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NIGEL POPPLEWELL MA, ATII, solicitor, of Burges Salmon presents the highlights of IIR's recent conference on Tax and Accounting for Commercial Property Transactions.
NIGEL POPPLEWELL MA, ATII, solicitor, of Burges Salmon presents the highlights of IIR's recent conference on Tax and Accounting for Commercial Property Transactions.
Stamp duty opportunities
Stamp duty on a transfer of shares is at 0.5 per cent whilst on real property it is 4 per cent. Thus the simplest way of mitigating tax is to securitise commercial property using a subsidiary company. However, the exit charge under section 179, Taxation of Chargeable Gains Act 1992 (company ceasing to be a member of a group) must be watched carefully. When acquiring properties it might be sensible to acquire them in a subsidiary in the first place. The property could then be sold out of the subsidiary leaving the original purchaser in the same position as it would have been had the property been bought into the parent company. However, it gives the parent company the flexibility of selling the shares in the subsidiary. John Challoner explained that a number of schemes are being used at the moment. One involves splitting legal and beneficial interests. The legal title to a property is transferred to a wholly owned subsidiary which holds as nominee for the parent. Shares in the subsidiary are transferred to the purchaser for £1, and the parent company then contracts with the purchaser to sell the beneficial interest for market value. The contract is stampable (paragraph 7(1)(a) of Schedule 13 to the Finance Act 1999), but is kept offshore. It is important from a Ramsay point of view (notwithstanding Westmoreland and Citibank) that the purchaser does not hive up the legal title from its newly acquired subsidiary. However, since the efficacy of this scheme depends on the contract for the sale and beneficial interests being left offshore, there is clearly going to be a problem should it need to be repatriated. Another scheme involves making a payment for a variation of a lease, which works whether or not an existing lease is in place. There is, however, a chargeable gains problem since the newly formed subsidiary company which pays for the variation will want to ensure that its payment can be used as a section 38, Taxation of Chargeable Gains Act 1992 base cost, going forward. There may be a technical argument that this is indeed a case based on paragraph 3(3) of Schedule 8 to the Taxation of Chargeable Gains Act 1992, but it is likely that a judge would want to construe this against a taxpayer given that the clear intention of the scheme is to defeat a charge to stamp duty.
Stamp duty
Stamp duty was now having a significant impact on valuations. With a 4 per cent charge on the purchase of the property and a 4 per cent charge on the sale, this was a substantial increased cost which needed to be factored into property returns. If and when it becomes possible for the Land Registry to complete transactions without paper, then stamp duty on conveyances will become otiose and will be replaced by stamp duty reserve tax. Neil Warriner said that this will mark a sea change since stamp duty reserve tax is charged on transactions and not on instruments, and, unlike stamp duty which can be seen as a 'voluntary tax', stamp duty reserve tax can, in the absence of payment, be assessed on the appropriate person.
Maximising capital allowances
As a result of the change of legislation on 24 July 1996, David O'Keeffe said that a buyer of a commercial building needs to know the date on which the vendor acquired it. This was important for identifying whether there would be a restriction on a claim for capital allowances on fixtures, in the building, where the vendor had not claimed allowances. If the vendor has acquired the property since 24 July 1996 and not claimed allowances, the purchaser's allowances will be restricted to the disposal value brought in when the vendor acquired the property from its vendor. On the other hand, if the vendor acquired the property before 24 July 1996, there was no such restriction on allowances for the purchaser.
Contaminated land
A company which incurs expenditure to clean up contaminated land will get a 150 per cent 'super deduction'. This is only, however, on the costs incurred over and above those of the normal site preparation costs. Whilst this is available to both investment and trading companies, David O'Keeffe warned that a trading company will only get the allowance if it takes the cost through profit and loss account; thus if it does not take these immediately, but defers them until the land is sold, it will suffer carrying costs until then. Additionally, the person cleaning up the land cannot get allowances if it was the same person (or connected to the person) who contaminated it in the first place.
Transfers of going concerns
Is a transfer of a going concern always a good thing? David Saleh said that the answer is usually yes for the transferee since it would not be charged VAT (and thus has a cash flow benefit), and there will be a lower stamp duty cost. For the transferor the position is not so clear cut, and will largely depend on its ability to recover VAT (and Customs practice in this area has now been questioned following the Abbey National case). Appendix B to VAT Notice 700/9/96 identifies circumstances which fall within the definition of a 'property rental business'. One of these is that the vendor has not let the building, but has found a tenant. It is important that this is a particular tenant. Until then, when the property is being marketed generally, the property will not be a property rental business. VAT looks at beneficial ownership, and there is thus a problem where property is held by nominees. It will be the beneficiary who makes the supply, and the beneficiary who receives it. Property is often bought by a nominee because the real buyer does not want the seller to know its true identity. However, to get transfer of a going concern treatment, the Statement of Practice dealing with this issue (see Appendix D, Notice 700/9 which allows transfer of a going concern treatment if the buyer is a nominee) applies only if the beneficial owner is named, and an agreement identifying the beneficial owner is signed by that person. If a transfer of a going concern is to be avoided on opted property, this might be possible if the purchaser opts but fails to notify Customs until after the 'relevant date'.
The construction industry
Given the 18 per cent deduction from subcontractors with a certificate CIS 4, Liz Bridge said that it is virtually impossible for CIS 4 holders to run a substantial workforce out to whom they had to pay wages. They are effectively paying out 82 per cent of their receipts, and thus if clients were approached by the construction industry for holders who have had substantial workforces, there seem to be three explanations. These are: (i) the mark-up on the job was enormous; (ii) something underhand was going on; or (iii) the holders had discovered the key secret of how to succeed in business!
Accounting for property
Following Herbert Smith v Honour [1999] STC 173, a provision for onerous leases will usually be allowable under Financial Reporting Standard 12. Mark Beddy considered that it may be possible, if there is a chain of retail outlets which are loss making, to argue that the reason for the losses is the rent that these outlets are paying. These can then be described as onerous leases, and the owner gets a deduction for the rent provision, accordingly.
The option to tax or not?
Following Higher Education Statistics Agency v Commissioners of Customs and Excise [2000] STC 332, John Voyez advised that prudent purchasers, looking to purchase at auction where a deposit will be held as agent for the vendor, will opt and notify Customs on all the properties which are in the auction catalogue. That option will bind them even if they do not purchase at that auction. If they subsequently purchase, they will therefore be bound even if they may make no specific election at that time, and may well have forgotten that they had opted on a protective basis at the previous auction. This has been known to happen. An option binds all floors in an office block, and thus if an option is required over, say, floors 1 and 2, but not 3 and 4, ownership of those floors should be split into different entities, and a specific option can then be made.
Securitisation
Property securitisation is simply a variation on basic debt securitisation. The properties are transferred by the property owning company to a special purpose vehicle in return for cash. The issuer raises that cash by issuing bonds to investors. The shares of the issuer are usually held by a charitable trust, and the repayment of the interest and principal on the bonds is serviced by the rent from the properties transferred. Nick Fagge explained that this provides two advantages for the property company. Firstly, because the bonds are secured against the rental stream, and separated from the ancillary activities of the property company, the issuer can get a better credit rating when issuing the bonds. Secondly, the funding raised can be off balance sheet as far as a property company is concerned. The issuer needs to be insulated from charges (e.g. tax). The problem is matching the tax profile of the income (the rent is taxable) with a deduction for the outgoings (the issuer will only get a deduction for the interest element of the bond and not the principal). One solution might be to put the issuer offshore, but the non-resident landlord scheme creates a problem, For United Kingdom resident issuers it might be possible to group the issuer with the property company so that losses can be group relieved into it. Commonly, grouping in this way is unattractive (balance sheet issues) as well as it being difficult to guarantee that there will be ongoing losses during the life of the bond. A better way of achieving this is to shift the tax charge using the loan relationship rules. The property company lends money to the issuer. The issuer will then get a further deduction for the interest payable which can be set off against the rent. The other side of the equation is that the property company will be taxed on the interest against which it can set its losses. In this way the tax charge is simply migrated to the property company in a non-aggressive way.
The tax-efficiency of joint ventures
Where property is transferred into a company which falls outside the 75 per cent group relationship for section 42, Finance Act 1930 purposes, Jonathan Evans said that it may be possible to achieve a stamp duty rate of 0.5 per cent under section 76, Finance Act 1986. The Stamp Office has confirmed that a transfer of a leased building is an undertaking (or part) for these purposes. Beware of arrangements to re-convey because of the rules in section 36, Taxes Act 1988, which charges to tax as rental income, the excess over sale proceeds of any re-conveyance price where land is sold with a right to re-conveyance. Often the party contributing the real estate to a joint venture may want to have the right to get the property back on termination. If this is at market value at that date, section 36 could apply. One way round this might be to grant a lease of the land instead of transferring the freehold, or instead to provide a minimum re-conveyance price equivalent to the sale price when it was transferred to the company. The joint venture vehicle of choice at the moment is a limited partnership which is generally transparent for tax purposes whilst providing the partners with limited liability. Such partnerships can be off balance sheet where the general partner is a deadlock company. Additionally, the tax legislation specifically excludes such partnerships from the definition of a unit trust scheme for tax purposes. One point to note is that there are restrictions for losses under sections 117 and 118, Taxes Act 1988 which apply to limited partnerships, but do not apply to general partnerships. However, these restrictions only apply to trading partnerships.
Payment on surrender of a lease
Section 34(4), Taxes Act 1988 applies where the terms on which a lease is granted provides (inter alia) for a sum to be paid by a tenant in consideration for the surrender of the lease. In such circumstances the whole or part of such sum is treated as a premium and deemed to be rent according to the length of the lease. Whilst amounts only become taxable under this heading when the sum in question becomes payable by the tenant, it is likely to apply where any payment is made when the lease is brought to an end (for example, pursuant of break clause). Mark Joscelyne pointed out that this only applies where the payment is made pursuant to the terms on which the lease is granted. If a tenant simply negotiates the surrender of the lease during its term and agrees to make a payment, this specific statutory provision does not apply. If the landlord was a property trader, the payment is likely to be taxable as Schedule D, Case I income. If he is a non-trading landlord, then it is likely to be subject to capital gains tax on the basis that it is a capital sum derived from an asset (section 22, Taxation of Chargeable Gains Act 1992).
Leasing problems
Whilst the landlord is usually free to waive exemption (for VAT) at any time (subject to any contractual restrictions), he is not free to do so if either he (or any relevant associate – broadly a company in the same VAT group) has ever made any exempt supply of that property. In these circumstances the prior written permission of Customs and Excise must first be obtained, and permission will only be granted if agreement can be reached with the taxpayer as to a 'fair and reasonable' apportionment for the recovery of input tax. Mark Joscelyne said that this 'fair and reasonable' apportionment is less restrictive than the recovery under the capital goods scheme which would apply if the property had cost more than £250,000.
Associates of the landlord
A tenant should ensure that any prohibition in a lease restricting a landlord to waive exemption should extend to a 'relevant associate' even if the relevant associate had no interest in the property. A relevant associate could make an election which would bind the landlord, but a tenant would have no contractual remedy if the restriction only bound the landlord, since the landlord was not in breach.
Intra group surrenders
Mark Joscelyne said that intra-group surrenders can be problematic for capital gains tax purposes. Normally intra-group transactions are capital gains tax neutral as section 171, Taxation of Chargeable Gains Act 1992 applies so that the transaction takes place on a no gain no loss basis. However, this only applies where there is both a disposal and an acquisition of the asset. On a surrender, there is a disposal but no acquisition. Since there will be a market value consideration imputed because the parties are connected, there could be a capital gains tax charge on a surrender on the difference between the market value of the lease at the time of surrender and the tenant's base cost. Accordingly, in intra-group situations it may be better to consider an assignment of the lease to the landlord rather than a surrender. The assignment would contain a declaration of non-merger. This ensures there is a disposal and acquisition and section 171 applies. On a subsequent merger, the base cost in the lease inherited by the landlord on the assignment is added to the landlord's base cost for the property under the capital gains tax merger provisions (section 43, Taxation of Chargeable Gains Act 1992). Note by Nigel Popplewell: Paragraph 45351 of the Revenue's Capital Gains Manual indicates that the Revenue will in practice treat section 171 as applying on the surrender of a lease between group companies, as it applies on the grant of a lease by one group company to another.
