Change in rate of VAT the reduction in the rate of VAT impacts slightly on the amount of stamp duty land tax payable Read more

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1 Property Tax Update February 2009 A periodic update designed to provide a summary of developments in property tax. If you would like further information on any of the areas covered, please catherine.robins@pinsentmasons.com or speak to your usual Pinsent Masons adviser. Contents Short summaries of each article shown below. If you would like to view the full article, click on the underlined links. To return to the start, click on the "Go back" link. Japanese knotweed - An HMRC change of interpretation means that landowners no longer need to wait until April 2009 to start removing Japanese Knotweed to qualify for 150% corporation tax relief and can claim relief on expenditure that has already been incurred. Read more Change in rate of VAT the reduction in the rate of VAT impacts slightly on the amount of stamp duty land tax payable Read more Disposals for CGT purposes a recent Court of Appeal decision considers what you have to do to make a disposal of a property for capital gains tax purposes. Read more Goodwill on sale of a business We look at the implications of HMRC's recently published guidance offering their view on how to apportion the price paid for a business as a going concern between goodwill and other assets involved in the sale. Read more Transfers of income streams it looked as if new rules aimed at preventing the conversion of income into capital by transferring income streams could have unintended consequences for property transactions but HMRC have now announced changes. Read more FULL ARTICLES 150% Tax Relief For Removing Japanese Knotweed HMRC has announced that it now accepts that the removal of Japanese Knotweed qualifies for Land Remediation Relief under current legislation. This means that purchasers of contaminated land no longer need to wait until April 2009 to start removing Japanese Knotweed to qualify for the relief and can claim relief on expenditure that has already been incurred. As explained in the previous edition of Property Tax Update, Land Remediation Relief enables developers to get a 150% corporation tax relief on expenditure incurred on certain specified works. Alternatively companies not making a profit can carry the relief forward or exchange an unrelieved loss arising from Land Remediation Relief for a payable tax credit worth 16% of the loss. Land Remediation Relief is currently available where there is a substance that is causing, or has the potential to cause harm. HMRC's previous view was that life forms could not be a substance and so Japanese Knotweed did not qualify for relief. It was proposed that the legislation would be changed from 1 April 2009 to allow land remediation relief in relation to Japanese knotweed. However, following HMRC's change of stance announced in November's Pre Budget Report, a landowner can claim Land Remediation Relief on expenditure before April 2009 to eradicate the Japanese Knotweed (including sending to landfill).

2 After April 2009 Land Remediation Relief can be claimed on the removal of Japanese Knotweed only for on or off site treatment. Relief will not be available if the Knotweed is to be sent to landfill and in addition landfill tax will be payable. Land Remediation Relief is being expanded from April 2009 so the land no longer needs to be infested at the time of acquisition as the Government now accept that Japanese Knotweed can spread through no fault of the owner. Where this is the case the owner can claim Land Remediation Relief on expenditure incurred after April However the relief will not be available where there is a statutory obligation to incur the expenditure e.g. under an Environmental Protection Act Order. There is an exemption from landfill tax for the removal of waste from contaminated land. However this exemption is being phased out and it will only be possible to claim the exemption if the landowner applied for an exemption certificate before 30 November If the landowner intends to remove the Japanese Knotweed to landfill they should do so before April 2009 so they can still claim the Land Remediation Relief and (if they have an exemption certificate) qualify for the exemption from Landfill Tax. Alternatively the landowner will be able to claim Land Remediation Relief for on or off site treatment of the Japanese Knotweed, whether incurred before or after April The changes are intended to encourage development of land as Japanese Knotweed is recognised as a major barrier to development. The changes also encourages on-site or off-site treatment as this is the most sustainable and effective approach and while it takes much longer than removing to landfill it is cheaper and ensures the weed is killed and unable to return. If you have removed Japanese Knotweed in the past, you should consider claiming the relief now for in-date years (broadly within two years of the end of the accounting period and any return which is still open). If you intend to remove Japanese Knotweed to landfill you need to incur your expenditure before 1 April 2009 in order for the relief to be available. If the Knotweed was not present on the site when you acquired it, but has since spread to the site you need to defer your expenditure until after 1 April, in order to qualify for the relief. Go back Change in the Standard Rate of VAT Introduction The widely publicised reduction in the standard rate of VAT from 17.5% to 15% applies to goods and services supplied on or after 1 December The rate is scheduled to revert to 17.5% from 1 January The change affects only the standard rate of VAT. It has no effect on zero-rated, exempt or reduced-rated supplies, all of which can be relevant to property transactions. In the property context, therefore, the rate change will affect supplies where an option to tax has been made or supplies that are otherwise automatically standard-rated for VAT purposes (for example, the sale of a new or uncompleted commercial freehold). Provided that businesses pass on the reduction in VAT when charging for goods and services, the VAT reduction will be of benefit to persons who cannot recover VAT charged to them. This can include, for example, those persons who make VAT-exempt supplies and/or persons who are not registered for VAT. Time of Supply As the VAT rate reduction is temporary, the "tax point" or "time of supply" rules are important, as these rules determine the rate of VAT on any particular supply. So far as is relevant to property transactions, a freehold or long (21 years or more) leasehold interest will be regarded as goods, whereas a short lease with periodic rental payments will be treated as continuous supplies of services. Each has its own rules as to the time of supply.

3 The basic time of supply for a freehold sale is the date of completion of the conveyance. As with other supplies of goods, however, an earlier tax point can be created where a VAT invoice is issued prior to completion, or if any of the purchase price is paid before completion. The payment of a deposit will create a tax point (but only for the amount of the deposit) if it is paid as agent for the seller. A deposit paid held as stakeholder will, however, generally not create a tax point. For payments of rent (i.e. continuous supplies of services), a tax point is created each time a VAT invoice is issued or when payment is made, whichever happens first. Temporary Relaxation of the Time of Supply Rules, and Anti-Avoidance Special rules were introduced around the time of the rate change, to allow businesses to charge 15% VAT where a tax point had been triggered prior to 1 December 2008 for something that would actually be supplied (in the everyday sense of the word) after 1 December Examples include the payment of a deposit for a freehold transaction that was to complete after 1 December 2008, or the advance payment of a quarter's rent that was to span 1 December 2008 (in which case the proportion of the quarter falling after 1 December 2008 could be subject to 15% VAT). The time limit for issuing credit notes and replacement VAT invoices for such supplies was, however, 45 days from the date of change in VAT rate, and therefore has now passed. Looking forward towards the end of 2009, it may be possible to utilise the time of supply rules set out above to ensure that a particular supply has a tax point triggered before the rate reverts to 17.5% (for example, by issuing a VAT invoice in December 2009 for a transaction that will not complete until after 1 January 2010). The Government has recognised that there is some scope for abuse here, and antiavoidance rules will seek to ensure that artificial pre-payments and VAT invoices with a date for payment more than six months after issue will be ineffective in terms of securing the 15% VAT rate. Stamp Duty Land Tax SDLT is charged on the VAT-inclusive consideration given for a land transaction. The reduction in the standard rate of VAT will mean a slightly lower overall SDLT charge for transactions subject to VAT. HMRC have issued a statement explaining how they will deal with the effect of the reduction in the VAT rate on SDLT calculations for leases. For leases with an effective date on or after 1 December 2008, for SDLT purposes the rate of VAT should be calculated as 15% from 1 December 2008 to 31 December 2009 and 17.5% thereafter. For leases granted in the past covering the period from 1 December 2008 to 31 December 2009, SDLT will have been calculated using VAT at 17.5%. HMRC's view is that the change in the VAT rate makes the rent for the first five years of the term of such leases uncertain. This means that SDLT can be recalculated once the uncertainty is resolved, which means there will be an entitlement to a repayment of SDLT in such cases. HMRC will, however, only accept claims after 31 December 2009 (or the expiry of the lease if earlier), and in any case since the figures involved will be very small (if the rent is 1m per annum the repayment will be less than 250) in many cases it may not be worth pursuing the repayment. The 2.5% reduction in the standard rate of VAT will be welcomed by those who pay VAT on rents or on property purchases, and are unable to recover that VAT. The reduction will stay in place until the end of 2009, and VAT savings could be made by triggering a tax point for supplies during this time. For businesses that are able to recover VAT in full, the change should have no effect. Stamp duty land tax refunds are unlikely to be worth the cost and effort of pursuing in all but the most substantial of cases. Go back Disposals for CGT purposes The recent Court of Appeal case of Underwood v Commissioners for HMRC looked at whether a disposal of a property to a third party had taken place when a contract had been entered into to sell the property at a loss in the 1990s property crash, but not properly completed. Mr Underwood purchased a property in 1990 for 1.4 million. The property market crashed and in 1993 the property only had a market value of 400,000. Mr Underwood agreed to sell the property to a company controlled by an unconnected third party (R Ltd) for 400,000. On the same day R Ltd granted Mr Underwood an option to repurchase the property at any time in the next year or so for 400,000 plus specified expenses incurred by R Ltd and plus 10% of any increase in the value of the property from the contract to the exercise of the option. Mr Underwood claimed a capital loss of about million in the tax year in which the contract with R Ltd was entered into.

4 The property did increase in value to 600,000 and Mr Underwood decided to transfer it to a company which he controlled and so in 1994 he entered into a contract to purchase it for 420,000 from R Ltd. It was accepted by the parties that this contract had the same effect as an exercise of the option. On the same day he entered into a contract to sell the property to the company he controlled. The solicitor acting for all the parties decided that as legal title had remained with Mr Underwood throughout, there was no need to execute three separate transfers, transferring the property from Mr Underwood to R Ltd, from R Ltd to Mr Underwood and then from Mr Underwood to his company. Instead a transfer was executed just from Mr Underwood to his company and R Ltd was paid 20,000. This also had the advantage of saving stamp duty. The Special Commissioners agreed with HMRC's argument that although the contract to sell the property to R Ltd and the contract to buy it back were performed, in the sense that the purchase price was paid under them by way of set off, R Ltd never acquired the property and Mr Underwood therefore never disposed of it to R Ltd because there was no time when the rights in the property were vested in R Ltd. The payment which amounted to performance of the contract to buy the property was essentially performance of the contract to sell it. The High Court judge also found for HMRC but on the basis that the contracts were not performed and were effectively abandoned and so there could be no transfer of beneficial ownership. The Court of Appeal found for HMRC, but on the reasoning of the Special Commissioners rather than the High Court judge. Lord Justice Collins gave the leading judgment. Section 28(1) TCGA 1992 provides that "where an asset is disposed of and acquired under a contract the time at which the disposal and acquisition is made is the time the contract is made (and not, if different, the time at which the asset is conveyed or transferred)." However the case of Jerome v Kelly confirms that section 28(1) is only a timing provision and does not deal with whether there is a disposal for CGT purposes, it simply determines the date of the disposal and acquisition, if it actually takes place. After contract, and until completion, the vendor becomes in equity a trustee for the purchaser with the main duty of preserving the property in the period between contract and completion. Beneficial ownership will pass as the purchase price is paid so that the vendor may become a bare trustee for the purchaser if the purchase price is paid in full prior to completion. Except in certain cases where transactions are deemed to be disposals, for capital gains tax purposes the word "disposal" bears its "normal meaning", which in a legal context is disposal of the entire beneficial interest in the asset. In this case the rights under the various contracts were simply netted off this did not amount to an acquisition of the property by R Ltd. To the extent that R Ltd turned an asset to account, the asset was its contractual rights under the 1993 contract to acquire the property, and not its beneficial interest in the property. Lord Neuberger agreed with Lord Justice Lawrence Collins but stated that he reached his decision with regret because if the solicitor had executed all the transfers of the properties rather than attempting to short circuit the process (and save the stamp duty) the parties accepted that there would have been a disposal of the property to R Ltd for CGT purposes. Mr Underwood was therefore not treated as disposing of the property to R Ltd which meant that the capital loss was not available. Mr Underwood did dispose of the property to his company but because the parties were connected this meant the loss set off was restricted. Mr Underwood's counsel suggested that the transactions he entered into were similar to bed and breakfast transactions or to sub-sales, which are treated as disposals for CGT purposes. The Court of Appeal held that Mr Underwood's transactions were quite different from bed and breakfast transactions, where there is an actual disposal and reacquisition of an asset. In the case of sub-sales where a transfer is made direct to the sub-purchaser at the request of the purchaser, the transaction can be characterised as two transactions in which the purchaser pays the seller for an interest and the sub-purchaser pays the purchaser for the same interest. There are two disposals, one by the seller to the purchaser and one by the purchaser to the sub-purchaser. The case provides useful clarification on the meaning of disposal for CGT purposes and illustrates the care that should be taken with tax planning to ensure that it is properly implemented. If it is important to show that a disposal is made, money should pass to the relevant parties and netting off arrangements should be avoided. Go back

5 Goodwill on the sale of a business There has been a long standing debate between tax advisers, valuation experts and HMRC as to how goodwill should be valued for tax purposes on the purchase of a business together with a property where the location of the property was important for the business. In the past HMRC have argued that in such a business there was likely to be little or no "free goodwill" which could be separately identified from the property. Instead most goodwill should properly be treated for tax purposes as part of the value attributed to the property. Why is goodwill important? When a business is sold as a going concern it may include land and buildings, trade fixtures and fittings, transferable intangible assets (such as trade marks and other IP rights) as well as, usually, a quantity of goodwill. How the price is apportioned between the various assets sold is important for number of tax reasons such as calculating: the capital gains tax arising on the disposal of the separate assets (a seller issue) the SDLT due on the acquisition of any interest in any land (a buyer issue) the deductions available against corporation tax for capital allowances (where a buyer would usually argue that there is little or no goodwill so that the price may be apportioned mainly to the fixtures and chattels) corporation tax deductions for purchased goodwill under Schedule 29 FA2002 (where a buyer would usually attempt to apportion a higher value to goodwill to increase the deductions). For capital gains tax, SDLT and capital allowances, where more than one asset is sold, the total sale price must be apportioned between each asset, regardless of what is said in any contract, on a "just and reasonable basis". The apportionments used for these purposes will also generally be reflected in the amount that may be treated as deductible for corporation tax purposes under Schedule 29. Where a business is transferred as a going concern therefore, getting the correct apportionment between goodwill and other assets can have a significant impact on both the seller's and the buyer's tax position. What is Goodwill? The leading case on the legal nature of goodwill is that of IRC v Muller and Co Margarine Limited (1901) in which Lord MacNaghten stated that goodwill is:- "..the benefit and advantage of the good name, reputation and connection of a business. It is the attractive force which brings in custom. It is the one thing that distinguishes an old established business and a new business at its first stage." This definition in itself is not particularly controversial but, when applied to trade related properties such as pubs, hotels, nursing homes, cinemas and restaurants etc, using it to identify what goodwill may have been transferred is far more problematic as the "attractive force that brings in the custom" is often the building itself. In these circumstances, careful consideration needs to be had as to whether the goodwill is part and parcel of the property, or whether it has been/can be transferred separately. Historically, HMRC in considering the issue had sought to differentiate between different categories of goodwill. These included "inherent goodwill" (eg the location of the premises), "personal goodwill" (eg the loyalty of a chef to the current owner), "adherent free goodwill" (eg a history of satisfied customers) and "transferable free goodwill" (eg the benefit of contracts). Of these, only "transferable free goodwill" would have been capable of being sold as a separate asset, meaning that for some businesses such as pubs, HMRC's view (and that of the Lands Tribunal) was that there was no goodwill capable of being sold separately from the property. HMRC has now, however, accepted that this categorisation is not particularly helpful and, though not departing from the principal that the goodwill must still be capable of being transferred separately from the land, is looking at the problem as more of a valuation issue, accepting that whenever a business is sold as a going concern, there must be some element of goodwill; with the real issue being what the value of that good will is.

6 What is the value of goodwill? In its latest guidance, HMRC recognise that there is a broad consensus across the valuation, accountancy and legal professions that the value of goodwill and other separately identifiable intangible assets (eg registered trade marks) is represented by the difference between the value of the business as a going concern and the value of the tangible assets included in the sale. So, for example, the process of identifying the goodwill on the arms length sale of a care home business and its assets for, say, 10 million would, broadly speaking, work as follows:- 1. Estimate the market value of the tangible assets in this context these will mostly consist of land and buildings of the business, taking into account their location and other inherent features/adaptations that enable them to operate as care homes. It shall also be assumed that a reasonably efficient care home operator will acquire the land/buildings and continue to run the business from them. For this example, we shall assume a tangible assets value of 8m. 2. Add to that figure the value of chattels sold with the property - for a care home this will probably include medical equipment and various other care related appliances. For this purpose we shall assume the chattels are worth 500, Deduct the figure for the tangible assets and chattels from the price paid to arrive at a figure for the intangible assets; so 1.5m in this example. 4. Identify which of the intangibles are not goodwill in a care home context these are likely to include assets such as licences, trade marks and trading names. Once a value has been attributed to these non-goodwill intangibles (say 50,000), the figure remaining will be assumed to have been paid for goodwill. The amount of the purchase price fairly and reasonably attributable to goodwill in this case would therefore be 450,000. This is a relatively high figure which is not unexpected as, in the case of a care home, there will typically be a fairly large number of classic goodwill assets sold such as the benefit of contracts with local authorities, staff that are trained and familiar with the business, and a body of loyal patients. From the perspective of a purchaser of a trade related property, significant SDLT savings and increased Schedule 29 corporation tax deductions can be utilised if a larger amount of the purchase price is attributable to goodwill; so HMRC's acceptance that there will always be an element of goodwill in the transfer of a business as a going concern is welcome. HMRC's move away from categorising goodwill and its clarification on the process of valuing goodwill are also good news for taxpayers. Now, taxpayers do not necessarily have to separately identify goodwill or fit it into a specific category. HMRC will accept that the value of goodwill is, effectively, the purchase price for the business, less the tangible assets (land, buildings and chattels etc) and other intangible assets (such as trademarks/licences). This should mean that the evidential burden of proving that a "fair and reasonable" apportionment has not been made will shift to HMRC, so that instead of the taxpayer having to attribute value to goodwill, HMRC will have to push any value they think has been incorrectly attributed to goodwill value back to the property or other intangibles. Go back Transfer of Income Streams In December 2007, HM Treasury and HMRC launched a joint consultation on a "principles-based" approach to financial products tax avoidance. The idea behind this is to have some anti avoidance legislation targeted at broad types of avoidance schemes, rather than introducing specific legislation each time a new scheme emerges. The two areas that this legislation will focus on are disguised interest and transfers of income streams. "Disguised interest" covers schemes which attempt to convert what should really be taxable interest into capital or into exempt income. "Transfers of income streams" covers schemes which attempt to convert income streams, such as rentals on a property, into capital. Both of these areas are already covered by existing legislation but the legislation is piecemeal, keeps being added to each time a new variant on a scheme comes to light and HMRC perceive there are still gaps in it. The legislation was originally due to be included in the Finance Act 2008 but has now been deferred to this year's Finance Bill. Several different versions of draft legislation have been published and HMRC have been consulting extensively.

7 The legislation dealing with transfers of income streams is potentially the most relevant to property transactions. This legislation aims to introduce into UK tax legislation the principle that an assignment of income from property without an assignment of the underlying property will, no matter what its form, bring about the result that the consideration for that assignment will be taxed as income rather than capital. There are already some provisions in the legislation which have this effect. For example, rent factoring arrangements are already subject to the structured finance arrangements legislation in sections 774A-G ICTA These rules tax, as income, a capital sum received from a bank in respect of the transfer of rental income streams. These arrangements will be carved out of the new legislation. The way the legislation is intended to work is that any consideration received in respect of the transfer of the right to relevant receipts will be taxed as income in the accounting period in which it would be recognised in the profit and loss account for accounting purposes. There were concerns with previous drafts of the legislation that, because the draft legislation is drafted so widely, it could apply to some situations where the underlying property itself was transferred, rather than just the rights to receive income from it. This was a particular concern in relation to the situation where property is already subject to a lease but rather than transferring the freehold subject to the lease an overriding lease is granted. HMRC has recently announced that, following concerns raised during consultation, further changes will be made to the draft legislation dealing with transfers of income streams. The draft legislation will be amended so that: it is clear that the transfer of income streams rules will apply only if the asset giving rise to the income is not transferred; and the grant of a lease over land will be treated as the disposal of an asset so that the new rules will not apply to it this will exclude the grant of an overriding lease subject to an underlying lease. Although the revised draft legislation has not yet been published, if it incorporates these proposals in a satisfactory way, it looks as if the legislation will only impact on property transactions when income streams are transferred separately from the underlying land (and this is not already covered by existing rules), as was the original intention. The revised draft legislation is expected in the next few weeks with a view to enactment in Finance Act It was intended that the legislation would come into force on 1 April 2009, but it is not clear whether this is still intended given the delays in finalising the draft legislation. Go back This note does not constitute legal advice. Specific legal advice should be taken before acting on any of the topics covered. LONDON BIRMINGHAM BRISTOL LEEDS MANCHESTER EDINBURGH GLASGOW DUBAI BEIJING SHANGHAI HONG KONG T Pinsent Masons LLP 2009 Pinsent Masons LLP is a limited liability partnership registered in England & Wales (registered number: OC333653) and regulated by the Solicitors Regulation Authority. The word partner, used in relation to the LLP, refers to a member of the LLP or an employee or consultant of the LLP or any affiliated firm who has equivalent standing and qualifications. A list of the members of the LLP, and of those nonmembers who are designated as partners, is displayed at the LLP s registered office: CityPoint, One Ropemaker Street, London EC2Y 9AH, United Kingdom. We use Pinsent Masons to refer to Pinsent Masons LLP and affiliated entities that practise under the name Pinsent Masons or a name that incorporates those words. Reference to Pinsent Masons is to Pinsent Masons LLP and/or one or more of those affiliated entities as the context requires. For important regulatory information please visit: