Cobbler’s children syndrome
Property Tax
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
I saw your post on Landlordzone, which certainly shed a little light, if not all. In fact, it is tantalisingly close!
Tell me why company’s holding the freehold beneficially for the leaseholders solves this problem? The leaseholders then each hold a percentage share of the total freehold, not the portion of the freehold relating to their leasehold interest. Accordingly on the extension of the lease of one of the leaseholders, surely ALL the leaseholders make a capital disposal, chargeable to CGT.
Please would you be so kind as to come back and point out the error in the above. Many thanks and kind regards.
There is no error in what you say.
The idea is that where the freehold is held by the company beneficially for the leaseholders there would be no disposal for CGT by a lessee on a surrender of his old lease, as the freehold is already owned beneficially by the lessees jointly and one cannot make a disposal to oneself.
As you point out, the tax position on a trustee/nominee analysis is not entirely free from doubt, because at first sight a surrendering lessee is making a disposal because he is disposing of a proportion of his old lease to the other lessees as his fellow joint freeholders. However, in the light of Jenkins (Inspector of Taxes) v Brown [1989] STC 577 and what was Extra-Statutory Concession D26 the better view is that these transactions are not disposals.
(With effect from 6th April 2010 ESC D26 was enacted in sections 248A to E Taxation of Chargeable Gains Act 1992).
Hope that helps.
Ann
Ann,
As a shareholder of my freehold management company I am in the process of granting myself a new long lease and have been advised of the potential Corporation Tax charge alluded to in your note, which has concerned me. I have been advised that the company as the owner of the freehold reversion has a seperate interest to the leasehold interest that I hold and that, by granting myself a new lease the landlord company wil be making a disposal.
I have looked at the case of Jenkins v Brown in order to try and get around this problem and have a couple of queries. It seems to have been accepted in the case that the assets in questions were at all times pooled and that the trustees held as bare nominees. How can I demonstrate that the freehold reversion is held as bare trustee? Must this have been declared when the company was created? I would be grateful for your thoughts on this.
The company can make a declaration of trust at any time but if it previously held the freehold beneficially the declaration will itself give rise to a disposal. A declaration of trust is not essential but is the best evidence of the capacity in which the company is holding the freehold. 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.
If no accounts have been drawn up and dormant company returns have been made to Companies House this may help to show that the company holds as bare trustee. If no ground rent has been collected this would also be a useful indicator (there is no point in collecting ground rent if the ground rent money would still belong to the lessee-payer as beneficiary of the trust).
What has happened when there have been changes of lessee is also relevant. Were share transfers made? Were there written transfers of the selling lessee’s beneficial interest in the freehold (which would have been done if the company held as trustee for him or her)?
The factors taken into account by HMRC in determining who has beneficial ownership of a property are listed in Lawson v Revenue and Customs [2011] UKFTT 346 (TC).
Is Extra-Statutory Concession D39 any help?
Ann