Landowners pooling their holdings for development can result in a double charge to capital gains tax. Gavin Le Chat explains other options available for maximising shared proceeds
A group of landowners wishing to realise the maximum development value of their land will often enter into collaboration agreements with one another, with a view to dividing the proceeds of sale between them in proportion to their holdings. This will often be accompanied by a promotion agreement, by which the landowners commission a planning promoter or developer to obtain planning permission and to market and sell the development site.
The principle of dividing up the proceeds of sale so that each landowner receives a fair and reasonable proportion of the value of the whole area being developed is known as “equalisation”. There are various mechanisms that can be used to achieve it, and the landowners will need to consider carefully which mechanism is right for them. One of the principal concerns is tax. As discussed by Alex Barnes in his article “Should you collaborate to accumulate?” (EG, 14 November 2015, p103), there can be unfortunate tax implications for landowners who enter into collaboration agreements without a full understanding of the implications. In particular, care has to be taken to avoid a double charge to capital gains tax (CGT).
Achieving equalisation
First of all, the proportion of the sale proceeds due to each landowner has to be calculated. This is relatively easy where the development area comprises bare ground. The proportion will usually be calculated by dividing the area comprised within each individual landowner’s ownership by the total area being developed. It becomes more difficult where the area to be developed includes buildings as well. In such a case, the value of each landowner’s property will need to be agreed prior to planning consent being granted and each landowner’s proportion will be calculated as a percentage of the aggregate of the value of all the landowners’ properties.
There are a variety of ways in which equalisation can be achieved, but whether they will be available in the case of particular developments will of course depend on the facts. The most straightforward solution is for the parties to ensure (through the development masterplan) that land uses are evenly distributed across the development area, so that each landowner obtains sale proceeds for its land that are proportional to the amount of land that has been contributed to the development. However, this is not always easy to achieve where (for example) infrastructure, public open space or playing fields have to be concentrated on particular areas of the land.
An alternative solution – which sounds straightforward, but can create the most difficulties in terms of tax – is for the parties simply to share all net proceeds for all sales of their different landholdings. This, however, is where the double CGT charge can arise. Every time there is a sale, each landowner becomes entitled to a share of the net sale proceeds, regardless of whether or not its land is included within the sale of that phase. The owner of the phase being sold will be liable to pay CGT on the whole of the proceeds of sale, regardless of the fact that a proportion of these proceeds are shared with the other landowners. The double taxation occurs because those landowners will be liable to pay CGT on the share of the sale proceeds that they receive, and there will be no initial acquisition cost of the land to be deducted, as it is not their land that has been sold.
One possible way of avoiding double taxation may be for the landowners to create a trust and to pool their respective landholdings into that trust. The transfer of land into the trust would not amount to a disposal for CGT purposes. However, this can be a costly exercise, particularly as it would be usual to involve tax counsel, and some landowners may not be keen on the idea.
Balancing payments and land transfers
An alternative to sharing sale proceeds may lie in balancing payments or land transfers. If, following the grant of planning consent, a landowner would not receive a sum that represents its agreed due proportion of the development value of the entire development area, then it may be agreed that the landowner should be compensated by a balancing payment or a land transfer. This could occur where one landowner’s land is being used predominantly for infrastructure, or accommodates more than the agreed due proportion of affordable housing. Essentially, compensation would be payable where the extent of the net developable land located on an owner’s property would be less than its agreed due proportion.
Balancing payments and land transfers are not a simple solution. Determining the amount of any balancing payment may require valuations to be carried out and agreeing how different land uses (such as affordable housing) are to be valued. Alternatively, if land is to be transferred, the extent and location of that land will need to be determined.
Where such arrangements are put in place, the landowners need security for their co-owners’ obligations. Again, such arrangements are complex as the manner in which the land is to be sold may not be known when the security is first put in place. This security may comprise cross-easements, cross-covenants and cross-options by one landowner in favour of others. The deed containing such arrangements will need to provide for their release upon a sale of the burdened land, once the secured obligations have been performed.
Achieving equalisation and avoiding adverse tax consequences is not a straightforward matter for landowners wishing to collaborate. Expert legal and tax advice should be obtained at an early stage.
Gavin Le Chat is a partner in the real estate group at Shoosmiths LLP and author of Property Development: A Practical Guide (2nd edition) published by the Law Society
