NSW wind farm held to be a fixture and valued under a profit rental approach - SPIC Pacific Hydro v Chief Commissioner of State Revenue

31 May 2021

In brief

The NSW Supreme Court recently handed down its decision in SPIC Pacific Hydro Pty Ltd v Chief Commissioner of State Revenue [2021] NSWSC 395 and SPIC Pacific Hydro Pty Ltd v Chief Commissioner of State Revenue (No 2) [2021] NSWSC 486 (collectively the SPIC case). This case considered the status of wind farm assets on leasehold land as fixtures or chattels at common law and the appropriate valuation methodology to be adopted for stamp duty purposes.

In summary, the Court held that:

• the wind farm equipment (including turbines) were fixtures at common law (not chattels);
• the lessee’s interest in the wind farm equipment arose as part of its leasehold rights rather than some other equitable interest in land
• the value of the leasehold interest and improvements was to be determined using a profit rental methodology (i.e. based on expected rental return on the assets) rather than determining separate values of the lease and the plant and equipment (i.e. under a Depreciated Optimised Replacement Cost (DORC) methodology); and
• even though SPIC was not successful in all of its arguments, as it was successful in having the original assessment revoked and a fresh assessment being issued for a substantially reduced duty amount (by approximately AUD 2.5 million in duty or 20 per cent of the original assessment), it was entitled to costs from Revenue NSW. 

The fixture/chattel classification has limited future relevance from a stamp duty perspective as a result of changes to the rules across almost all States and Territories which mean that items are generally dutiable if they are “fixed” to land, even if they are easily removable and would not be fixtures at common law.  However, the classification of assets as fixtures or chattels continues to be important in determining whether the Taxable Australian Real Property (TARP) rules under Division 855 of the Income Tax Assessment Act 1997 (Cth) apply.

This decision also raises a number of questions about the appropriate valuation methodology to be used when valuing fixtures from both a stamp duty and income tax perspective. Both the Commissioner and the taxpayer had put forward valuations using a DORC methodology. However, the Court rejected this approach based on the statutory context, preferring instead a profit rental approach. This is a departure from the valuation approach commonly used for most leasehold improvements and non-building plant and equipment on freehold land for both stamp duty and income tax purposes and creates uncertainty regarding whether this alternative approach should also apply in the statutory context of the amended stamp duty laws (in NSW and elsewhere, that now include the express deeming provisions) or the income tax legislation.

The SPIC case is still subject to appeal periods. 

In detail

In 2016 SPIC (the taxpayer) acquired all units in the Taralga Holding Land Trust (Taralga). At the time of the purchase Taralga held long term leasehold interests in land on which it had built a wind farm (along with some minor freehold assets). The wind farm was comprised of 51 wind turbine generators housed in custom-designed towers which were bolted into substantial concrete foundations. It also had a switchyard and power substation, a control building, hardstands for heavy equipment, meteorological masts, and 23 kilometres of road access.

The Chief Commissioner determined that Taralaga had landholdings with a value of AUD 223.6 million and assessed the taxpayer for AUD 12,394,573.37 in landholder duty (based on the value of landholdings and dutiable goods). The taxpayer submitted that the wind farm assets on the leases were chattels rather than fixtures and thus no landholder duty should apply. Alternatively, if they were fixtures, then the dutiable value should be lower than the value adopted by the Chief Commissioner.

Fixtures v chattels

In considering whether the wind farm assets were fixtures or chattels the Court considered the degree of annexation (i.e. how attached were they to the land) and the object of annexation (the purpose/objective intention for attaching them to the land). The Court noted that in making this classification, every case turns on its own facts, and held that the wind farm equipment were fixtures, noting the points set out below.

• The wind farm equipment should be considered as a part of an interconnected whole rather than individual items, as none of these items had a function or use independent of the wind farm operation conducted on the land.
• These assets were substantially affixed to the land, with the turbines on towers 80 meters above the ground and the towers held in place by substantial concrete foundations (and a number of sturdy bolts) and connected by predominantly underground cables. Removal of the assets (including 51 turbines) would require cranes, take 8 to 13 weeks and still leave some permanent changes to the land.
• While it was relevant that the parties’ had agreed in the leases that the lessee had the right to remove the relevant assets, this alone was not determinative of whether they were fixtures or chattels.
• The turbines were designed to maximise the electricity generation from the particular site based on 18 years of wind data.
• The wind farm equipment was intended to remain in place for a substantial period of time and, whilst there was a clear intention for the assets to be removed from the land at the end of the lease, the evidence before the Court did not indicate that it was a “realistic commercial possibility” that the assets would actually be removed from the lease before the end of their effective lives.
• These assets were installed on the leasehold land so that the land could be used as a wind farm. This was for the better enjoyment of the land (which is three dimensional and includes the windspace above the land) rather than turbines.  

The Court accepted that some assets, namely, development costs, construction costs, furniture and fittings, spare parts and those parts of the electronic control system not affixed to the land were not fixtures (totalling approximately AUD 18.5 million out of approximately AUD 227.1 million of value). The roads and tracks (about AUD 7.2 million of value) were held to be landlords fixtures rather than tenants fixtures.

These conclusions are a direct contrast to the recent Victorian Supreme Court decision in AWF Prop Co 2 Pty Ltd (as trustee) (ACN 603 996 407) v Ararat Rural City Council [2020] VSC 853 (Ararat Case) where the Court held that above ground wind farm assets were chattels at common law.  The turbine foundations, roads, fences, carpark and underground cabling were the only assets considered fixtures. The Ararat Case was distinguished by the NSW Supreme Court in the SPIC case on the basis that:

• the Ararat case considered a different statutory regime (i.e. fire services levy) which required the determination of the value of the freehold land without regard to any lease, whereas the SPIC case was considering NSW landholder duty, which required identification and value of the interest in land owned by Taralga (i.e. a leasehold interest); 
• as the wind farm was located on a lease in Victoria, it was subject to section 154A of the Property Law Act 1958 (Vic) which gives the lessee a statutory right to remove any improvements they have placed on the land and has been held in other cases to prevent the improvements from becoming part of the land (colloquially referred to as “statutory severance"). There was no equivalent provision applicable to the NSW windfarm assets considered in SPIC.
• the judge in the SPIC decision considered that while the terms of the Development Consent and leases (in particular the inclusion of an obligation to remove the equipment at the end of lease and a statement that they continue to be owned by the lessee) were relevant factors, he disagreed with the conclusion that they should be determinative.

This highlights the importance of carefully considering the specific statutory regime which is being applied and the particular circumstances of each project (including impact of other local or asset specific statutes) in determining whether assets should be classified as fixtures or chattels.

This is important when considering whether similar assets are fixtures or chattels for determining whether an entity is land rich under the TARP rules under Division 855 of the Income Tax Assessment Act 1997 (Cth) and, in turn whether capital gains tax is payable by a non-resident on the sale of the relevant holding entity. It means that it is possible that the classification may potentially be different for similar types of projects located in different States (notwithstanding that income tax is a federal regime) or governed by different types of industry specific legislation (e.g. telecommunications or specific electricity infrastructure legislation).

Tenant’s fixtures - is it an interest in land?

The Court held that it was incorrect to classify the lease and tenant’s fixtures as two separate interests in land, being a leasehold estate in the land and an equitable interest in the tenant’s fixtures. A tenant’s interest in unsevered leasehold improvements arises from, and is governed by, the terms of the lease and rights under the common law (as it would be unnecessary for equity to intervene during the term of the lease). However, the Court noted that there is still an unresolved issue about whether an owner of land can transfer a legal interest in unsevered fixtures and, if so, whether this might give rise to any interest in land but did not consider it necessary to conclude on this point in the current case.

Valuation methodology

Both parties had prepared valuations which valued the leasehold interest and wind farm equipment separately. The parties’ valuers prepared a joint valuation report which valued the wind farm equipment using a DORC methodology and reached an agreed value for these assets of AUD 227,182,500. The leases were valued at nil. This is consistent with the approach commonly used for valuations of this type of asset for stamp duty, income tax and accounting purposes.  

However, the Court held that this approach was inconsistent with the statutory context and the Court’s determination of the nature of the interest to be valued. As noted above, the Court held that a tenant’s interest in the unsevered fixtures is a right that it derives from the lease and, accordingly, it is not appropriate to value the lease and fixtures separately.  In terms of the statutory context, the Court held that the landholder duty provisions required all of the assets of the landholder to be valued on a going concern basis (i.e. on the assumption that they would all be transferred together).

To give effect to this, the Court held that it was necessary to value the rights under the lease, including the right to remove the plant and equipment affixed to the land during the term of the lease and at its expiry.  

SPIC had also prepared an alternative valuation which valued the landholdings in accordance with these principles, which was ultimately adopted by the Court. This valuation determined the value of the lease and fixtures using a profit rental method.This involved:

1. Determining the fair annual rack rent  that could be maintained for the leased site (based on the terms of the lease, an inspection of the property and an inspection of any existing comparable properties).  
2. Ascertaining whether there was a profit rental under the lease by subtracting from the fair annual rack rental the rent and outgoings actually payable under the lease.
3. Estimating the percentage rate of return to capital which a prospective purchaser could be expected to require on their investment (ideally based on comparable properties).
4.  Multiplying the amount of profit rental (step 2) by the rate of return (step 3) and subtracting the estimated cost of repairs or renewals that may be needed to sustain the current rack rental.  If the terms of the lease also require the lessee to meet any costs at termination (e.g. make good) that should also be subtracted from the value (also discounted to present value).  

In applying this to the leases and wind farm equipment in question:

• The valuer noted that the typical market rental for assets such as wind farms and solar farms was usually 8.5 per cent to 11 per cent. This was determined based on the market rate of return applied to the DORC value of the windfarm assets and lease (excluding the assets identified above as not being fixtures, or as being landlord’s fixtures - e.g. development costs, moveable assets, roads and tracks).
• To quarantine the benefit of the lessee paying no rental for the fixtures, the rental sums were adjusted downward for the actual rental being paid by the lessee to determine the “net underletting”.
• The value of the lease was then determined by taking this "net rental" multiplied by the number of years remaining under the lease at an appropriate discount rate, less the deferred rectification liability at the end of the lease (at net present value).
• SPIC’s valuer adopted a discount rate of 20 per cent.
• The Court accepted all of the approaches above except for the discount rate. Instead, it substituted a 9.5 per cent discount rate, being the upper end of the discount rate suggested by the Commissioner’s valuer (and higher than the rate adopted in SPIC’s transaction modelling for the actual acquisition - where a 9 per cent discount rate would have resulted in the project being not financially feasible).  
• This resulted in a landholdings value of AUD 201.6 million in the initial judgment, which was reduced to AUD 177.3 million as part of the final orders. This was substantially lower than the Commissioner’s assessment of AUD 223.6 million).

Ultimately, the landholdings value determined under this approach was less than the value determined under the DORC approach (which has been the common historical practice for fixed plant and equipment). However, from a practical perspective, it does add extra complexity and compliance costs to determining the value of assets of this nature, given that a DORC valuation was still required as an input into the profit rental valuation approach.  

The other question that arises is whether the preferred valuation approach is impacted by the subsequent changes to the landholder duty statutory regime. NSW (along with all other States other than ACT), now include assets “fixed” to land in addition to fixtures as landholdings. This may support an argument for moving back to a DORC methodology for the separate “fixed to land” assets as these items are specifically identified as landholdings. There will be a few issues to try and balance and resolve in determining the most appropriate valuation methodology within the new NSW “fixed to land” regime (which is similar to the regime in other States), such as:

• Tenants fixtures may be captured in the value of landholdings on the basis that the right to remove these fixtures adds value to the leasehold interest (as for the SPIC case). They now also fall within the definition of landholdings on the basis that they are “fixed to land”. However, it would be a highly anomalous outcome for the value of the same asset to be counted more than once (especially in light of the going concern comments below).
• If a different valuation approach is required to be used for tenants’ fixtures vs chattels that are fixed to land, it means that the fixture/chattel classification would once again become important from a stamp duty perspective, which is clearly contrary to the legislative intent of moving to a fixed to land regime.
• The judgement in SPIC was quite clear about the importance of applying a going concern approach to valuations for landholder duty purposes and the shift to a “fixed to land” regime should not change this.  

If there is to be a retention of the historical DORC approach, it may be borne out of practicality and compromise rather than based solely on the difference in the statutory regime. This is because: 

• a DORC valuation results in lower compliance costs - as it would be required for both methods as either the standalone valuation or an input to the profit rental value (favourable to the taxpayer); 
• gives rise to less overall subjective elements and areas for potential disagreement or dispute - e.g. the profit rental approach adds additional variables, such as profit rate and discount rate etc (favourable to both parties); and 
• may potentially result in higher values, as it values the item of plant and equipment itself rather than the benefit of the use as part of the lease (for the term of the lease) and associated right to remove (favourable to the revenue offices).

Costs

As noted above, while SPIC was not successful in all of its arguments, the Chief Commissioner was required to pay SPIC’s costs. This is because, while SPIC was not successful in all of its submissions, they were successful in having the Chief Commissioner’s initial assessment of duty substantially reduced by approximately AUD 46 million of landholdings value, which equates to approximately AUD 2.5 million of duty, or 20 per cent of the original assessment.

The takeaway

The judgement in the SPIC case highlights the potential difficulties in determining whether certain assets (particularly infrastructure assets) should be treated as fixtures or chattels and is a reminder of the importance of taking into account the impact of the relevant statutory regime and other specific facts or regulations that may impact the particular asset. The need to classify assets as fixtures or chattels has been largely removed in a duty context but is still relevant in a number of other areas including income tax.  

The decision has also created uncertainty regarding the appropriate valuation methodology for these kinds of assets. While on the face of it the guidance is quite clear, in practice it is likely to mean greater complexity and increased compliance costs.