Real Estate Budget Update on Tax Changes.

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1 24 March 2011 Real Estate Budget Update on Tax Changes. Introduction The taxation announcements in the Budget are likely to have a relatively limited impact on the real estate industry. One announcement of interest is the creation of 21 new enterprise zones with some tax incentives. The key issue here for real estate businesses will be whether the incentives offered by the zones will be sufficient to justify relocation. Other welcome announcements are the consultation about a relaxation of the REIT rules and the introduction of a SDLT relief for portfolio purchases of residential property. In terms of revenue raising, three specific SDLT avoidance techniques have been targeted. Furthermore the Chancellor indicated in his Budget speech that over the coming months extra work is to be undertaken on combating avoidance of tax on very high value property transactions by the wealthiest which we interpret as meaning there will be a renewed focus on closing SDLT mitigation techniques, such as owning property via SPVs (e.g. non-uk companies), which are becoming more common in the residential sector. However, the possibility of such a clampdown also applying in the commercial sector cannot be ruled out. A consultation on the capital allowances treatment of fixtures in buildings is also promised. Contents Introduction... 1 SDLT Changes... 1 Relaxation of the REIT Rules... 4 New Enterprise Zones... 5 Fixtures in Buildings - Capital Allowances... 6 SDLT Changes Anti-Avoidance Measures Three specific SDLT anti-avoidance measures were announced. Sub-Sale Transactions The sub-sale rules ensure that where A contracts to sell real estate to B and B (before completing the purchase from A) contracts to sell the same real estate to C SDLT is, generally, only payable in respect of the B to C transaction if there is a single conveyance from A to C. The sub-sale rules can also apply if there are two conveyances from A to B and from B to C and both conveyances are completed at the same time. Accordingly, the sub-sale rules have offered an opportunity for SDLT avoidance if the B to C transaction would either be exempt from SDLT or would be subjected to a lower SDLT liability than the A to B transaction would be if it was separately taxed. To counter such avoidance the sub-sale rules have been tightened up, at various stages. In particular with effect from May 2005 sub-sale treatment was not...three specific SDLT anti-avoidance measures were announced... Real Estate Budget Update on Tax Changes 1

2 available where the B to C transaction would be eligible for an exemption pursuant to the alternative property finance rules as they then stood. However, this exclusion failed to keep pace with the fact that since 2005 further alternative property finance exemptions have been introduced. The Budget change now ensures that sub-sale treatment will not be available where the B to C transaction would be eligible for any form of alternative property finance exemption. Previously HMRC have announced that they intend to use the general antiavoidance rule in Section 75A FA 2003 to challenge the sub-sale schemes involving an alternative property finance exemption. In light of the fact that these schemes have now been specifically targeted it remains to be seen whether HMRC will continue to pursue these section 75A challenges. Alternative Property Finance Exemptions The SDLT rules currently contain a number of exemptions where there are transfers of land, or grants of leases, which fall within the various statutory definitions of an alternative property finance transaction contained in section 71A to section 73B FA A common theme to these various exemptions is that they require a financial institution to be party to one or other of the land transactions. The change which has been announced in the Budget narrows down the definition of what can constitute a financial institution so that it will no longer be possible for an SPV, or other entity which is not genuinely involved in financial transactions, to qualify as a financial institution simply by obtaining a licence under the Consumer Credit Act The definition of a financial institution, even as narrowed, will continue to apply, to amongst others, banks, building societies and wholly owned subsidiaries of banks and building societies. Exchanges Where a real estate transaction is effected wholly or partly in consideration for another real estate transaction (e.g. a sale of a building and the grant of a pre-emption right or option to repurchase) the SDLT rules require SDLT to be levied by reference to the market value of the land which is transferred rather than the value of the actual consideration passing between the parties. Usually, when the parties to the transaction are dealing at arm s length, this market value rule would provide little scope for SDLT avoidance because the actual consideration which would be payable would usually be broadly equal to the market value. However, in a case where VAT is chargeable on the consideration which is payable the market value exchange rule has presented an opportunity for reducing the overall SDLT liability. This is because under HMRC s current practice when you apply the market value rules you ignore VAT (i.e. you value the land on a VAT exclusive basis). In contrast the general rule for SDLT purposes is that where VAT is chargeable on the consideration for a land transaction SDLT is also levied on the VAT element of the price (i.e. SDLT is charged on a VAT inclusive basis). Accordingly, in case where VAT is chargeable on the sale price structuring the transaction as an exchange Real Estate Budget Update on Tax Changes 2

3 transaction has meant that the overall SDLT burden could be reduced. Given that the current rate of VAT is 20% ensuring the transaction was treated as an exchange could reduce the SDLT burden by 0.8% of the VAT exclusive consideration (i.e. saving the 4% SDLT charge which otherwise would be levied on the 20% VAT element). Under the change announced in the Budget where there is an exchange transaction SDLT will now be levied on the higher of market value or the consideration payable for the real estate transaction. Effective Date and Transitional Measures The measures will apply to transactions which have an effective date falling on or after 24 March The effective date for SDLT purposes will usually be the date on which the transaction completes, although if the transaction is effected pursuant to a contract which is substantially performed (e.g. because 90% or more of the price is paid) prior to completion the effective date will be the date on which substantial performance takes place. Where the effective date of a transaction occurs on or after 24 March 2011, but pursuant to a contract (which is not an option contract) entered into before 24 March 2011 the changes will not generally apply. There are, however, a number of exceptions to this grandfathering rule. In particular, the grandfathering rule will not apply to contracts entered into before 24 March 2011 if, after 24 March 2011, there is a variation to the terms of those contracts, an assignment of rights under the contract or a sub-sale or similar transaction. The grandfathering rules will also not apply to transactions which are within the scope of the general anti-avoidance rule in section 75A FA 2003, which in broad terms covers a case where a real estate transaction is implemented by means of a number of separate transactions which all form part of one overall scheme, if any one of the scheme transactions has been completed before 24 March 2011 and further transactions remain to be completed on or after 24 March Relief for Residential Portfolio Purchases The rate of SDLT which is chargeable depends on the total consideration given for the land (i.e. 1% for commercial transactions with a value of no more than 250,000, 3% for transactions in the 250,001 to 500,000 range and 4% for transactions with a value of more than 500,000). However where there are a number of linked transactions between the same purchaser and vendor (or, in either case, persons connected with them), as there will be when a portfolio of properties is purchased, the SDLT rate is determined by reference to the aggregate consideration rather than on a property-byproperty basis. So, for example, if three dwellings with a value of 250,000 each were purchased as part of a single transaction SDLT would be chargeable at 4% rather than the 1% rate which would apply if there were three separate property sales. To encourage bulk purchases a relief will be introduced for purchasers of residential property who acquire more than one dwelling. Where the relief is claimed, the rate of SDLT on the consideration attributable to the dwellings will be determined by the mean consideration i.e. by the aggregate...to encourage bulk purchases a relief will be introduced for purchasers of residential property who acquire more than one dwelling... Real Estate Budget Update on Tax Changes 3

4 consideration divided by the number of dwellings (subject to a minimum rate of 1%). In a case where the relief is claimed the usual rule that a purchase of more than six dwellings is not treated as a residential transaction (so that it attracts the SDLT rate applying to commercial property) will not apply. The new relief will need to be claimed on a case by case basis and in some cases it may be better not to claim the relief. For example, where there is a sale of more than six residential properties with an average unit value of in excess of 1 million. This is because in such a case if the relief is not claimed SDLT will be charged at the 4% rate which applies to commercial property. Whereas if the relief is claimed SDLT will be charged at the new 5% rate which applies from, 6 April 2011, to sales of residential property for more than 1 million. Relaxation of the REIT Rules REITs currently benefit from a very favourable tax regime because income and capital gains arising from the REIT s property rental business is exempt from tax. However, the trade-off for benefiting from this regime is that the REIT is subject to initial 2% tax charge on the value of its property when it enters the REIT regime and it must comply with a number of detailed tax rules. In particular the REIT must have a full stock exchange listing and must not be a close company (i.e. a company which is under the control of five or fewer persons). The REIT is also subject to special rules governing its financing, the distribution of its profits and the scale of its non-property rental activities (the so called balance of business test). If these detailed tax rules are not complied with the REIT potentially faces losing the benefit of its tax exemptions. Although the real estate industry generally welcomed the introduction of the REIT rules, and the REIT regime is generally judged to have been a success, the industry has been lobbying the Government to relax a number of the rules which the REIT must comply with. The Government has now indicated that they will engage in an informal consultation to consider: > relaxing the non-close company rule where the REIT is owned by institutional investors; > allowing cash to be a good asset for the purpose of the REIT balance of business asset test; > extending the time limit for complying with the profit distribution requirements where stock dividends are paid; > redefining financing costs for the REIT interest cover test;...the industry has been lobbying the Government to relax a number of the rules which the REIT must comply with. The Government has now indicated that they will engage in an informal consultation... > abolishing the 2% conversion charge for companies joining the REIT regime; > introducing a fixed grace period for new REITs to meet the non-close company requirement; > relaxing the requirement for a REIT to be listed on a recognised stock exchange; and > making other technical changes to the REITs legislation. Real Estate Budget Update on Tax Changes 4

5 New Enterprise Zones As expected the creation of a number of new enterprise zones was announced. Businesses located in these zones will benefit from the following incentives: > a 100 % business rate discount. Details of how this will operate have not yet been released but it has been indicated that the relief will be worth up to 275,000 over a five year period;...as expected the creation of a number of new enterprise zones was announced... > Government and local authority help in streamlining the planning process within the zones; and > Government support to ensure that superfast broadband is rolled out throughout the zones. The Government will also work with the individual local authorities which are responsible for the zones to consider: > introducing enhanced capital allowances for plant and machinery used in manufacturing; > the use of Tax Increment Finance. This is a financing technique which is popular in the US under which a local authority which wishes to finance a development raises finance against the security of the enhanced local tax receipts which are expect to arise from the completed development. The precise location of the first ten zones is yet to be determined by the Government but it has been announced that a zone will be located in each of the following: > Birmingham and Solihull > Leeds City Region > Sheffield City Region > Liverpool City Region > Greater Manchester > West of England > Tees Valley > North Eastern > The Black Country > Derby & Derbyshire with Nottingham & Nottinghamshire There will also be a zone in London in the Royal Docks (the location which has been chosen by the Mayor of London). A further ten zones will be determined by competition. Real Estate Budget Update on Tax Changes 5

6 Fixtures in Buildings - Capital Allowances A consultation document will be issued in May 2011 on plans to introduce a requirement that businesses must elect to pool their expenditure on fixtures which qualify for capital allowances. Any legislation introducing such a change will be included in Finance Bill No further detail is given as to how these changes will interact with the existing separate pooling rules that apply to normal fixtures (which currently qualify for 20% allowances) and integral fixtures (that currently qualify for 10% allowances). Contacts For further information please contact: Martin Lynchehan Partner (+44) martin.lynchehan@linklaters.com Author: Martin Lynchehan This publication is intended merely to highlight issues and not to be comprehensive, nor to provide legal advice. Should you have any questions on issues reported here or on other areas of law, please contact one of your regular contacts, or contact the editors. Linklaters LLP. All Rights reserved 2011 Linklaters LLP is a limited liability partnership registered in England and Wales with registered number OC The term partner in relation to Linklaters LLP is used to refer to a member of Linklaters LLP or an employee or consultant of Linklaters LLP or any of its affiliated firms or entities with equivalent standing and qualifications. A list of the names of the members of Linklaters LLP together with a list of those non-members who are designated as partners and their professional qualifications is open to inspection at its registered office, One Silk Street, London EC2Y 8HQ or on and such persons are either solicitors, registered foreign lawyers or European lawyers. Please refer to for important information on our regulatory position. We currently hold your contact details, which we use to send you newsletters such as this and for other marketing and business communications. We use your contact details for our own internal purposes only. This information is available to our offices worldwide and to those of our associated firms. If any of your details are incorrect or have recently changed, or if you no longer wish to receive this newsletter or other marketing communications, please let us know by ing us at marketing.database@linklaters.com. One Silk Street London EC2Y 8HQ Telephone (+44) Facsimile (+44) Linklaters.com Real Estate Budget Update on Tax Changes 6