The Chancellor has announced proposals that will radically alter the face of stamp duty. Measures will be introduced in the Finance Bill 2002 designed to combat the widespread use of planning techniques for avoiding stamp duty on real estate transactions. In addition a consultation document has been issued which presages the move away from stamp duty as a charge on documents to stamp duty as a charge on transactions. It is, in effect, proposed that stamp duty as we know it will disappear and be replaced by a property tax on all movements of value in relation to property and assets deriving their value from property. The purpose of this note is to highlight the proposed changes and to assess the immediate impact that they will have on the most used stamp duty avoidance techniques. The conclusions that may be drawn at this stage can only be provisional pending publication of the Finance Bill 2002, expected this week. In the case of the proposals set out in the consultation document and which will be introduced in Finance Bill 2003 comment at this stage can only be in broad terms.
Whilst various mitigation techniques will remain available in the short term, a wholesale reappraisal of how we structure property investment is inevitable. As a firm we intend to provide our clients with help on the impact of the specific proposals as well as at the strategic level (including lobbying).
General
There are two main drivers of this major overhaul of the stamp duty regime. First, the obvious widespread use of avoidance techniques to eliminate stamp duty on high value commercial deals; despite the large rises in the rate of stamp duty, the rate of growth in revenue from stamp duty has, during this Governments period in office, by no means matched the growth expected from the higher rates. Second, the Revenue has been forced to step back and take a look at how stamp duty works in the light of the move towards electronic conveyancing.
The thrust of the new stamp duty regime (post Finance Act 2003) will be to subject to stamp duty transactions concerning land and buildings and shares and away from levying stamp duty on transfers of other property.
Advantageous stamp duty changes
There is no increase in rates of stamp duty. This is small comfort however given the changes proposed. Most of the changes are directed towards countering avoidance schemes but with effect from 23 April 2002, transfers of, and agreements to transfer, goodwill will be exempt from stamp duty. An exemption for the transfer of debts and other non-property related assets will also be introduced but not before enactment of the Finance Act 2003.
In the light of the new direct tax regime for intellectual property and goodwill and the move towards exempting from stamp duty the transfer of any property other than land and shares there may well be an accelerated move towards acquisitions of businesses rather than shares.
Finance Bill 2002 measures
Introduction of a stamp duty degrouping charge
Where there has been an intra-group transfer executed after 23 April 2002 for which s42 Finance Act 1930 intra-group relief has been obtained then if the transferee leaves the stamp duty group within two years of the transfer duty on the intra-group transfer will become payable.
This would seem to be introduced to prevent packaging property in SPVs and reflects the Revenue view that the existing anti-avoidance provisions denying the relief where there are arrangements in place for the transferee company to leave the group are not sufficient.
The transferee company is liable to pay the duty where the degrouping charge arises but the legislation (which has been imported from the direct tax arena) permits recovery of the duty from any company that was in the same group as the transferee at the time of the transfer or from any person who at the time of the transfer was a director of a company having control of the transferee company or who was a director of the transferee who has control of it.
Where property is transferred to a new company as part of the transfer of a business prior to sale to a third party ("a hive-down") the stamp duty degrouping charge will be triggered if the new company is sold within 2 years. Some "hive-downs" (which are currently effective because they are carried out before arrangements are in place for the hive-down company to leave the group) involving transfers of high value real property will now result in significant stamp duty charges.
Taxpayers will need to think about alternatives. S75Finance Act 1986 relief, largely ignored in the past because of the strict conditions that need to be met, will now require close inspection. In appropriate cases assets to be retained within the seller's group may be transferred out of the existing company and the existing company (holding the property and shares in subsidiaries that are to be transferred) sold rather than a NewCo.
These provisions will affect intra-group transfers made after 23 April 2002 unless effected pursuant to a contract made before 18 April. If an intra-group transfer is in the offing and there is no contract it will need to be completed on or before 23 April 2002 to fall outside these provisions.
Countering s76 Finance Act 1986 schemes
The current s76 permits the reduction in stamp duty from 4% to 0.5% where an undertaking (including substantial real estate) is transferred into a new company ("NewCo") in return for the issue of shares in the NewCo which are then sold (triggering 0.5% duty on the sale of shares and 0.5% stamp duty on the transfer of assets to NewCo). Under the scheme it was often important to avoid grouping the vendor and NewCo for capital gains tax purposes so as to avoid a s179 capital gains exit charge on NewCo leaving the seller's group. This was achieved by ensuring that the purchaser was issued with sufficient ordinary shares in NewCo to start off with and for the seller to be issued with preferred shares in return for the transfer of the property (the preferred shares were then subsequently sold pursuant to put and call options thereby ensuring that the seller realised cash).
Two separate measures to counter the use of s76 schemes are being introduced. The first denies s76 relief where NewCo "is under the control of a third party" at the time the transfer is made to NewCo and there are arrangements in place for the third party to receive the shares that are issued to the seller. This measure would counter the basic scheme. Following the changes to the s179 capital gains degrouping charge from 1 April 2002 (permitting the reallocation of the charge to a company in the seller's group and for the increased flexibility in its set off) this measure could be circumvented by making NewCo a part of the seller's group from the outset.
However, the second anti-avoidance provision denies s76 relief where control of NewCo passes to a third party within two years of the acquisition by NewCo. The meaning of "control" is imported from the direct taxes legislation and will be very difficult to circumvent though not necessarily impossible.
Transfers of property effected on or before 23 April 2002 will qualify for s76 relief which cannot be clawed back as will subsequent transfers made pursuant to a contract made on or before 17 April 2002.
Bringing certain contracts within the charge to stamp duty
A contract for the sale of land with a consideration of more than £10m will be subject to stamp duty where the contract is "deliberately not completed" in order to avoid paying stamp duty. This measure will apply to contracts executed after the Finance Bill receives Royal Assent (towards the end of July).
To assess the scope of this charge, sight of the Finance Bill is crucial. Is the legislation to introduce a motive or purpose test? How will the legislation affect sub-sales? For example, in the case of a sub-sale, if the second contract for the sale of the land is executed contemporaneously or within a short time after the execution of the first contract, will this be sufficient to demonstrate that the main purpose was not tax avoidance and that the normal sub-sale approach with execution of a transfer from the first seller to the ultimate purchaser is available? The precise wording of the legislation will also determine whether other techniques such as sub-dividing property into packages of less than £10M in value will be available.
Extension of the penalty regime to documents executed offshore
For documents executed after Royal Assent of the Finance Bill 2002 and which are presented subsequently for stamping will attract a penalty by reference to the date upon which the document was executed outside the UK (and not, as at present, 30 days after the date when it was brought into the UK). Thus, the existing techniques for mitigating duty using split legal and beneficial ownership and offshore contracts will remain available (until the overhaul at the end of 2003 – see below). However, after Royal Assent of the Finance Bill 2002 parties already faced with the risk of interest (at, say, 6.5%) on duty if the document is required to be brought into the UK will from then be faced with the additional risk of a penalty of up to 100% of the duty in issue. The scheme is thus not dead but will require a greater appreciation of the risks of having to bring documents back onshore. Will the Revenue really be able to insist on documents being returned to the UK other than for the purposes of litigation in the English courts (for example, to establish capital gains base cost)? Offshore arbitration of disputes between the parties will continue to assist.
Stamp duty proposals to be introduced in Finance Bill 2003
The proposals set out in the consultation document published on Budget day herald the wholesale revision of stamp duty. Stamp duty will cease to be a tax on documents and will instead be a tax on transactions including a number of transactions relating to the creation or realisation of value derived from land that are currently not within the scope of duty (for example lease variations). The consultation process will be in several stages. Responses to the Budget Day consultation document are required by 19 July 2002. There will be formal consultative committees made up of representatives from relevant sectors eg property, banking and the legal profession. It is expected that draft legislation will be published before the end of this year along with any further technical notes that are considered to be necessary. The primary legislation is intended to appear in Finance Bill 2003 and final implementation will be after Royal Assent and effected by subsequent statutory instrument but will be in place before the end of 2003.
Scope of the stamp duty charge
Stamp duty will be charged not only on land transfers and leases but also "other arrangements affecting the value of land with another person". The charge will apply to the transaction (it will not therefore be dependent upon there being a document). The charge will only relate to land (and other arrangements affecting the value of land) and will no longer apply to goodwill (Finance Act 2002) nor receivables or other non-property related assets (Finance Act 2003).
It is intended to bring within the scope of the charge transfers of shares or interests in certain property owning vehicles. The charge will approximate to the stamp duty chargeable if the land and buildings in the SPV were sold separately (meaning that companies sold for £1 with a property worth £100m and debt worth £100m will be subject to stamp duty by reference to £100m). The charge is likely to apply to the transfer of "substantial" interests (30% or more) in certain qualifying entities (which includes companies, partnerships and possibly non-UK vehicles) whose "major" activity involves the ownership or exploitation of UK land and buildings and whose assets consist "primarily" of interests in UK land and buildings (eg 70% of total gross assets). Immediate issues include whether shares in quoted companies will be affected. The paradoxical impact of the widely drawn provisions currently proposed may be to provide quoted property companies with an effective "poison pill" against takeover.
The new regime may extend to transactions relating to land that had the same effect as a valuable transfer of rights attaching to land but do not actually involve a transfer or grant of an interest in land (for example, the surrender of a lease or a payment for the variation of the terms or value of the lease or the release of rights over land).
The charge would be based on an extended definition of "money or money's worth". In particular, it is intended that this would cover services provided as consideration or consideration that cannot be ascribed a monetary value. It will be important during the consultation process to make the point that stamp duty should not be extended too far. For example, it ought not to increase stamp duty on development structures and the consultation document recognises that there will be problem areas that need to be considered to ensure that the new charge is not set too widely.
It is intended to reverse the current treatment of exchanges of property so that on an exchange of property a stamp duty charge will arise on both legs of the exchange.
The legislation will make it clear that it is the purchaser or lessee or other person giving value is the person that is liable to pay the duty (currently, although the purchaser or lessee ordinarily pays the duty the legislation is silent on this).
Consideration will be given to removing the stamp duty charge from certain leases, for example, leases of less than 3 years (the rationale being that leases of less than 3 years can be created orally although given that the new regime will no longer be a tax on documents it is difficult to see how this is relevant; perhaps, more logically, the exemption should be for leases for 7 years or less to bring it in line with the land registration proposals under which leases in excess of 7 years must be registered at the Land Registry). The consultation document recognises the fact that if an exemption is given then there will need to be anti-abuse provisions, for example, the prevention of the grant of a 3 year lease which is perpetually renewable.
Assessment and enforcement
Stamp duty on property transactions will cease to be a "voluntary" tax. The consultation document envisages the introduction of what amounts to a self-assessment type regime for stamp duty (and indeed even suggests the possibility of quarterly reporting for some companies who regularly acquire land interests and the possibility of linking this with the corporation tax self assessment). The consultation introduces the concept of the "enquiry" in much the same way as the self-assessment enquiry. Gone will be the need to actually present a document to the Stamp Office for stamping (save where a post-transactional determination of the duty is required in a specific case). Instead, it will be necessary to notify the Stamp Office (using a standard form) of the transaction and make payment of the duty. The consultation document invites comments on the possibility of a pre-transaction ruling. It also adumbrates a reduction in the 30 day limit for making payment.
The consultation document is a little woolly on enforcement. It suggests the introduction of an interest and penalties regime "to encourage compliance and help tackle non-compliance" and also indicates (paragraph 5.10) that the link between payment of stamp duty and registration of documents will be preserved under the revised regime but it is not yet clear whether the rule that prevents unstamped documents being used in court proceedings needs to be carried into the new regime. The use of the enquiries mechanism in line with self-assessment might have suggested that the Revenue would be given direct powers of assessment and enforcement but this is not clear but will no doubt be something that will be addressed during the consultation process.
However, under Revenue powers it does suggest that other Revenue departments may become involved in stamp duty issues with guidance from the Stamp Office (see paragraph 3.19). It also suggests that the Revenue would be given power (in the course of an enquiry) to obtain all documents relating to a transaction (paragraph 3.23) and that the Revenue will be given power to obtain records from other parties (paragraph 3.25).
Appeals will no longer be to the High Court and, instead, is likely to be by way of appeal to the General/Special Commissioners.
Stamp duty rates
The consultation document suggests that the Revenue may want to move away from the existing computation of stamp duty in the area of leases. The idea seems to be to adopt a formulaic approach where rents payable under a lease are "capitalised" and added to any premium payable with a view to charging it at the appropriate rate. In crude terms this is likely to be something like premium plus (term of lease x annual rent). The formula would have to build in some sort of discounting to get at the net present value of the rents.
There is a real risk that the change to a transaction based tax and the widening of the scope of the tax (for example, to include lease variations and commutations of rent) will kill off property based structured finance schemes.
The document also proposes that there should be a major overhaul of the contingency principle. Broadly, there are two alternatives. First, that in the case of unascertainable consideration an initial payment is made that reflects either the value to be ascribed to the unascertainable consideration or the best estimate of what might ultimately be paid and for there to be a repayment or further payment of duty once the final sums payable become known. The alternative is for stamp duty to be payable on each occasion that value passes. It would seem that both alternatives are likely to give rise to administrative difficulties in that it will always become necessary to revisit the original transaction.
Other
S42 intra-group relief, the exemption for transfers to charities and other reliefs are generally expected to be retained but will be reviewed and in particular, Ss75-77 Finance Act 1986 (reconstructions) will be reviewed.
It is also intended that the consultation document should carefully review complex commercial arrangements including partnerships, joint ventures, development arrangements and the raising of finance using property as security. It is unclear what will happen to unit trusts whether UK or offshore. This area may continue to be a fruitful area for mitigation.
Is the nominee structure still viable?
Sale of beneficial ownership offshore
No amendment is to be made to s90 Finance Act 1965 (conveyance in contemplation of sale) and therefore the issue surrounding a transfer of legal title to nominees being potentially subject to the charge remains the same as before. In recent weeks there has been experience of the Land Registry and the Stamp Office paying closer attention to transfers to nominees and it is therefore more important than ever for these structures to be set up before a property is marketed.
The execution of a contract for the sale of an equitable interest in land continues to be a stampable document (as it always has been). The proposed Finance Act 2002 changes will only increase the additional cost (over and above the stamp duty payable) that will arise if the contract is required to be brought into the UK (this is because the penalty will be payable by reference to the date of execution). However, our view remains that it is unlikely that it will need to be brought into the UK.
If clients are willing to take the risk there is no reason why the nominee structure cannot continue to be carried out, at least until the Finance Act 2003 is enacted, when it is likely that such structures will cease to be effective.
On a practical level, purchasers may become more nervous about the nominee structure and stamp duty indemnities may become ever more difficult to negotiate and settle. Certainly adjudication of the transfer to nominees is likely to become essential if these structures are to be used. One might also have some concern about the statement made in paragraph 3.19 of the consultation document which suggests that the main taxes network could identify stamp duty issues. That said, it seems unlikely that there is any additional risk in an Inspector of Taxes requiring sight of stamped contracts in order to deal with corporation tax issues generally. The risk is likely to arise only where litigation is involved. Litigation between parties (perhaps for specific performance claims) can be dealt with by offshore arbitration.
Resting on contract
If the consideration is £10m or less then the contract is not stampable and, therefore, the scheme works as before (at least until Finance Act 2003 is enacted).
Contracts in excess of £10m are stampable documents in their own right. Until the Finance Bill 2002 is enacted it seems preferable to implement a nominee structure by using the sale of the beneficial ownership offshore route. If the resting on contract route is taken a decision not to stamp the contract may be made but if it becomes necessary to stamp it the penalty would be higher, at least for the period up to the date the Finance Bill 2002 is enacted. As from the date that the Finance Bill 2002 is enacted there will be little difference in implementing the nominee structure by way of a sale of the beneficial ownership offshore or by resting on contract (assuming in both cases that the shares in the nominees are shares in offshore companies).
Conclusion
It seems clear that the nominee structure techniques will not be viable once the Finance Act 2003 provisions are operative but it seems likely that these techniques will continue to be so until then. Of course, the effectiveness of all stamp duty elimination and mitigation techniques will need to be reviewed in the light of the detailed provisions that will be included in the Finance Bill. In the short term there is every reason to believe that there will continue to be scope for stamp duty planning. This may become more difficult or even impossible, if and when, legislation is enacted to reflect the outcome of the consultation. Clearly, it will be vital to ensure that the views of the property industry are taken into account in the consultation process.
In tax terms, these proposals are the most important changes to affect property since the introduction of VAT on property 13 years ago. Given that at 4% stamp duty is a significant obstacle to property investment the proposals may well presage a wholesale change in the way property investments are structured. One can envisage the creation of large property funds (whether all tracker or pan-European) with institutions gaining exposure to UK property by dealings in interests in the fund. Indeed the new rules may result in a re-appraisal of listed property companies including a closing of the discount to net asset value.
If you would like any further information, please contact
Mark Nichols, Phone: +44 (0)20 7367 2051
Email: [email protected]
Richard Croker, Phone: +44 (0)20 367 2149
Email: [email protected]
Mike Boutell, Phone: + 44 20 367 2218
Email: [email protected]
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