When acquiring property a purchaser or tenant is likely to have to pay Stamp Duty Land Tax (SDLT) on the acquisition. Whilst assessing SDLT following the purchase of a property is fairly straightforward, the same cannot be said when entering into a lease. The rules on calculating SDLT on lease transactions are complicated and often incorrectly applied. Whilst HMRC have an online calculator this often fails to cover more complex transactions. Tenants (and their solicitors) should be well-versed with the nuances of the rules so as to benefit from any tax efficiencies which may be available and to ensure that the correct amount is accounted and overpayments, penalties and interest avoided. In this article we will look at a number of common scenarios.
Break Option V Option To Renew
It is common for a tenant to seek to negotiate a break clause to permit an early exit from a lease. Tenants prefer the security that comes with a longer term with an option to break as opposed to a shorter term lease with an option to renew which relies on the tenant serving notice of its intention on the landlord prior to a certain date.
However, rarely are the SDLT implications explained to the tenant.
A ten year lease with a five year break is taxed on a multiplication of the annual rent by a temporal discount rate (to take account of inflation at 3%) over the full term of the lease. This is known as the Net Present Value. Where the break is exercised at year five, there will be no refund for the remaining five years of the term for which SDLT was accounted on.
An option to renew can be a much more tax efficient arrangement. Should the tenant agree a five year term with an option to renew for a further five years it will have only accounted for SDLT on the five years for which it occupied the property. Liability for the second five year period will only arise on exercise of the option which might be advantageous to the tenant from a cash flow perspective and mean that there is no danger of overpaying SDLT which cannot be later recovered.
The calculation of SDLT on a lease renewal is complex and one of the areas where the HMRC SDLT calculator falls short. With lease renewals, it will be necessary to determine whether any tax is payable on any holdover period between the end of the previous lease and the start of the new lease and also what the SDLT is on the new lease. Factors to take into account include whether the tenant had security of tenure under the previous lease, whether the term of the new lease is backdated to the expiry of the previous lease; and whether the new lease is granted within a year of expiry of the previous lease. Whenever you are renewing a lease or entering into a period where you are holding over under the terms of an existing lease, you should seek appropriate advice from a professional with a clear understanding of the rules to ensure that the correct SDLT is paid.
A linked transaction in respect of a lease is one which involves the same landlord and tenant or persons connected with either of them (which includes group companies).
The implication of a transaction being ‘linked’ is that the transaction will be treated as one transaction for the purposes of calculating any SDLT. Failure to identify a transaction as being ‘linked’ and properly accounting for SDLT on all of the linked transactions could give rise to HMRC assessing the need for further payment with penalties and interest being levied where such payment is not made within 30 days of the effective date of the transaction (usually the date of grant).
Calculating the correct Net Present Value on a lease transaction can, in itself, be challenging. However, this alone will not guarantee that a return is correctly filed and the tax due correctly assessed without a consideration of any reliefs that may be applicable.
The most common reliefs are group relief and charities relief but one should be aware of the full range of reliefs available so as to avoid the risk of accounting for SDLT unnecessarily. Reliefs such as overlap relief are rarely understood but can be particularly useful on lease renewals or the surrender and re-grant of a lease.
One final point worth noting is in respect of rent reviews. Any review which falls on or after the fifth anniversary of the date of grant is generally ignored for the purposes of SDLT. However, where a contractual start date falls before the date of grant, this can often bring the rent review within the first five years of the term. This is significant as where a rent review falls within the first five years and where the increased rent cannot be identified until its exercise (for example on an open market rent review),the tenant will be required to submit a new return taking account of the increased rent within the requisite period (30 days from the exercise of the rent review,) Failure to do so may result in the tenant being liable for penalties and interest.
SDLT is a self-assessment tax which often falls to the tenant’s solicitor to calculate and file the requisite return(s). The rules are complex and few solicitors will hold themselves out as being tax experts. Nevertheless, a detailed understanding of the rules is imperative to ensure that the correct amount of SDLT is paid (if at all) and penalties and interest for underpayment or late payment avoided. Consideration of the SDLT implications at heads of terms stage can also help mitigate the potential tax payment.
Whilst tenants have had 30 days in which to file the requisite return, this period is due to be shortened to just 14 days from 1st March 2019. It is therefore imperative that returns are correctly submitted with the appropriate tax paid at the outset in order to avoid penalties and interest.