by Professor J E Adams
Numerous commentators have agreed that the associated company exemption provides an avoidance device to circumvent Part I of the 1987 Act. It remains to be seen whether Parliament blocks or restricts it and, if so, how quickly. In the meantime, this article explores another method of side-stepping the collective right to buy given to qualifying tenants, by using the combination of a subsidiary company and a reversionary lease. So it provides an alternative to the approach described in these columns on May 14 1988.
The basic features of Part I of the Act have been well discussed in Mr Stuart @@ article at [8] 19 EG 21 and it is not @@ repeat his very thoughtful treatment. @@ writer does not dissent, either, from @@ of the possible pitfalls and @@.
“Landlord” defined
The essence of what may be called the “intermediate lease” device is the definition of landlord contained, for the purposes of Part I, in section 2 of the Act, which reads @@:
2. — (1) Subject to subsection (2), @@ for the purposes of this Part the landlord @@ to any premises consisting of the whole @@ building if he is —
(a) the immediate landlord of @@ tenants of the flats contained in those @@
(b) where any of those tenants is a @@ tenant, the person who, apart from the statutory tenancy, would be entitled to possession of the flat in question.
(2) Where the person who is, in accordance with subsection (1), the landlord in relation to any such premises for the purposes of this Part (“the immediate landlord”) is himself a tenant of those premises under a tenancy which is @@ —
(a) a tenancy of a term of less than @@ years, or
(b) a tenancy for a longer term but terminable within the first seven years at the option of the person who is the landlord under that tenancy (“the superior landlord”),
the superior landlord shall also be regarded as the landlord in relation to those premises for the purposes of this Part and, if the superior landlord is himself a tenant of those premises under a tenancy falling within paragraph (a) or (b) above, the person who is the landlord under that tenancy @@ also be so regarded (and so on).
(Section 58 defines those exempt or resident landlords not affected by Part I.)
Accordingly, if the intermediate landlord has a fixed term of seven years or more not terminable by the reversioner, that reversioner — “the superior landlord” — is insulated from the Part I obligations. Creation of such an intermediate lease by the landlord of qualifying tenants would be a relevant disposal within section 4, but is exempt if made to an associated company. Mr Lightman’s article discusses the meaning of that label although it is, in fact, defined in section 20(1) by reference to section 736 of the Companies Act 1985. (See Mr Lightman’s letter published on June 11 1988.) In what follows, it is assumed to be a wholly-owned subsidiary.
Form of intermediate lease
All that seems to be needed is a lease for, say, eight years, under which the lessee — a newly formed, asset-free, debt-free company associated with the lessor — undertakes to discharge all the obligations imposed on the landlord by the flat leases or tenancies (or indeed by all leases and tenancies in the building if the intermediate lease is of the whole building, as would seem desirable) and to indemnify the lessor against @@. The rent payable would be the @@ all the rents payable under the @@ leases, with allowances for @@, plus possibly a small extra rent as a “handling charge”.
To avoid that lease being too artificial, it is suggested that it also contains a forfeiture clause; by analogy with the shorthold tenancy case of Paterson v Aggio (1987) 284 EG 508, this should not fall foul of section 2(2)(b).
Timing
The intermediate lease should be granted as soon as the prospect of sale of the reversion is imminent and before any firm commitment to a purchaser is entered into. This will strengthen the chances of its not being caught by any Furniss v Dawson attack; in this respect, see the consideration lettered (c) in the third column of Mr Lightman’s article at p 21 and the majority decision in Gisbourne v Burton (see The Times, July 23 1988). An eight-year term is suggested to give one year’s negotiating space in case seven years in section 2(2)(a) is measured not at the outset but at the date when Part I is said to operate. It involves a price compared with a seven-year lease — stamp duty at 2% on the rent instead of 1% — which may not be thought prohibitive.
Effecting the sale
With the intermediate lease in place, and notification of the new landlord having been given to satisfy sections 48 and 50 of the 1987 Act, the sale of the reversion is negotiated in the usual way. The reversion to the intermediate lease is sold for the agreed price, subject to the intermediate lease and the subleases (as they have now become) of the occupiers, and the shares in the intermediate lessor are sold for a nominal amount, given the lack of value in its sole asset, the lease. The shares could possibly be sold to a buyer chosen by the purchaser of the reversion, other than that purchaser, but it should be an associated company with that purchaser to facilitate a future surrender of the lease without being within Part I.
Some of the incidental points to be watched may be stated. The indemnity given by the mesne lessor should be backed by the indemnity of the purchaser of the reversion, who should also indemnify the vendor against any revival of its continuing liability on termination, by expiry or surrender, of the intermediate lease. This will be no more onerous than what should be sought on a “straight” sale.
Accumulated reserves collected from the residents must be handed over, particularly when Part V has come into force and they are held in trust under section 42. The change of address of the mesne lessor should be notified under section 48. The buyer of the shares will ask for usual indemnities (as it undoubtedly would under the transaction described in the earlier article).
Costs, liabilities, risks
Stamp duty
As explained, 2% stamp duty will be payable on the rent reserved by the eight-year lease. Stamp duty on the purchase price of the reversion will be payable by the purchaser in the usual way.
Land Registry fees
The eight-year lease is not registrable; it is an overriding interest, of course. The purchaser will pay the fee on registering the transfer to it.
Corporation tax on capital gain
It is suggested that the intra-group lease generates neither gain nor loss, irrespective of the impact of section 278, Income Tax Act 1970; at the least it will be a small item, and the vendor should readily offer an indemnity. The sale of the reversion to a purchaser outside the group will generate a capital gain calculable and taxable on the usual basis. This avoids the complications discussed by Mr Lightman on p 22 of his article, it is submitted.
If it is felt that the potential problems where the property passes through the new associate can be avoided, so that neither taxation nor a “protective” price reduction ensues, that would argue for “his” scheme rather than this, but the prospects of achieving either objective are not high.
The belt-and-braces approach advocated in this article — an exempt disposal to an associated company rendering the property owner no longer a landlord affected by Part I followed by a disposal of the “exempt reversion” and of the ownership of the intermediate lessor — does seem less susceptible to attack than what may seem initially the more straightforward use of the exemption suggested by the previous author. No obvious disadvantage arises compared with those of any other scheme venturing to test the limits of this new and untested Act.