A periodic update designed to provide a summary of developments in property tax, including recent cases, and a round-up of forthcoming changes.

Transcription

1 Update February 2008 Property Tax A periodic update designed to provide a summary of developments in property tax, including recent cases, and a round-up of forthcoming changes. 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. Capital allowance developments - we look at the implications for property transactions of the classification of assets (such as lifts) as integral features qualifying for allowances at only 10%. Read more Capital v income - a recent case looking at whether a payment of damages in relation to land was taxable as income or as capital. Read more Contribution of assets to a partnership - HMRC change their practice in relation to the CGT treatment of the contribution of assets to a partnership. Read more Brownfield sites - tax reliefs - the relief from corporation tax known as land remediation relief will be extended to long derelict land even if it is not contaminated and the exemption from landfill tax for waste derived from contaminated land will be withdrawn - action is required from those who may be affected by the landfill tax change. Read more Withdrawal of EZ allowances - enterprise zone allowances (EZAs) will be withdrawn from 1 April The changes will affect those with "golden contracts" who may still be able to claim EZAs as well as those (including enterprise zone property unit trusts) holding property in respect of which EZAs have already been claimed. Read more REITs - worth the wait? - one year on from the introduction of UK REITs we look at whether they have been worth the wait and at the practical implications of REITs. Read more

2 FULL ARTICLES Capital allowance developments Background In the 2007 Budget, major changes to the system of capital allowances were announced. Technical documents now give more detail of the changes. The main changes from April 2008 are: Rate of capital allowances on plant and machinery goes down from 25% to 20% Some plant and machinery (eg lifts) treated as "integral features" and allowances only available at 10% Rate of allowances on long life assets increased from 6% to 10% IBAs to be phased out - the rate goes down to 3% in April 2008, reducing to nil by 2011 First year allowances for SMEs abolished but a new Annual Investment Allowance will be introduced giving 100% allowances for all on first 50,000 of expenditure on plant and machinery in any accounting period A payable tax credit will be introduced for loss making companies investing in designated green technologies. Integral features We look at the implications for property transactions of the classification of some assets as "integral features". Assets classified as integral features will qualify for allowances at only 10% (unless they qualify for 100% environmentally beneficial allowances). It is proposed that the following will be integral features: Electrical systems (including lighting systems) Cold water systems Space or water heating systems, powered systems of ventilation, air cooling or air purification and any floor or ceiling comprised in such systems Lifts, escalators and moving walkways External solar shading Active facades. Who will be affected? The changes will only apply to expenditure incurred by companies on or after 1 April 2008 and by individuals on or after 6 April There will be no reclassification of assets for those already owning assets. The changes will therefore affect: Purchasers of new or used buildings on or after 1 April 2008 (6 April for individuals) Those incurring expenditure on construction works involving such assets on or after 1 April 2008 (6 April for individuals). Timing Implications The changes mean that it may be advantageous for some buyers to incur expenditure before 1 April, but for others there will be advantages in waiting until after 1 April. Timing will not affect the seller. When would you want to advance sale to before 1 April (6 April for individuals)? - if the building contains significant assets which currently qualify for 25% allowances and will become integral features (allowances drop to 10%) - this may be particularly relevant to those in leisure and retail sectors where 25% allowances may currently be available for items such as ambient lighting. When would you want to wait until after 1 April (6 April for individuals)?- if there has been significant expenditure on items which don't currently qualify for allowances eg electrical systems in offices or active facades/external solar shading.

3 For anyone incurring expenditure on construction works, there could be significant advantages in delaying the expenditure until after 1 April (6 April for individuals), if the works include expenditure on items which don't currently qualify for allowances but after 1 April (6 April for individuals) will qualify for 100% environmentally beneficial allowances eg active facades and external solar shading. Information requirements For deals which will complete on or after 1 April (6 April for individuals), in order to work out the allowances that will be available to it the buyer will need to ascertain which of the assets comprised in the building will be integral features. Sellers who are asked for this information may not be able to provide it readily since the integral features classification will not be relevant to the seller's capital allowance position. Sellers should therefore be careful about agreeing to provide the information - a seller could take the view that if the buyer has details of all the individual items comprised in the building, it can then take its own view as to what assets constitute integral features. Grant of lease - should section 183 election be made? On the grant of a lease, allowances on fixtures installed in the building prior to the grant of the lease will remain with the landlord unless a section 183 Capital Allowances Act 2001 election is made passing the allowances to the tenant. Where the lease will be granted on or after 1 April 2008 (6 April for individuals) and the fixtures include assets which will be integral features from 1 April (6 April for individuals), if the election is made allowances will be available to the tenant at only 10%, whereas if the election is not made, allowances will continue to be available to the landlord at 20% (as the new rules do not require a reclassification of assets acquired before April that continue to be held by an existing owner). This may therefore affect the decision as to whether a section 183 election should be made. Go back

4 Capital v income One of the issues to be considered where damages are received is whether the receipt is capital or income in nature. The Court of Appeal has recently considered the issue in a property tax context in the case of Able (UK) Ltd v Revenue and Customs Commissioners. Able used land for a landfill tipping site. As a result of a compulsory purchase order which was eventually withdrawn, Able was kept out of possession of its land for just over 3 years. It was awarded approximately 2million in compensation and the case concerned the tax status of that payment. Able argued that the payment was capital in nature because, by being kept off the land, it had lost a never to be repeated opportunity to bid for a highly profitable waste disposal contract. HMRC argued the payment was income in nature and should be taxed as a trading receipt. The principle established in previous cases is that consideration received for the once and for all realisation of the capital value of an asset is capable of being a capital asset notwithstanding that the asset remains in existence and in the ownership of the recipient. For example, in the 1922 case of Glenboig Union Fireclay Co Ltd v IRC the taxpayer owned a bed of fireclay which ran underneath a railway. The railway required the company not to work the bed underlying the railway line and paid it compensation. The House of Lords held that the compensation was a capital receipt, paid for the sterilisation of a capital asset since although Glenboig still owned the bed of fireclay, it was worthless if it could not be worked. The Court of Appeal found that in the Able case, although the capacity of the land as a landfill site was disrupted by the CPO, the capacity was not exhausted. The reason the site no longer had potential for use as a landfill tipping site was because of a change in the market. Comment: The case does not establish any new principles but illustrates how difficult it is to get this sort of compensation treated as capital rather than trading income. Go back

5 Contribution of assets to a partnership HMRC has issued Revenue and Customs Brief 03/08 in which they clarify their position in relation to capital gains tax and corporation tax on chargeable gains ("CGT") on a contribution of assets to a partnership. Despite HMRC's assertions that Brief 03/08 clarifies the position, many consider this to be a change in practice and a withdrawal of a concessionary relief. In brief, Statement of Practice D12 (published in January 1975) sets out HMRC's understanding of how the tax legislation governing partnerships works in practice. Although D12 does not deal specifically with the contribution of an asset to a partnership, in some cases HMRC accepted that the disposal consideration on a contribution could be calculated by reference to paragraph 4 of D12 (which applies to changes in partnership sharing ratios). The effect of paragraph 4 D12 applying is that the consideration given for the disposal is the fraction of the contributing partner's base cost in the asset that is being transferred to the other partners resulting in a no gain/no loss transfer for CGT purposes. Following the issue of Brief 03/08, the contributing partner will be treated as making a part disposal of the asset to the partnership for the consideration actually paid (represented by the amount credited to the contributing partner's capital account) or the market value (where the transaction is between connected persons or is entered into on non-arm's length terms). In many cases, this will give rise to a tax charge for the contributing partner which could lead to unwelcome cash flow issues either for the contributing partner or the partnership (where the partnership deed allows a partner to withdraw sums by way of loan or profit share from the partnership to fund its tax liabilities). In calculating the amount of the chargeable gain on the part disposal, HMRC confirmed that allowable costs will continue to be calculated by reference to the fraction that the contributing partner passes to the other partners rather than by reference to the statutory A/A+B formula (where A is the consideration or deemed consideration for the part disposal and B is the market value of the part that the contributing partner holds onto). HMRC do acknowledge in Brief 03/08 that some taxpayers will have proceeded in reliance on erroneous practice and state that they will not seek to change the tax treatment where they have had discussions on individual cases. Comment: In light of Brief 03/08, any partner contributing assets to a partnership should consider carefully whether it has sufficient cash to fund any resulting tax liability and the availability of tax reliefs on the contribution such as losses that it can set against the gain, or may be able to defer the gain by claiming business asset rollover relief or holdover relief in relation to other business assets. Alternatively, partners may wish to reduce the amount of exposure to any chargeable gain by leasing the asset to the partnership rather than making a contribution. Go back

6 Brownfield Sites - Tax Reliefs Currently there are two tax reliefs targeted at developers and others involved in cleaning up contaminated land: a corporation tax relief known as land remediation relief, which gives a tax deduction of 150% of qualifying expenditure for the costs of decontaminating land; and an exemption from landfill tax for waste derived from contaminated land that is sent to a landfill site. A consultation document issued at the time of the 2007 Budget considered whether these reliefs were achieving their objectives and proposed some changes. A further document was issued in December setting out the Government's current proposals. The current proposals are: Phase out landfill tax contaminated land exemption - as the Government wishes to encourage on-site treatment rather than removal of contaminated material to landfill, the landfill tax exemption will be removed. Anyone wanting to claim the exemption has to make an application before 30 November 2008 and even then the relief will only apply to waste disposed of at landfill before 1 April Extend land remediation tax relief to cover long derelict sites - at present these sites only benefit from relief if contamination is present, yet there are significant other cost barriers to development. The proposal would be to give land remediation relief for certain expenditure (such as removing foundations or obsolete services such as gas or water) for land that had been derelict since 31 March The proposed definition of derelict land is from the Derelict Land Grant Act of 1981 ("Land or buildings so damaged by previous development that it is incapable of beneficial use without treatment".) It would correspond to Category C land in the National Land Use Database of Previously Developed Land and Buildings - although if land is not on that list and it met the test it would still qualify. Further, consistent with the "polluter pays" principle, the land must have been derelict before being acquired by the present owner. There will be no linkage to obtaining planning consent but expenditure incurred to satisfy a statutory obligation will not attract relief. It is not clear when the changes will come into force as the state aid implications need to be investigated. A further announcement is expected in the 2008 Budget. Extend remediation relief to include the costs of removing Japanese Knotweed - by on site or off site treatment (excluding removal to landfill). Comment: Whilst the extension of land remediation relief is some way off, the withdrawal of the landfill tax exemption will require action from those who may be affected who need to make an application before 30 November Go back

7 Withdrawal of Enterprise Zone Allowances Announced A technical note has been published on the changes to capital allowances announced in the 2007 Budget. Previous publications were silent on enterprise zone allowances but this note announces that the Government has now decided to withdraw enterprise zone allowances from 1 April The changes will affect those who may still be able to claim EZAs as well as those (including enterprise zone property unit trusts) holding property in respect of which EZAs have already been claimed. Background In March 2007, the then Chancellor, Gordon Brown announced that industrial buildings allowances were to be phased out so that by 1 April 2011 they would no longer be available. IBAs are currently available at 4% per annum. Enterprise zone allowances ("EZAs") are available as a 100% first year allowance for qualifying expenditure on the construction of an industrial building: within ten years after the site was first included in an enterprise zone; or within 20 years after the site was first included in an enterprise zone if it is incurred under a contract which was entered into within those ten years. As the last enterprise zone was designated in 1996, no zones are still within their initial ten year period. EZAs are therefore only available now if incurred under a contract entered into within the ten year period (a so called "golden contract"). At present, if EZAs are claimed, a balancing charge can arise if a balancing event such as the sale of the building takes place within 25 years from the date the allowances were first obtained. Many therefore still hold such properties to prevent the allowances being clawed back. Before January 1994 it was possible to avoid the balancing charge by granting a 999 year lease (or other long leasehold interest) at a premium to a purchaser rather than selling the freehold. There are therefore some (including many EZPUTs) who hold the freehold reversionary interest to these leases (so called "rump interests"). The changes The technical note announces that: EZAs will cease to be available from 1 April 2011 Balancing adjustments will remain for events, such as a sale of the building, taking place in the period of 7 years after the allowances were claimed. Reasons given for the changes are the continued exploitation of EZAs by way of golden contracts and the fact that a scheme for exploiting allowances has been disclosed to HMRC under the disclosure of tax avoidance scheme rules. Comment: Those holding golden contracts still have another three years to get their buildings built and claim the allowances. The reduction of the period during which balancing adjustments will be triggered to 7 years will enable many to sell their properties and wind up rump interests without triggering a clawback of the allowances. We will need to see the draft legislation to see exactly what can be done. It is due to be published in the next couple of months. Go back

8 REITS - Worth the Wait? A long gestation period can sometimes lead to a sense of anti-climax when the waiting is finally over. A UK REIT model was talked about for almost 20 years before REITs were introduced at the beginning of We look at whether REITs have been worth the wait and, one year on, we ask the question: what has been the practical impact of REITs? The conversion to REIT status of many listed UK property groups confirmed the relevance of REIT status to the sector, and the UK now has one of the largest REIT sectors in the world. The perceived advantages of REIT status are also demonstrated by reports that groups with pubs and similar properties are looking at options to alter their business models to access the REIT regime. The comparative lack of new REITs since the initial conversions has been the result of market conditions rather than the operation of the REIT regime. On the downside, however, it must be acknowledged that the REIT regime does not easily permit residential portfolios to be brought within the REIT regime. Given that one of the initial aims of the introduction of REITs was to act as a stimulus to investment in the residential sector, this is likely to be a disappointment to the Government and it may be under reconsideration as part of the wider initiative on social housing. It is clear that REITs are here to stay, and as better market conditions return, we are likely to see new launches. Those in the property sector need to be aware of some of the implications of transacting with REITs, particularly as many of the leading UK property industry groups now have REIT status. For individual shareholders who own unquoted property companies, the potential CGT uplift on the company's portfolio on a sale to a REIT can be of considerable advantage and will potentially enhance the value of selling a corporate portfolio to a REIT, as compared with other buyers. However, REITs are generally concerned to ensure that benefits arising from their REIT status are retained for the benefit of their shareholders, so sellers may expect a vigorous negotiation over the value of this benefit and the impact on the deal price. Interesting issues also arise in relation to partnering or joint venture arrangements with REITs. Generally, a REIT will enjoy a tax advantaged position from its participation in a joint venture, whereas a non-reit partner will not. A REIT will generally be concerned to ensure that such benefits are retained for the REIT and its shareholders, rather than shared with the non-reit partner. The analysis of future events such as portfolio disposals and exits from the joint venture require careful consideration to ensure the tax positions of both the REIT and non-reit parties are properly protected. Comment: REITs may be only in their infancy but, as they continue to develop, those in the property industry will need to become more familiar with how they operate. Go back Pinsent Masons 2008 This update 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