- Tenants potentially face a new charge to SDLT
- The new rules only apply to leases on which SDLT (rather than stamp duty) has been paid
- The charge will arise if, after the fifth year of the term, the rent payable under the lease is increased by an 'abnormal' amount
- The rules apply on a rent review, but can also apply to rent increases as a result of stepped rents, geared rents or turnover rents
- Whilst the new rules have come into force, HMRC has acknowledged they are flawed and will be changed in Budget 2009 - This will lead to a period of uncertainty until the rules are amended.
1 December 2008 marked the first date on which new rules can impose a stamp duty land tax ('SDLT') charge on tenants when the rent payable under their lease is increased by what legislation deems to be an 'abnormal' amount. The tax charge could arise following a rent review, but could also arise where a lease provides for a stepped rent, geared rent or turnover rent.
BACKGROUND – SDLT ON RENT
When a lease is granted, a tenant must pay SDLT on any premium paid for the lease and also on the rent payable under the lease. The calculation of the SDLT charge on rent is based upon the net present value of the rent payable over the term of the lease. For these purposes, legislation deems the rent payable over the term of the lease to be the actual rent paid in the first five years of the lease and, for every year thereafter, the rent is deemed to be the highest amount of rent payable within any consecutive 12 month period in the first 5 years of the term.
ABNORMAL RENT INCREASE
The concept of the abnormal rent increase was introduced into legislation as an anti-avoidance measure to prevent tenants utilising a perceived planning opportunity presented by the SDLT calculation. If a tenant pays an artificially low rent in the first five years and thereafter pays a higher rate of 'catch-up' rent, the result would be a lower SDLT liability.
To prevent tax planning of this type, HM Revenue and Customs ('HMRC') introduced rules to impose an additional SDLT charge for 'abnormal' rent increases which takes place after the first 5 years of a lease. The new rules only apply to leases on which SDLT has been paid and therefore do not apply to leases which were only subject to the old stamp duty regime.
Broadly speaking, an increase is 'abnormal' under the current legislation if the rent payable has increased by over 20% year on year since the last increase in rent. An abnormal rent increase calculator appears on the HMRC website to assist tenants in establishing whether the rules apply.
If rent payable under an SDLT lease increases 'abnormally' after the fifth year of its term, the legislation treats this as the deemed grant of a new lease for a sum equal to the excess rent, upon which SDLT is payable and an SDLT return must be filed.
PROBLEMS WITH THE CURRENT RULES
Whilst the rules imposing the new SDLT charge came into force on 1 December 2008, the property and tax industries have been lobbying HMRC for some time on the basis that the rules can give rise to an unfair tax charge being levied and also that the rules impose a disproportionate compliance burden on tenants.
The major criticism of the rules is that the formula for ascertaining whether an increase in rent is 'abnormal' is fundamentally flawed. In certain circumstances it is possible that the rules will crystallise a tax liability for any increase in rent after the fifth year of the term (and not just a 20% year on year increase). This will be the case if, for example, the rent payable under the lease increased during the fifth year of the term and the rent is then also increased in the sixth year of the term. Tax practitioners have asked HMRC to amend the formula in order to target situations where there has been an increase in rent which is truly abnormal, given the context of the lease transaction.
In addition, the drafting of the current legislation leaves open a number of important practical issues, including such basic questions as what actually triggers the filing requirement for an SDLT return in respect of an abnormal rent increase – is it the date that the reviewed rent is agreed or the (potentially earlier) actual review date?
In response to the criticism, HMRC held an informal consultation process in late 2008, and has since accepted that the rules require amendment. It has published draft legislation which was circulated to stakeholders in late December 2008. The draft legislation has gone some way to addressing the issues raised by industry. However, there is still much work to be done before a set of comprehensive and workable rules can be introduced in accordance with HMRC's stated deadline of Budget 2009.
IN THE MEANTIME…
This leaves a period of uncertainty between 1 December 2008 and Budget Day 2009 in which tenants must comply with the current flawed legislation. It is therefore a welcome development that HMRC has publicly stated that it intends to treat with sympathy any tenants who are impacted by the rules in a 'disproportionate or burdensome way'. The most obvious way in which HMRC can extend this sympathetic approach would be not to impose penalties and interest to taxpayers who have tried to comply with the rules in good faith. Furthermore, HMRC has also informally agreed a number of practical 'work arounds' for the problems arising out of the current rules. However, our advice is that tenants should be wary of HMRC's ability to grant such assurances which depart from the strict letter of the law. Recent case law has shown that HMRC's discretion to make concessions that depart from a strict interpretation of statute is more limited than had previously been thought.
As such, in the event that a tenant suffers an abnormal increase in rent, we are advising tenants to contact HMRC SDLT Complex Transactions Unit to ensure they are adopting the correct approach in respect of the current rules. Obtaining specific assurances from HMRC will provide tenants with better protection in the event that HMRC's approach to the abnormal rent increase rules changes in the future.
Tenants face uncertainty over the application of the current abnormal increase in rent rules, an uncertainty which it is hoped will be lifted following amendment to the rules in Budget 2009.
In reality, it is thought that very few tenants will suffer an abnormal increase in rent in the period from December 2008 until Budget 2009, particularly given the current economic climate. However, this is of little comfort to those tenants who are affected and are left to grapple with the flawed and potentially inequitable current set of rules.