Land Consortium Agreements and s756 Income Tax Act 2007 Francis Fitzpatrick 11 New Square The situation (1) Whiteacre is a large area of land ripe for development Whiteacre is owned by 10 landowners, a mixture of individuals and trusts. Their financial and tax circumstances are all different. They are represented by different professional firms. The situation (2) What the landowners have in common is that they have all held the land for many years as a capital asset None acquired it as a trading asset
The project The landowners are agreed on one issue they would like to develop their land Some would like to develop the land themselves and sell on or hold as an investment Others, lacking the resources to do this would prefer to sell on to a developer but would like a slice of the action if the development is succesful Uncertainty If the land owners are to co-operate, they will all be expected to share the costs of the initial steps of paving the way for planning permission At this stage, it is not known whether all of the land will be successfully developed or only some of it Some may be winners and some may be losers Providing a reward for all Assuming at least part of the land is successfully developed and sold, there needs to be a mechanism to ensure that all parties are reimbursed their costs and that all parties have some share in the profits of such success (not just the landowners whose land is sold)
Simplest solution The simplest solution would be for a successful landowner to agree to pay a percentage of the proceeds of sale to the other landowners The problem is that the successful landowner would be subject to tax on the proceeds and would not be able to deduct the payments to the other landowners Use of a company or LLP A company imposes two levels of taxation corporation tax on the company and income tax on the withdrawal of profits by way of dividends LLPs, whilst tax transparent, are complicated to set up and operate Land pooling using a bare trust The landowners each place their land into a bare trust so that each is a tenant in common with a share equivalent to that which they put in (this might be on the basis of acreage or value or some other formula depending on the precise circumstances This is known as a land pooling arrangement
The use of land pooling The attraction of land pooling is that all the owners are tenants in common they will each have an interest in the proceeds of sale of any part of Whiteacre both as a matter of property law and of tax law What about capital gains tax on joining or leaving and SDLT? Jenkins v Brown (1) This happened in Jenkins v Brown [1989] STC 577 where the CGT consequences of leaving the arrangement were considered Taxpayer and children set up a trust into which they conveyed farms to which they individually absolutely entitled They were all absolutely entitled under this trust for CGT purposes it was a bare trust Jenkins v Brown (2) Subsequently, some of the children took back their land and it left the trust HMRC said there had been a disposal of assets Knox J in the High Court found that there was no disposal He followed the approach of the Court of Appeal in Booth vellard [1980] STC 555 where there was a share pooling arrangement
Jenkins v Brown (3) In essence the reasoning was whilst there might be a difference in the precise legal interest which a beneficiary enjoyed prior to and after pooling Where the interests in the pool precisely reflect the individual interests prior to the pool being entered into then there is for the purposes of capital gains tax no disposal either on entry or exit from the structure For example: Jenkins v Brown (4) A owns the A Land worth X B owns the B Land worth X The A and B Land is pooled and held in trust for A and B as tenants in common in equal shares this reflects the value of the A and the B land being the same Jenkins v Brown (5) In effect A and B have exchanged their absolute beneficial interests in the A and B Land for beneficial interests of equivalent value under the trust It is important to appreciate that at law there has been a change in their interests but Jenkins says this is not a disposal for CGT purposes
Jenkins v Brown (6) SDLT SDLT is charged on land transactions A land transaction means the acquisition of a chargeable interest in land If the interest in land acquired under a pooling arrangement is different from the interest previously held then there is, prima facie, an acquisition of a chargeable interest in a pooling arrangement Jenkins v Brown (7) A land transaction is exempt from charge if there is no chargeable consideration An exchange of a major interest in land for another is treated as two separate transactions with the consideration being the market value of the subject matter of the acquisition Prima facie there would seem to be a SDLT charge in a pooling arrangement HMRC have suggested this is not the case but have given no formal ruling on the issue on which reliance can be placed A cross option structure for land pooling Cross options The landowners grant each other options over their land A future purchaser will pay a release fee to the unsuccessful option holders
The problem of s756 ITA 2007 For the landowners their interests in the land are capital assets with an exposure to CGT at a top rate of 28% If s756 ITA 2007 applies they may pay income tax at a rate of 50% Overview This anti-avoidance provision dates from 1969 Its aim is to prevent the avoidance of income tax by persons concerned with land or the development of land and taxes as income what might otherwise be taxed as gain It is of renewed importance given the current differentiation between rates of capital gains tax and income tax The key conditions (1) The provision can apply where land or property deriving its value from land is effectively disposed of by one or more transactions or by any scheme or arrangement The reference to property deriving its value from land means that, for example, options over land are within the scope of the provision
The key conditions (2) For the section to apply one of four circumstances must be met and a gain of a capital nature must be obtained from the disposal of all or part of the land A gain of a capital nature is one that does not fall to be included in any calculation of income The four circumstances (1) The land is acquired with the sole or main object of realising a gain from disposing of all or part of the land Where land is acquired with such an intent, the land will normally be trading stock in any event The four circumstances (2) Any property deriving its value from land is acquired with the sole or main object of realising a gain from disposing of all or part of the land This could apply to shares in land holding companies and to options
The four circumstances (3) The land is held as trading stock A direct sale of land held as trading stock will be outside the scope of the section as the proceeds will be taxed as income and not as a gain in any event The four circumstances (4) The land is developed with the sole or main object of realising a gain from disposing of all or part of the land when developed This is the most common circumstance The meaning of development HMRC s view (BIM 60460) is that development means any physical adaption of the land for a new use HMRC accept that seeking and/or obtaining planning permission is not development
Slice of the action schemes A classic example of where this circumstance arises is where a landowner sells land to a developer and the sale agreement provides for the developer to make further payments once the land is developed if the proceeds of sales exceed a set figure Installing infrastructure prior to sale It may be commercially attractive to install Infrastructure prior to a sale to a developer This is development within s756 ITA and may mean that at least part of the proceeds of sale are taxed as income When is the the intention to develop formed? Where the provision applies because the development condition is met, there is an exemption so that such part of the gain as is attributable to a time before the intention to develop was formed is outside the scope of the provision s765 ITA 2007 This is an inherently uncertain test
Land development and s756 When considering any of the various options for facilitating the development of land held in multi-ownership, careful consideration must be given to s756 as it has the potential to turn gain taxable at 28% into income taxable at 50% HMRC view on the necessity for there to be avoidance of income tax The HMRC Manuals suggest that HMRC regard it as necessary for the provision to apply that there has been an avoidance of income tax BIM 60315 This does not accord with the case-law see eg Page vlowther 57 TC 199 Advance clearance procedure In some, but not all, cases where the provision may be met, HMRC is required to give its view as to whether the provision will apply or not S770 ITA 2007 Where, for example, the development condition is met but there is no tax avoidance HMRC ought, consistent with their guidance, to give advance clearance