Most charities are subject to statutory restrictions on disposals of charity land, which are contained in Part 7 of the Charities Act 2011. In order to comply with the statutory requirements, the charity trustees will usually be required to obtain a report from a qualified surveyor as to how best to structure any disposal so that the charity gets the best deal reasonably obtainable.
The trustees are obliged to consider the surveyor’s advice. If the land has development potential the surveyor might recommend that, in addition to the sale price, the sale contract includes provisions for additional payments (or ‘overage’) to be paid if development increases the value of the property in the future, so that the charity may participate in a share of the profits.
Overage is also known as a ‘slice of the action’ or ‘clawback’, and will provide that on a particular trigger event, such as a disposal with planning permission for development, a percentage of the uplift in value of the property will be paid to the charity. There are several different ways the overage agreement may be structured and the method will depend upon the proposals for the land and the parties involved.
When contemplating imposing overage on a sale of land charity trustees should carefully consider the issues involved, as overage is notoriously complex. This article touches on two of the issues involved: enforceability of overage and tax consequences for the charity.
Enforceability of overage - will the charity actually secure any profit from the arrangements?
Every method of securing overage is vulnerable to loopholes, and the structuring of the obligations should be considered very carefully. For example:
- positive covenants (essentially contractual promises) only bind the person who gave them and might fall away if the developer disposes of its interest in the land, unless a complicated arrangement is set up so that any owners of the land must each promise in similar terms (chains of covenants are difficult to police and will fail if the chain is broken)
- overage provisions may be secured by a legal charge over the land - however if the developer needs finance in order to undertake the development then it is unlikely it can agree to a first legal charge to the charity, and the charity might not have this option
- if the developer is a company then overage provisions might be vulnerable on the insolvency of the company to being set aside as an onerous contract
- overage may be secured via a restrictive covenant, which runs with the land - however if the charity does not retain land which has a genuine connection with the sold land then the covenant might be unenforceable (also, case law is clear that restrictive covenants should not be used to secure financial payments).
For these reasons the legal fees involved in drafting overage provisions can be significant, so before embarking on such an exercise the trustees should be satisfied that there is a reasonable prospect of receiving an overage payment and that it is a reasonable use of the charity’s funds to incur the necessary legal fees. If the potential for development is, in fact, remote the trustees will need to weigh up the costs involved against the likelihood of receiving a payment. Sometimes it might be a better option to negotiate a higher selling price for the land.
Tax treatment of the overage receipt
If charity land is sold and the profits are used for charitable purposes then the gain is generally exempt from tax. However, the position might be different for an overage payment that is received as an additional bonus on the successful development of the land some time after the original sale.
This is because the charity might be treated, for tax purposes, as participating in the developer’s trading activity, and the gain will then be taxed as income rather than a capital gain. Whilst primary purpose trading is exempt from tax, non-primary purpose trading activities above the de minimis exemption are not, and the rules about charities and trading are not commonly understood.
Trustees should therefore take specialist tax advice before committing to any overage arrangements, as it might be possible to structure the transaction in a more tax-efficient way and ultimately secure more money for the charity from the disposal.