- Option Agreements offer cash “up front” for the landowner, with a discount benefit for the developer but are not suitable for every case
- Under a Land Promotion Agreement, the landowner and developer work together to maximise the value of the land on a sale to a third party
- Any agreement must be carefully structured to ensure the most advantageous tax treatment
- Estate planning opportunities should be considered before any action is taken
With the continuing political focus on housing need, there are opportunities for rural landowners who are fortunate enough to have holdings in suitable locations. Our private client team, with support from specialist commercial real estate, planning, environmental, banking and corporate lawyers, has considerable experience of acting for such clients.
A landowner could get their land “under option” which means, in lay terms, the landowner entering into a formal agreement (usually with a developer) to give that party a right to buy their land at a specified point in the future, for a price based on the value of the land once planning permission has been obtained for development.
Option Agreements have been entered into by landowners and developers for many years, and have advantages for both parties. For the landowner, there is the opportunity to receive some cash “up front” in return for a promotion commitment from the developer. The developer, on the other hand, secures land which is usually of strategic benefit, at a price which is often discounted against market value. However, an Option Agreement may not always the right choice for all landowners looking to dispose of their land for development.
One of my clients, Richard Hanson, farms 700 acres of agricultural land in the West Midlands. He arranges a meeting with me as he has read much in the local paper about the need for affordable housing in the area and believes that 120 acres of his land may be suitable for development. He has two grown up children (who themselves have young families) and his key objective is to maximise the value of his land in the mid to long term, rather than secure the quick realisation of a cash payment.
I ask Amanda Tagg, a partner in our agriculture and estates team and Vanessa Warren a senior solicitor in our real estate team to join me in the meeting. We ascertain the current planning position from Richard, which is often key. Richard tells us that his land has not yet been allocated to the local Development Plan and moreover, as far as he is aware, allocation of his land to the plan is not imminent. Richard has already engaged the services of an agent, who has held preliminary discussions with some prominent house builders. The agent believes that the uncertainties over the planning position, combined with a decline in residential land values in the area during the economic downturn, are deterring developers from entering into discussions over “optioning” the land at the present time.
Amanda and Vanessa advise Richard that Land Promotion Agreements are increasingly common and might be a more palatable alternative for developers. These differ from Option Agreements as the developer does not buy the land but, in conjunction with the landowner, offers it for sale on the open market. The aim is to find a buyer who will (usually) build out the development. This offers something of a role reversal for the developer, who steps back from the physical development to instead, take on the role of “promoter”.
Before the land reaches the open market for sale, the developer is required to use its own funds and expertise to promote the property within the Local Development Framework, and then obtain a planning permission which maximises the value of the land. When the land is sold, the proceeds are divided between the developer and landowner, giving both parties a vested interest in maximising the value of the land. This is in contrast to an Option Agreement, where the landowner would be striving for the highest possible land price, with the developer wanting to pay the lowest possible land price.
As both parties know in advance the precise percentage of the sale proceeds that they will receive, any promoter under a Land Promotion Agreement will have a clear incentive to work hard and commit resources to promote the land and maximise its value. In return, the promoter has the certainty of knowing that it will receive a fixed percentage of the sale proceeds and that its costs associated with promoting the land will be reimbursed out of those proceeds.
From a tax perspective, I advise Richard that it is crucial to analyse whether the developer’s rights under the promotion agreement are either:
- a right to be paid a fee for his work in due course only if the conditions are met (finding a buyer, planning permission etc), with the payment computed by reference to the sale price; or
- a right to acquire a share of the land itself, again on satisfaction of certain conditions.
The tax consequence will differ accordingly.
Under (1) Richard has made no disposal of his land to the developer at any stage. It will be Richard who sells to the eventual purchaser and one of his costs of sale will be the fee payable to the developer (I tell Richard that he might have to consider the VAT issues of this).
Under (2), there is a form of contract for a share of the land to pass to the developer on satisfaction of certain conditions. It is not until the conditions are satisfied that there is a land disposal for tax purposes. At which stage, Richard is then treated as selling a part interest in his land to the developer for the then market value (and the VAT position would again need to be considered). Based on current rules, Richard’s rate of capital gains tax is now 28 per cent, and it is unlikely that he would qualify for the “entrepreneurs relief” which might otherwise reduce this tax rate to 10 per cent.
However, for present purposes, the key aspect is that the tax position must be considered carefully from the onset and will be dictated by the exact structure of the promotion agreement, which are generally fashioned on a bespoke basis to meet the requirements of the particular deal.
We go on to discuss that, although farm land can be exempt from inheritance tax on death, this exemption will be lost once the land is sold. Richard is keen to consider how he might avoid the sale proceeds being taxed at 40 per cent on his death. I advise that Richard could transfer the land, or a share in it, as a gift to his sons before entering into the agreement. Provided that he survives the gift by seven years, the value of the interest gifted will fall outside his estate for inheritance tax purposes. If he fails to survive that long the asset will form part his taxable estate but, advantageously, the taxable value is at the date of the gift rather than at the date of death.
If Richard went ahead with this gift, provided that the land qualifies as agricultural property (and certain conditions are satisfied) any capital gain can be held over thus avoiding an immediate capital gains tax charge. I noted to Richard that if the conditions are not satisfied a gift to a trust would be a way of avoiding an immediate capital gains tax charge arising.
If Richard’s sons are joint owners in the land they would then also need to enter into the Land Promotion Agreement. They would need to be aware beforehand that there is a risk that the capital gain the sons receive on (a) disposal of the right to receive part of the sale proceeds and (b) the ultimate disposal of the land, will be taxed as income on the basis that it has been acquired by them with the object of realising a gain.
Richard confirms that he is very interested in the idea of a Land Promotion Agreement and that he would like to explore this further. Whilst this kind of agreement can take several years to yield proceeds of sale, Richard advises that this suits his needs as his priority is to maximise the value of his estate in the longer term for the benefit of his children and grandchildren. Vanessa confirms that it is sometimes possible to enter into an arrangement whereby the promoter will meet the landowners reasonable legal fees for negotiation of the agreement.
Richard confirms that he will speak to his agent to explore the possibility of entering into a Land Promotion Agreement with a house builder or other developer. In the meantime we agree with Richard that we will ask Beverley Firth, a partner in the planning team, to review the planning position.