When should a joint venture be used as a structure for a property development?
Property development is one of the few commercial activities that can genuinely be undertaken utilising a JV structure, because it is one that allows the parties to share the output of the activity, rather than the income or the profits arising from the activity (some other industries that commonly employ JVs include mining and primary production).
JVs are particularly useful for property developments involving unrelated parties, where each party often brings different resources and skills to the property development, and they agree they will each be entitled to certain parts of the final development, and each will retain their own separate tax treatment and liability. Each party also has their own choice of entity to participate in the JV.
However, joint developments can also potentially be undertaken ‘within the family’, such as by separating the land-owning entity from the building/construction entity.
In a JV to develop land where only one party is the landowner, it would be common for the agreement between the parties to provide the other venturer(s) with rights in respect of the land, possibly amounting to proprietary rights over the land. Where those rights give the other venturer(s) ‘dispositive power’ over the land (i.e., power to dispose of the land), and that venturer is in a business of land development, the land (or subdivided parcels of land) would be their trading stock on hand, even if it has not yet been transferred to them from the land-owning entity. The concept of ‘dispositive power’ is discussed in IT 2670. This may mean that the developer will effectively not be able to deduct expenses as they are incurred.
Under S.70-15(3), if an outgoing is incurred in connection with acquiring an item of trading stock, and that item does not become part of the taxpayer’s trading stock on hand during that year, the outgoing is not deductible until the year in which it becomes part of the taxpayer’s trading stock on hand (i.e., the deductions will effectively be deferred until the trading stock is no longer on hand).
In other words, if the outgoing relates to an item of trading stock that the developer is not required to account for as at 30 June, no deduction is available.
In addition, if the landowner is also carrying on a business of property development, the transfer of dispositive power may result in the land ceasing to be trading stock on hand and, therefore, the crystallisation of a gain in their hands at an earlier date than the date of eventual sale.
This may therefore be problematic for both parties. Therefore, if the arrangement would otherwise give (or will give in the future) dispositive power over the land to the building/construction entity, they may prefer a different arrangement.