1 December heralds the introduction of stamp duty land tax (SDLT). The new legislation represents a major upheaval of the existing stamp duty regime, and its impact will be widely felt across the property market.
One of the major changes is to the way in which leases will be taxed.
It is expected that the new rules will lead to a significantly higher tax charge on tenants; in some cases, the tax payable will be seven or eight times higher than under the old rules. This is because, under the formula for calculating SDLT, tax is charged at 1 per cent of the net present value (NPV) of the aggregate rent for the whole term of the lease, whereas stamp duty is currently charged on the average annual rent of a lease.
The Government believes that under the new lease rules only 40 per cent of commercial leases (and 7 per cent of residential leases) will be liable for SDLT. This is largely due to the introduction of a nil rate band, which exempts leases with an NPV below a certain threshold. However, the nil rate band will make little impression on the amount of SDLT payable by tenants at the higher end of the market. For example, the tenant of a 25-year lease at £300,000 per annum would expect to pay stamp duty of £6,000 under the existing regime. Under the new rules, SDLT of £47,944 will be payable. It remains to be seen how this additional burden will be split between landlords and tenants and whether SDLT will lead to leases being granted for shorter fixed terms.
The new tax will apply to leases granted after 1 December 2003. Unsurprisingly, tenants have been seeking to accelerate the grant of new leases prior to that date, to ensure that their leases do not fall within the scope of the new rules. In some cases this has involved the provision of a longer rent-free period, or the inclusion in the lease of a tenant’s break right (for example, in circumstances where development of the premises is not yet complete). In this way, the commercial position of the parties has been preserved and the lease has escaped the increased tax charge.
It had been thought that one way to avoid the prohibitive new tax charges would be to take advantage of the relief from SDLT for transactions between group companies. Prior to marketing the relevant property, the landlord would grant a lease of it to a company in its group. The property would then be marketed and, when a third party tenant was found, the lease would be assigned. The lease grant would have benefited from the exemption from SDLT as an intra-group transaction. There would be little or no SDLT payable on the assignment, as there would be little value in the tenant’s interest in such a rack rent lease.
The Government has made it clear, however, that this sort of SDLT planning will not be effective. Under revised provisions, in circumstances where a relief from SDLT means that the grant of a lease does not attract SDLT, the first assignment that is not relieved from SDLT will be treated as the grant of a new lease by the assignor to the assignee. In this way, the intragroup relief given on the grant of the lease will effectively be cancelled and SDLT will be payable as if the landlord had simply granted a new lease to the third party tenant.
Other possible loopholes in the new rules have also been closed down by the Government. For example, there are special rules designed to prevent tax avoidance in circumstances where there is an “abnormal increase” in the rent of a lease after the fifth year of its term. In cases where there is such an increase, the effect of the rules is to treat the increase as the grant of a new lease, with tax payable accordingly.
With only a short time to go before the new tax comes into force, any tenants who have not taken steps to ensure that their new leases are granted before the 1 December implementation date could therefore face a large increase in their tax bill. n
Kirsten Davison is an assistant solicitor at Macfarlanes