On 13 December 2016, HMRC published their guidance in relation to property development tax and the new transactions in land legislation that was introduced in Finance Act 2016. The new legislation can potentially apply where any taxpayer undertakes development of UK land. In particular, these rules extend the scope of UK taxation in relation to profits arising from the trade of dealing in or developing UK land to tax the profits, regardless of whether the taxpayer is UK resident or has created a Permanent Establishment in the UK.
The legislation to which this guidance applies (new sections 5A/5B CTA 2009, new sections 6A/6B ITTOIA 2005 and the insertion of Part 8ZB CTA 2010 and Part 9A ITA 2007) was effective from the date that it was introduced at the Committee stage of Finance Bill. No draft legislation was published in advance of its enactment and therefore the guidance is essential for clarifying HMRC’s position in relation to this widely drafted legislation.
Two of the most important clarifications that are outlined in the guidance are how these rules will be applied to investment transactions and how debt from a related party will be considered for the purposes of the anti-fragmentation rules.
Investments – Are they caught?
The new Property Development tax applies where a person realises a profit or gain from a disposal of any land in the United Kingdom, and any of the following conditions are met:
- The main purpose, or one of the main purposes, of acquiring the land was to realise a profit or gain from disposing of the land.
- The main purpose, or one of the main purposes of acquiring any property deriving its value from the land was to realise a profit or gain from disposing of the land.
- The land was held as trading stock.
- In the case where the land has been developed, the main purpose, or one of the main purposes, of developing the land was to realise a profit or gain from disposal of the land when developed.
Where the above conditions are met, the profit/gain realised is treated as income and subject to either income tax or corporation tax, depending on the taxpayer’s identity.
There were concerns, particularly with the first condition, that these rules would catch property investment transactions where an investor was looking for capital appreciation as well as a rental yield. Within the guidance, HMRC have clarified that the legislation is only intended to be applied to activities which when looked at “in the round” amount to a (i) trade in land or (ii) a trade of developing land and ensuring that these are taxed as trading profits. The rules should “not alter the treatment or re-characterise investment activities, except where they are part of such a wider trading activity. In particular, they do not apply to transactions such as buying or repairing a property for the purpose of earning rental income, or as an investment to generate rental income and enjoy capital appreciation”.
HMRC have made it clear that the facts of each case will determine whether or not one of the main purposes was to making a trading profit from development or disposal. It will therefore be important for clients who have an investment intention at the time of acquisition that they retain appropriate contemporaneous evidence (such as business plans, board minutes) supporting this intention as too often, external factors means that original intentions subsequently change.
This part of the new legislation is principally aimed at preventing offshore property developers carving up the property development trade in such a way that only minimal profit (and the resultant tax liability) is retained within the entity that is actually undertaking the UK property development.
Under these provisions, where a related party (‘R’) makes a contribution to the property development activity, then in calculating the profits realised by the property developer (‘C’) from the disposal of the property, the profit is taken to be what the profit or gain would be if R were not a distinct person from C (and as if everything done by or in relation to R had been done by or in relation to C). In effect, the profit from the property development trade is consolidated in the property developer. These rules do not however bite where the profits of R are recognised as income for UK tax purposes i.e. no double tax charge should arise on any income. In addition depending on where R is located, it may be possible to claim unilateral relief under the relevant double tax treaty.
Contribution for these purposes has been defined as “the provision of professional or other services, or a financial contribution (including the assumption of a risk)”. The legislation therefore provides that interest from an offshore related party to a property developer in the UK would not be deductible against the property development profit. HMRC have indicated in the guidance (BIM60611) that these rules will apply where there is an intra group loan which result in the lender being entitled to a proportion of the profit or gain from the project (e.g. via a profit participating loan) or where the terms of the loan mean that the lender is bearing a portion of the risk of the project. However, the rules should not be applied where the intra-group lending is commensurate with third party senior debt funding based on the terms and interest rates applied or to mezzanine debt where there is no participation in the profits of the development and no risk premium element.
The guidance also makes it clear that where intra-group debt can be traced back through to an independent third party (e.g. where the debt is taken out by a holding company and then dropped down to a subsidiary) then the rules will not apply provided that the lending has been in whole or in part on materially the same terms.
Overall, the guidance is welcomed as it contains a number of worked examples on the potential application of the new legislation and adds further colour on how HMRC will seek to interpret it. The explanations above will clarify the application of the new rules on “financial contributions” for property investors and developers who use connected party debt.