However, they can apply to transactions with no link to cross border structures.The example of an individual selling part of a garden for development illustrates how wide the rules can be.
The transactions in land rules were replaced and extended in Finance Act 2016, which took effect for disposals of land on or after 5 July 2016. There has been some commentary on the new rules and their slightly controversial application in certain sectors. What is clear is that the rules are, in certain cases, very wide reaching.
The purpose of the new rules, as set out in the 2016 Budget, is "to ensure offshore structures cannot be used to avoid UK tax on profits that are generated from developing UK property" and to level the playing field between UK and offshore developers. The government’s focus seemed to be on targeting those larger property developers, whether corporates or individuals, who have the means to implement cross-border structures to avoid UK income or corporation tax.
Although it is understood that the rules are intended to catch such avoidance arrangements, in actual fact they continue to apply to a range of scenarios that have no link to cross-border structures at all. This is particularly the case for what HMRC calls ‘slice of the action’ schemes where following the 1983 Court of Appeal case of Page v Lowther, HMRC considers that the transaction in land rules will apply to deferred consideration received in the form of a share of the profit made by a developer (see HMRC’s Business Income Manual at BIM60645 onwards). HMRC's interpretation is questionable as this was not the ruling in the case.
Take the following example. An individual, Granny Smith, enters into a contract to sell a portion of her garden, attaching to her main home, to a development company in order for that development company to build flats. Granny Smith can structure the consideration in two ways:
Option 1: Granny Smith receives initial consideration of say, £100,000 and deferred consideration of say £100,000 due two years after the sale.
Option 2: Granny Smith receives initial consideration of £100,000 and deferred consideration of £100,000 on the sale of four of the developed flats expected to be two years after the original sale.
The gain made on the initial consideration in both options (and indeed, in the case of option 2, any gain ‘fairly attributable’ to a period before the intention to develop the land is formed) will be a capital payment that should qualify for the principal private residence exemption (PPR) to capital gains tax.
However, despite being the same amount and de facto payable in the same timeframe, the deferred consideration would attract differing treatment. In option 1, it should be a capital payment, also benefiting from PPR; whereas in option 2, HMRC considers it to be subject to income taxation, as it will be profit from a property trade – even though Granny Smith’s activity has none of the badges of trade. If Granny Smith structured the consideration in option 2 so that she gets her extra £100,000 on the earlier of two years post-sale or when four flats are sold, she is within the CGT regime as per HMRC’s guidance.
The difference here between the old rules and the new rules is that, whereas under the old rules there was scope to argue capital treatment in option 2 (albeit a Marren v Ingles right could arise for the deferred consideration which would not benefit from PPR), now capital treatment will only apply where the amount due bears no relation to the development.
The odd thing here is that HMRC is once again using an extension of existing rules to enact what it has always treated as an arbitrary distinction the basis of which was always questionable
Satvi Vepa is a corporate tax expert at Pinsent Masons, the law firm behind Out-Law.com. This article was first published in Tax Journal on 29 September 2017.