Back to Basics: Property taxes made simple

Mark Whiteside provides a high-level summary of some of the main property taxes that arise in relation to the typical lifecycle of UK commercial property – buying, holding and selling. Buying UK property Stamp duty land tax  Stamp duty land tax is charged on the acquisition of a “chargeable interest” in land in England or Northern Ireland (land transaction tax is charged in Wales, and land and buildings transaction tax is charged in Scotland). A “chargeable interest” includes the acquisition of a freehold interest or the grant of a lease. SDLT is payable by the buyer by reference to the “chargeable consideration” (including the net present value of any rent payable under a new lease). Key issues to note: SDLT is paid on the “chargeable consideration”, which is generally any premium/rent, but also includes other things, such as the assumption or release of debt (and in certain situations is deemed to be at an open market value, if the actual consideration is lower). SDLT must be paid to HM Revenue & Customs within 14 days of the effective date of the transaction. SDLT can be triggered if a contract for a land transaction is “substantially performed” before completion of the sale (or the grant of the lease, as the case may be), including where the buyer/tenant takes early possession of the relevant interest. SDLT is not paid on chattels or other items which are not fixtures (in which case the total purchase price must be apportioned on a just and reasonable basis). Capital allowances The buyer of commercial property may be able to secure tax relief for part of the purchase price by claiming capital allowances, particularly if the property contains plant and machinery fixtures. The plant and machinery does not have to be of an industrial nature. For example, qualifying items include central heating, air conditioning and electrical wiring. It is common for a buyer and seller to enter into a fixtures election as part of the sale contract (known as a “section 198 election”, referring to section 198 of the Capital Allowances Act 2001), which has the effect of apportioning part of the purchase price for the property to the qualifying fixtures contained with it. The figure included in the election is binding on both parties (however, it cannot exceed the amount originally paid for those fixtures by the seller). A buyer should therefore consider whether there are any valuable fixtures contained within the property and seek to negotiate a capital allowances election with the seller; the buyer can then claim capital allowances (at either 18% or 6% as the case may be) against that apportioned figure going forward. Conversely, the seller will usually want to retain the benefit of any available capital allowances attributable to the fixtures it originally acquired; this is achieved in practice by having a nominal (£1) section 198 election. Holding UK property Tax on income Income from commercial property will generally be made up of rent and licence fees (and anything that is deemed to be rent for tax purposes, such as part of any premium paid for a short lease of less than 50 years). Any service charge which is reserved as rent will also be taxable as income in the landlord’s hands.  Corporation tax (currently 19%) is charged on the profits from a company’s property letting business; however, some property businesses will constitute a “trading” rather than an “investment” activity for tax purposes (for example, serviced office accommodation and furnished holiday lettings might qualify as trading activities for tax purposes).  There are a number of important tax consequences arising from this distinction: Shares in a trading (rather than investment) company can usually qualify for valuable tax reliefs, such as inheritance tax business property relief, business asset disposal relief (formerly entrepreneurs’ relief) and the substantial shareholding exemption from corporation tax. Trading losses can generally be used more easily. Any gain on the sale of the property (if it is used for trading purposes) can usually benefit from roll-over relief, if replacement trading assets are acquired. VAT treatment of services Any additional charges for services provided by the landlord to the tenant (for example cleaning, maintenance and utilities, such as electricity, heating and lighting) will give rise to additional income for the landlord.  The VAT treatment of such charges will generally depend on whether the landlord has “opted to tax” the property for VAT purposes. If no option to tax has been made, and the rent is exempt from VAT, the landlord will not be able to recover any of the VAT charged to it on acquiring those services/utilities from a third-party supplier.  As a consequence, the landlord will generally look to pass on the VAT-inclusive cost to the tenant (with the tenant being unable to recover the “VAT” element of that charge, as it is not properly VAT being charged by the landlord).  Depending on the terms of the lease, the tenant (perhaps via a management company if there are a number of tenants in a similar position) might look to acquire those services and utilities directly, in order for the VAT charge to be recoverable by the tenant(s) as input tax. Selling UK property Value added tax  While VAT is important to both the buyer and the seller of commercial property, it is the seller (as the supplier for VAT purposes) who has the primary responsibility to: (1) charge the correct amount of VAT and provide a valid VAT invoice; and (2) account for such VAT to HMRC. For VAT purposes, the grant of any interest in land or property (including a freehold sale or the grant of a lease) is exempt from VAT, unless one of the following scenarios applies: The seller has exercised an “option to tax” over the property (in which case the sale or lease will be subject to VAT at the standard rate of 20%, assuming that the option to tax is not disapplied). The sale is of the freehold interest in “new” commercial property (defined as being less than three years old), in which case the sale will be subject to VAT at the standard rate of 20% regardless of whether the seller has exercised an “option to tax”. The sale constitutes a “transfer of a business as a going concern” (and the sale will be outside the scope of VAT). Transfers of going concern A “property letting business” will exist for TOGC purposes where a tenant is already in occupation under a lease, even if the tenant is enjoying a rent-free period at the time of the sale (as well as where there is an agreement for lease in place and the tenant is not yet in occupation). Where the seller is VAT registered, the buyer must already be VAT registered (or become compulsorily liable to VAT register as a result of buying the business). Where the seller has exercised an option to tax over the property, the buyer must also opt to tax the property before completion of the sale (and must also notify that option to tax to HMRC and confirm to the seller that the option to tax will not be disapplied). TOGC treatment is possible where the seller disposes of its property letting business by granting a long lease and only retaining a minor reversionary interest (as opposed to having to sell the freehold interest). Income or capital? A disposal of commercial property will generally be treated as giving rise to a capital receipt, unless the seller is carrying on a “trading” activity. For a company, both activities will give rise to corporation tax on profits (currently 19%), but the way in which the profit is calculated (as well as other matters, such as the availability of certain tax reliefs) will be very different. By way of example, indexation allowance can be claimed in relation to capital disposals to allow for the effect of inflation (based on changes in the Retail Price Index). In practice, a number of different factors will be taken into account in determining whether a property business is treated as an “investment” or a “trading” activity (see the table below). Mark Whiteside is a partner at Brabners Photo © StockSnap/Pixabay