Tax treatment of proposed lease changes

A building had been divided into four leasehold properties, two residential units (let to A and B respectively) and two commercial units (let to C and D Ltd). The freehold of the building was owned by NGM Ltd, a property management company. A, B and D Limited were also the directors and shareholders of NGM Ltd.

The two residential lessees were entitled to extend their leases under the Leasehold Reform, Housing and Urban Development Act 1993 as amended and they had begun this process. During several months of discussion, valuations have been proposed by A and B and accepted on behalf of NGM Ltd. The total payments were to be around £86,000.

D Ltd had requested that its lease was altered to permit a change of use from commercial to residential. A payment of £30,000 by the lessee had been agreed as consideration for the alteration of the lease.

It was proposed that the payments were made to NGM Ltd and the leases were then extended/altered. NGM Ltd would then pay the monies on to A, B and D Ltd, the three shareholders and directors in NGM Ltd.

It was assumed that the consideration for the changes was market value and that the leases had more than 50 years to run at the date of the changes) so that the provisions relating to deemed lease premiums did not apply.

From a tax point of view a great deal turned on whether NGM Ltd owned the freehold in its own right, i.e. ‘beneficially’, or as trustee or nominee for the lessees or some of them. The presumption is that anyone who owns an asset owns it beneficially, and the onus is on anyone who wants to claim that the asset is held as a trustee to show that.

Tax analysis if NGM Ltd did not hold the freehold as nominee/bare trustee

Tax position of the residential lessees when surrendering their existing leases: capital gains tax

An individual is chargeable to UK CGT on gains made in a tax year during any part of which he is resident in the UK or during which he is ordinarily resident in the UK.

The extension of the term of a lease takes effect in law as a surrender of the existing lease and a regrant of the lease extended in term. When the lessees surrender their leases to NGM Ltd they will making disposals of them for the purpose of the CGT legislation. Although they receive no cash, they are receiving the new longer leases in return. The amount they pay to NGM Ltd, together with the value of the old lease they have surrendered, will form part of the acquisition cost of the new lease.

Lessees who at all relevant times have occupied the demised premises as their principal private residence (‘PPR’) will not have a CGT liability on the disposal of the old lease. If a lessee had occupied his premises as his PPR for part of the period of ownership only, he would need individual advice on how the PPR rules will apply to him.

A lessee whose premises are not his PPR could have a CGT liability on his chargeable gain. Extra-Statutory Concession D39 which prevents a charge in the case of a surrender and regrant in these circumstances applies if the transaction is on arm’s length terms.

NGM Ltd’s grant of the new longer leases: capital gains tax

When NGM Ltd grants the new, longer, leases it will be making part disposals out of its freehold for CGT purposes (strictly, for the purposes of corporation tax on chargeable gains) in consideration of the surrender of the old lease and the lump sum paid by the lessee for the new lease.

Commercial lease variation

A sum paid by a tenant to vary its lease is treated as capital for tax purposes (Tucker v Granada Motorway Services Limited (1979) 53 TC 92, HL). It is expenditure the purpose of which is the improvement or enhancement of a capital asset of the business – the lease.

The lease variation payment will be treated as a capital receipt in the hands of the freeholder.

Tax analysis if NGM Ltd held the freehold as nominee/bare trustee

If NGM Ltd owns the freehold as trustee or nominee for the three lessees, A, B and D Ltd, then there would be no disposals for CGT purposes by the lessees or by NGM Ltd when the leases were extended or varied as the freehold would be owned beneficially by those lessees (see section 60 TCGA 1992) and one cannot make a disposal to oneself. Seeking ESC D39 treatment would therefore not be necessary.

The tax position on a trustee/nominee analysis is in fact not entirely free from doubt, because at first sight a surrendering lessee, for example, is making a disposal because he is disposing of part of his old lease to the other lessees as his fellow joint freeholders. However, in the light of the decision in Jenkins v Brown [1989] STC 577 and what was Extra-Statutory Concession D26 (now enacted as sections 248A to E TCGA 1992) the generally accepted view is that these transactions do not count as disposals.

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.