Renewing the concept of fixtures and valuation of land interests

The recent judgment of the Supreme Court of New South Wales in SPIC Pacific Hydro Pty Ltd v Chief Commissioner of State Revenue [2021] NSWSC 3951 provides us with important guiding principles in the classification of fixtures (and in particular tenant’s fixtures) and valuation of land interests in the context of renewable energy projects. With the continued shift towards such projects in Australia, this case demonstrates the potentially hefty stamp duty implications in acquiring and disposing of interests in renewable projects. It also has relevance to the identification and valuation of fixtures for the purpose of the income tax regime involving “taxable Australian real property”.

Background

To effect the acquisition of the Taralga Group, SPIC (the taxpayer) entered into an agreement in March 2016 to purchase 100% of the units in the Taralga Holding Land Trust, along with 100% of the shares and units in other companies and trusts in the Taralga Group structure.

In this case, the relevant acquisition in question was that of the Taralga Holding Land Trust which indirectly held the relevant freehold and leasehold interests in land constituting the Taralga Wind Farm. The leasehold interests consisted of properties which were separately leased and subleased through the Taralga Group structure.

The Chief Commissioner (Commissioner) determined that the Taralga Holding Land Trust was a “landholder” for the purposes of s 146(1) of the Duties Act 1997 (NSW) (Duties Act), with the consequence that  the  acquisition  of  the  units  by  SPIC  triggered  a liability for landholder duty. The Commissioner subsequently assessed landholder duty in the amount of USD12,394,573.37, based on a valuation of USD 223.6 million for the relevant landholdings.

SPIC contested the conclusion that Taralga Holding Land Trust was a landholder on two main points:

1. that the relevant wind farm assets on the leases were chattels rather than fixtures
2. that in the alternative, even if the relevant wind farm assets were fixtures rather than chattels, the valuation of the landholdings relied upon by the Commissioner in his assessment of landholder duty was excessive.

In this case, the relevant questions to be decided (and which are discussed in this article) were:

• What of the plant and equipment installed on the leased land was a “fixture”?
• To the extent that any plant and equipment was a fixture, what (if any) interest in land did this give rise to on the part of the Taralga Holding Land Trust (through its linked entities)?
• Was Taralga Holding Land Trust a “landholder” for the purposes of the Duties Act?
•  How should interests in land on account of fixtures be valued?

Taralga Wind Farm

As is typical of wind farm assets that generate renewable energy into the National Electricity Market, the value of any land interest inevitably depends on the nature of the key assets. In summary, the following key assets were identified on the Taralga Wind Farm:

• 51 Wind Turbine Generators (WTG), which comprised the main assets on the leased land responsible for converting energy to generate electricity. Each WTG was made up of a concrete foundation, a tower section, nacelle and the hub and blades of the generator. The concrete foundations were connected to the ground through concrete and steel reinforcement and were separately connected to the tower sections by bolts cast into the concrete.
• Underground electric cabling which connected the WTGs to a switch room and building located in a switchyard.
• Control building for maintenance and operations staff.
• Meteorological or monitoring masts and television re-transmitter on the land to collect wind data.
• Long access roads across the site to provide vehicular access to the WTGs.

Although a fixed asset register was provided, both SPIC and the Commissioner relied upon expert evidence to value the plant and equipment assets, which was analyzed by the Court (see further below).

Unravelling the chattel and fixture distinction

Maxim quincquid plantatur solo solo cedit.  The ancient Roman law proverb, which provides that “whatever is attached to the soil becomes part of it” remains, in the Court’s view, the key starting point for any fixtures analysis. Although it is presumed that objects that are affixed to the land, to any extent, are fixtures, this presumption may be displaced if the objective intention is that they should not remain there.

Case law in Australia has indicated that there is now less of an emphasis on the traditional principle of degree of annexation but rather a refocus on the purpose of such annexation, a trend which is supported by the Court in this case. The principles in relation to the purpose and degree of annexation tests are widely accepted but were helpfully restated by the Court.

There are the following guiding factors in relation to purpose:

• Whether the attachment was for the better enjoyment of the property generally or for the better enjoyment of the land and/or buildings to which it was attached.
• The nature of the property the subject of affixation.
• Whether the item was to be in position either permanently or temporarily.
• The function to be served by the annexation of the item

There are also the following guiding factors in relation to degree of annexation:

• Whether removal would cause damage to the land or buildings to which the item is attached.
• The mode and structure of annexation.
• Whether removal would destroy or damage the attached item or property.
• Whether the cost of removal would exceed the value of the attached property.

Where assets are found to be fixtures, there is also a need to consider whether it is a landlord or tenant’s fixture. The traditional principle is that all fixtures are landlord’s fixtures (which means they must be left for the landlord at the end of the lease) but if the tenant has a right of removal of their fixture, then they would constitute tenant’s fixtures. However, it was held in TEC Desert Pty Ltd v Commissioner of State Revenue (2010) 241 CLR 576; 273 ALR 134; [2010] HCA 49; BC201009579 that the express right of removal of a tenant’s fixture must not be allowed to obscure the fact that the legal title to the fixtures is in the landlord until the tenant chooses to exercise its power and severs it from the land. That is, the tenant may do so only during the tenancy (except in cases of forfeiture or surrender) or within such reasonable time thereafter as may properly be attributed to its lawful possession.

On the facts in this case, the Court concluded that the WTGs, meteorological masts and infrastructure (which were affixed to the land) were necessary to send generated electricity to the National Electricity Market and were fixtures in the nature of tenant’s fixtures. The roads and tracks on the land which provided access to the WTGs were fixtures, but landlord’s fixtures.

In coming to this conclusion, the Court found that there was a strong degree of annexation. By product of their purpose, the WTGs were very strongly affixed to large concrete foundations and the tower sections were custom designed and built into the concrete foundation. Significantly, removal of the foundations and cabling would cause considerable damage to the land. The taxpayer argued that the WTGs were strongly affixed to prevent them from falling over and therefore, the attachment was for the better enjoyment of the WTGs rather than the land. However, the fact that the degree of affixation was necessary to prevent the WTGs from falling over did not dispel the Court’s finding that the WTG hub and blades were simply required to be elevated to a certain height to capture the wind energy (being the purpose of the WTGs). That is, the purpose of the tower being on the land necessitated such affixation. More fatally to the taxpayer, the Court found that every item of plant and equipment was fixed for the better enjoyment of the land as an integrated wind farm operated on the land (i.e., it was purposefully built).5 Interestingly, the Court observed that the taxpayer had focused on the use of the land in a 2-D plane on the Earth’s surface and omitted to consider the airspace above the land. The Court noted that a tenant also has rights to make use of the airspace above the land and in this case, that use is made by annexing plant and equipment to the land to better enjoy the wind passing above the surface in generating electricity. Relevantly, the evidence pointed to the plant and equipment affixed to the land for the purpose of the wind farm with the intention of being removed only when that plant and equipment had exhausted its useful life or when the wind farm was decommissioned. Since the tenant’s fixtures had been installed so that the tenant could make better use of the land, the purpose of annexation suggested that the majority of the items of plant and equipment were fixtures.

It was also important to note that the facts and outcome of this case were to be contrasted with the case of AWF Prop Co 2 Pty Ltd v Ararat Rural City Council [2020] VSC 853; BC202012608, where the Victorian Supreme Court found that the relevant plant and equipment assets, which were utilised as part of a wind farm, were not fixtures. In that case, the Court gave heavy weight to the terms of the particular leases and related development consents in determining that certain plant and equipment were affixed for a temporary purpose and therefore not fixtures. However, the Court in this case pointed out that although such factors are relevant, they will not, by any means, be a controlling fact in the analysis.

What land interests did the fixtures give rise to?

Next, the Court clarified the nature of the land interests to which the fixtures gave rise in the hands of Taralga Holding Land Trust.

The Commissioner submitted that the taxpayer enjoyed the right to remove the fixtures during the lease term, characterized as an interest in land protected both at common law and in equity, which gave rise to a separate equitable interest in addition to the taxpayer’s legal leasehold interest. This equitable interest was a valuable land interest for landholder duty purposes. In arguing that the equitable interest was a land holding for duty purposes, the Commissioner relied upon TEC Desert.

The Court found that these contentions were not supported by authority and were incorrect in principle. Further:

• The Court helpfully simplified the characterization of a tenant’s interest in un-severed leasehold improvements as a purely legal interest in land arising from the lease and rights under common law.
• It was unclear to the Court why, during the term of a lease, it would be necessary for equity to intervene to protect the tenant’s right to sever and remove tenant’s fixtures. As a tenant has exclusive possession of the land (including items annexed to it) during the term of the lease, the tenant’s interest is simply a leasehold estate or interest in land, including the fixtures.
• In the Court’s view, it was not correct and also unnecessary to say that the tenant held separate legal and equitable interests in the land or any part of it.

Were the interests in land on account of the fixtures to be valued?

The Court stated that the starting point in identifying, and assessing the value of, any landholding is by looking at the relevant statutory provisions in the Duties Act. Although the definition of “landholdings” under the current Duties Act adopts a “fixed to land” model (i.e., physically affixed assets, irrespective of whether the asset is a fixture at law, can be caught under the provisions), these provisions were not in force at the time of acquisition in this case. Therefore, the Court’s finding that the items of plant and equipment were fixtures was relevant in determining those items which were landholdings of the Taralga Holding Land Trust for the purposes of the Duties Act and which had to be valued.

For duty purposes, the value of landholdings is the unencumbered value, which is generally accepted as representing market value. The Court reiterated the Spencer test, which states that market value is the value or price negotiated between a knowledgeable, willing but not anxious purchaser and a willing but not anxious vendor. In determining the application of this test in valuing landholding interests, the Court relied on two important authorities, both from an income tax and duty perspective:

• The High Court case of Placer Dome laid down the key principle that “in the case of a corporation which is a going concern, the statutory valuation exercise requires comparison of the value of land as part of the going concern with the total property of the going concern” and specifically that there is generally “no statutory or other warrant for stripping going concern value out and attributing it with a value separate from the land”. Significantly, where the chosen valuation methodology indicates a significant difference between the valuation placed on the entity’s land assets and the purchase price paid for the acquisition of the entity, the reliability of the valuation may be questioned.
• A similar approach was taken in Resource Capital Fund III LP, a case dealing with the valuation of “taxable Australian real property” for income tax purposes. The case established that the assets of an entity should be valued on the basis of them being simultaneously sold to the same hypothetical purchaser as a bundle, rather than on the basis of stand-alone separate sales.

Relying on these two important cases, the Court here clarified that the interest in land is to be “valued in the context of a hypothetical sale of a going concern where the hypothetical purchaser will also have access to and receive the benefit of other assets of the landholder which affect land value”.

Interestingly, this contrasts with the Commissioner’s position. The Commissioner’s primary position was that the relevant interest in land to be valued was an equitable interest in the land to come onto the land and remove fixtures during the currency of the lease. That is, a hypothetical purchaser would expect to pay, and a vendor would expect to receive, the market value of the affixed plant and equipment as separate goods at the time of sale. The Court did not accept this position on the basis that, as outlined above, the Court did not accept the premise that the right to remove fixtures under a lease gave rise to a separate equitable interest in land.

Discounted cash flow analysis

Although much effort was spent by both parties and their respective valuers in arguing about the appropriate valuation methodology, the Court found that a dis- counted cash flow analysis was appropriate as it valued the relevant land interests as being part of a going concern. However, the Court cautioned valuers on applying unrealistic discount rates, which would produce a valuation involving a transaction that would not have occurred in the real world.

Specifically, SPIC’s valuer argued that a 20% discount rate was appropriate given the existence of significant risks that applied to the acquisition, being the unknown costs of repairs and maintenance and the potential that the lessee of the land had to replace the assets before the expiry of the lease. The Court rejected this approach as it implied the valuer had considered the value of the assets on a standalone basis and not part of the leasehold interest acquired as a whole. Rather, an appropriate discount rate identified by the Court was the discount rate that SPIC had used in its financial model- ling (i.e., 6.5% to 9.5%) in determining the appropriate transaction price for its acquisition of the Taralga Group at first instance, which reflected their risk assessment of the acquisition at the time.

A further criticism of SPIC valuer’s 20% discount rate was that the original acquisition analysis found that any discount rate above 9% was not financially feasible and would have led to losses on the investment. In coming to its conclusion, the Court helpfully provided that:

This real-world transaction [i.e., the original acquisition], involving the same assets, provides an appropriate range of discount rates to use in valuing the relevant interests in land here. SPIC, at arms-length, transacted at that implied discount rate when acquiring these interests in land as part of a going concern.

The Court’s reasoning on this issue serves as a reminder that although a discounted cash flow analysis may be a useful methodology in valuing land interests as a going concern, it is necessary to ensure that all elements of the valuation exercise reflect the going concern principle.

Conclusion

The SPIC case provides greater certainty as to the determination of whether major items of plant and equipment (in renewable energy projects or otherwise) are to be treated as land interests or merely goods at law. It also provides some helpful clarity on the concept that a tenant’s interest in unsevered leasehold improvements is a purely legal interest in land which arises from and is governed by the terms of the particular lease and rights under the common law, rather than any separate equitable interest in land held by the tenant.

In this regard, it should be noted that:

• In Australia’s capital gains tax regime, a capital gain or capital loss made by a foreign resident may be disregarded depending on whether particular assets constitute or do not constitute “taxable Australian real property”. As “real property” includes fixtures for general law purposes, it will need to be considered whether certain plant and equipment (e.g., which are used in an integrated wind farm facility) are fixtures and how a tenant’s interest in such fixtures would need to be valued.
• Under various transfer duty and landholder duty regimes in Australia, the classification of an asset as a fixture or chattel may not make any economic difference. Transfer duty is typically calculated by reference to any interests in land and goods that are together transferred under an arrangement. As noted further above, in almost all jurisdictions, “landholdings” includes interests in land and any assets that are physically affixed to land, whether or not they constitute fixtures at law. Accordingly, whether an item is a fixture or chattel should not impact the overall duty base for transfer duty or landholder duty purposes.
• However, uncertainty remains in relation to the valuation of projects for landholder duty purposes. For substantial plant and equipment, revenue offices have generally accepted that a landholder’s fixed asset register provided a reasonable estimate or representation of current market value. In light of this case, it may be necessary to revisit key valuation principles in assessing duty obligations and to consider whether the approach of revenue offices will shift towards the going concern principle in the future (and whether an independent valuation of certain plant and equipment is required). This would be consistent with the approach for the valuation of taxable Australian real property for income tax purposes, where the valuation as a going concern principle and consideration of assets on the basis of their simultaneous sale to the hypothetical purchaser are standard practice.

We note that the NSW Court of Appeal confirmed that a Notice of Intention to Appeal was lodged by SPIC against the decision.

First published in the June edition of the Australian Property Law Bulletin (2021, Vol 36 No 5).