Cobbler’s children syndrome
Frank, a fellow tax lawyer, has a friend whose son has just started as a trainee solicitor in a high street firm which does a lot of property work. In his first week, the trainee was asked to research a tax point by the senior partner. Finding his new shoes suddenly rather uncomfortable, he adopted the stance of many a trainee before him and panicked. Then he asked Frank for help and Frank in turn asked me.
The query was deceptively simple – what were the tax consequences if the leaseholders in a small, mainly residential, development extended the term of their leases from 125 to 999 years? The leaseholders owned the freehold through a company in which they were all shareholders and were not intending to pay for the extension of the lease term. My first thought was ‘There can’t be a problem, this happens all the time’. However, once I started to analyse it, the question began to seem more complicated.
English land law treats the extension of the term of a lease as the giving-back of the original lease and the grant by the landlord of a new, longer, one. This means that a lease extension is treated for tax purposes as a barter transaction – one asset is exchanged for another. Both landlord and leaseholder have disposed of something and acquired something with no money changing hands.
The land law rule that increasing the length of a lease is treated as the exchange of one lease for another can have unpleasant and often unexpected tax consequences, namely, a potential charge to capital gains tax for any leaseholder who does not occupy the property as his private residence, a tax charge for the freehold-owning company when it grants the new leases, and income tax for the leaseholders as shareholders in the company on deemed dividends.
Everything turns on whether the leaseholders’ company owns the freehold for itself, or on behalf of the leaseholders. If the company holds the freehold for the leaseholders, there will seemingly be no tax problems at all as one cannot make a disposal to oneself so there is nothing to tax.
As I was crossing Tower Bridge, dodging the tourists and ruminating on the vagaries of English land law and its interaction with the tax system, the cogs clicked into place and a number 42 bus missed me by a couple of inches.
For the past three years the residents of my small block have been in the process of granting themselves new longer leases in similar circumstances and the new leases were to be granted within a matter of days. As we have instructed experienced property lawyers, until the trainee asked the question I hadn’t really given the matter any thought. Now my barefoot children were staring me in the face: the trainee’s problem was also in fact my own.
By the way, children’s shoes are free of UK VAT.
Tax lawyer specialising in business tax, SDLT and VAT