SDLT – Option to renew lease or break clause?

Q: Is it preferable for SDLT purposes to have a 5 year lease with option to renew for further 5 years with first year of follow-on lease rent-free or a 10 year lease with a break clause at the end of year 5 which is exercised?

Lease with break clause which is exercised at end of year 5

SDLT is calculated on basis of full 10 year term. No refund for years 6 to 10 if break clause exercised. Highest rent in years 1 to 5 used as rent for years 6 to 10 in SDLT calculation. Rent-free year 6 not reflected in the SDLT calculation.

Lease for 5 years with option to renew

SDLT is calculated on basis of 5 year term. Option ignored initially.

If the option to renew is exercised it is extremely likely that the ‘successive linked leases’ rules in paragraph 5 of Schedule 17A FA 2003 will apply.The two successive leases will then be treated as one lease, granted at the same time as the first lease, for a 10 year term.The rent-free year 1 of lease 2 will not be reflected in the SDLT calculation as that year will be treated as year 6 of the notional 10 year lease. Tax will be charged on that basis and credit given for any SDLT paid on lease 1.

If the linked leases rules do not apply the two leases will be taxed separately, the rent-free year 6 will be year 1 of the second lease and therefore taken into account in the SDLT calculation.

A: The option to renew route has cash-flow advantages if the option is exercised and saves SDLT if it is not. 

At the time of publication this case study was technically accurate however, as tax law and practice change rapidly, you should take specific advice before taking any action.