouse at page 130 referred to above.20 See Maree Chetwin "Joint Ventures - A Branch of

Partnership Law?" (1991) 16 University ofQueensland Law Journal 256.

21 See Alan Millhouse at page 147.22 For an excellent analysis of financing joint ventures

by using debentures and public offerings see MikeGibson "Financing Joint Ventures: Raising MoneyThrough Private Investment" IIR Conferences,29 March 1995.

23 Mark Cohan "Critical Considerations in Planning,Negotiating and Establishing Property JointVentures" in Australian Construction LawNewsletter, Issue #13 August 1990, page 31.

24 Michael Gray "Property Joint Ventures - FactorsRelevant to Structures" in Australian ConstructionLaw Newsletter Issue #11, April 1990, page 31.

25 See Ralph Pliner "Incorporated Joint Ventures" inAustralian Mining and Petroleum Law AssociationYearbook, 1991, page 5 and David Gonski'scommentary on that article at page 23.

26 Section 6(1) Income Tax Assessment Act 193627 For a discussion on the stamp duty consequences of

transfer of shares in landholding companies seeMichael Gray's article on "Property Joint Ventures- Factors Relevant to Structures" at page 35 referredto above.

28 This complicated issue is well analysed in the paperby Mike Gibson "Financing Joint Ventures - RaisingMoney Through Private Investment" referred toabove.

29 See section 160ZM relating to assessment of taxincome by unit holders.

30 See taxation ruling TR92/D28.31 Taxation ruling TR93/32.32 See income tax ruling IT2540.33 Graeme Dennis "How to Select the right Structure

for your Project" referred to above, page 20.

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