SDLT: Overlap relief to the rescue

In the second instalment of his two-part look at stamp duty land tax, Bill Chandler answers a question on SDLT and overlap relief QUESTION I have a 15-year lease of commercial premises. I have agreed a deal with the landlord for a new lease, which will extend the existing term by five years and include the rear yard, in return for a slight increase in rent. Will I have to pay full stamp duty land tax (SDLT) on the new lease, even though I have already paid on the existing lease? ANSWER Overlap relief should come to the rescue. Put simply, overlap relief exists to prevent a tenant paying SDLT twice on the same rent. Rents already taxed under the existing lease can be deducted when calculating the net present value (NPV) of the new lease, leaving you to pay tax just on the additional rent payable under the new lease. EXPLANATION Under the old stamp duty regime that applied until 2003, the duty was calculated as a percentage of the average annual rent, meaning that the same amount was payable whether the term was for 10, 15, 20 or 25 years. SDLT works differently, with the tax being calculated by reference to the NPV, which essentially capitalises the rents payable over the full term of the lease. If we take the example of a 15-year commercial lease at an annual rent of £50,000 plus VAT, the NPV is £691,044 and the tax payable is £5,410. The tenant has paid tax on the rent payable over the whole 15 years, albeit that future rents are discounted by 3.5% pa. It is bad enough that the tenant cannot reclaim any tax if the lease terminates early, perhaps owing to the exercise of a break clause or the negotiation of a surrender. But if the lease is replaced with another lease, the tenant will not want to pay any more tax on rents already taxed under the previous lease. This possibility can arise in various scenarios, including: where the parties agree to replace an existing lease with a new lease (surrender and regrant); lease renewals; where a guarantor is required to take a new lease; where a subtenant claims a new lease following termination of the headlease. In practice, surrender and regrant is the most commonly encountered. The law does not allow a lease to be varied to include additional premises or extend the term. Any attempt to do so takes effect as a surrender and regrant, replacing the existing lease with a new one. This has many implications, including the potential loss of guarantors and the loss of contracted-out status, but for the tenant the primary concern is SDLT. An unusual relief Where one lease is replaced with another, overlap relief allows the tenant to reduce the tax payable on the new lease by offsetting the rents already taxed under the previous lease when calculating the NPV of the new lease. Overlap relief does not have to be specifically claimed on the land transaction return and there is no relief code for it. You put the reduced figures into the NPV calculation. So, if our example lease is replaced after five years with a new lease for the residue of the existing term and at the same rent, the full rent can be offset to create an NPV of £0. If the replacement lease is for the residue of the term but the rent is increased to, say, £60,000, then the NPV for the new lease is calculated using only the increase of £10,000 plus VAT pa. The position becomes more complicated if the replacement lease also extends the term by, say, five years. In this case, the NPV is calculated using the amount of the increase until the date the existing lease would have expired and then using the full rent of £60,000 plus VAT for the extra five years. This may sound straight-forward, but there is a practical difficulty. Manual override SDLT is calculated on the assumption that the rent for every year after the fifth anniversary is equal to the highest amount of rent payable over any 12-month period in the first five years of the term. Overlap relief is disregarded for these purposes. HMRC’s online SDLT calculator assumes this figure to be the highest annual figure inputted for the first five years. However, the calculator does not know whether overlap relief is being applied and there is no opportunity to input the full rent or the dates of the overlap period. If the overlap period extends beyond four years, the calculator will not know what a year’s full rent looks like and will produce an artificially low NPV. This in turn will cause the tenant to pay too little tax. A manual calculation is required in these circumstances. This can be a daunting prospect the first time you attempt it, but once you have mastered how to apply the temporal discount rate to the rent for each year of the term, you won’t look back! My top tip is to test it out first on a simple hypothetical lease (without overlap relief), so that you can use the online calculator to confirm your calculation. Exclusions Overlap relief is not available in every situation. It cannot be claimed if the existing lease was subject to stamp duty rather than SDLT. This is why the extension of commercial leases has commonly been effected by the grant of a reversionary lease whose term begins only on expiry of the existing lease, although the number of rack rent stamp duty leases is rapidly diminishing. Other than specific exceptions for guarantors and subtenants, it also doesn’t apply if the new lease is being granted to a different tenant, perhaps another group company. It is also a condition that the new lease must be of the same (or substantially the same) premises, although HMRC guidance suggests that taking additional floors in the same building would qualify – so the addition of the rear yard should not deny relief. Bill Chandler is a professional support lawyer at Hill Dickinson LLP Click here to read the first part of this look at SDLT Photo: Christopher Jones/Shutterstock