Melissa Needham addresses the different treatment of rent arrears and service charges and how they are apportioned on a share sale, compared with an asset sale.
Whether the parties to a transaction choose to sell a property asset directly, or whether they choose to do so indirectly via the sale of the shares in a special purpose vehicle (SPV) which owns the relevant property, is generally tax driven.
The tax considerations are wider and more complex than simply mitigating stamp duty land tax, and tax advice needs to be taken on each individual sale.
The sale of a property-owning SPV will involve the transfer of the shares in the company. Ownership of the property will remain with the company throughout, as will all other assets and liabilities of the company.
There will be no transfer of ownership of the property. In contrast, on the direct sale of a property, there will be a transfer of ownership of the property from seller to buyer.
Whether there is a direct or indirect property sale, agreement between the buyer and the seller as to how to treat rent arrears and service charges is critical to all concerned and may go to pricing.
The share sale contract or the property sale contract will set out in some detail how the parties are to treat arrears of rent, service charges and other assets and liabilities.
Completion accounts or apportionments schedule?
On more complex property company sales, the contract may contain a completion accounts pricing mechanism.
This means that the final price payable for the shares is determined only following completion of the sale. The price is often fixed by reference to net asset value accounting policies and practices prescribed by the parties in the contract.
Typically on a company sale, the completion accounts will prescribe a fixed amount for the value of the property.
At completion, an estimate of the price (often being an estimate of the net asset value of the company) is paid to the seller and there is then a post-completion payment to adjust the price either upwards or downwards.
The upwards or downwards price adjustment is dependent on the final assets and liabilities of the company as at completion determined in accordance with the completion accounts.
It is important to be aware that contributions payable by the company as property owner/landlord (such as contributions to a marketing budget and making up for service charge shortfalls owing to caps or vacant units) are not necessarily best dealt with as part of the completion accounts mechanism.
Completion accounts are sometimes perceived as a cleaner way to deal with price adjustments than an apportionments schedule.
However, the negotiation of completion accounts provisions can get bogged down in accounting policies, which may cause unintended consequences when it comes to the final true-up. It is therefore important to seek expert accountancy advice on them.
In completion accounts, rental income will be apportioned between seller and buyer based on the date of completion.
This means that rent payable in respect of the period pre-completion will increase the net asset value of the company. This in turn increases the price payable by the buyer to the seller for the sale of the shares by an equal amount.
On a direct property sale, rental income is also apportioned, but it is apportioned between seller and buyer on completion, with usually the only post-completion exercise focusing on clarifying service charge liability (if any).
The advantage of a separate apportionments schedule on a direct property sale is that it therefore removes any question of an impact on purchase price, while still ensuring that the seller and buyer contribute and/or receive their respective liability and benefit for the period before and after completion.
More generally, it is important to note that, on both a direct property sale and on the sale of shares in a company, apportionments of rental income and service charges should be undertaken in respect of each individual tenant rather than on an aggregated basis.
An aggregated apportionment can produce a distorted result. In the case therefore of a multi-tenanted property, the relevant provisions may best be contained within a separate apportionments schedule.
Rent arrears
In the context of a sale, rent arrears are rents due and payable from a tenant to the landlord prior to completion of the sale.
Rent that relates to the pre-completion period is not in arrears unless it is overdue for payment. Rent and, separately, rent arrears are treated differently from one another on a share sale and a direct property sale.
Generally, on a share sale, arrears under the occupational leases are excluded from any completion accounts mechanism and dealt with under separate apportionment provisions of the contract.
Those separate provisions often aim to replicate the provisions applicable to the treatment of arrears on a direct property sale.
On a direct property sale, the seller’s preference may be for the buyer to buy the arrears outright at completion. Old and (post-1995) new leases deal with arrears differently.
If the occupational tenancy is a new lease, the acquisition of the rent arrears by the buyer would be achieved by the seller assigning the benefit of the arrears to the buyer.
Under an old lease, the benefit of the rent arrears will pass automatically to the buyer with the reversion.
On a share sale, the seller’s preference will also probably be to receive an amount equal to the full value of the arrears at completion. As the company owns the benefit of the arrears, this would be achieved by including the rent arrears as a good debt at full value in the completion accounts.
This would correspondingly increase the net asset value of the company and therefore the price payable at completion to the seller for the shares in the company.
Buyers may, however, be unwilling to take the risk of non-recovery of the rent arrears. On a direct property sale, this means that buyers want sellers to make an allowance to the buyer for the rent arrears (being a deduction from the purchase price) rather than buying the debt outright.
Contractual provisions are often added to the effect that following completion the buyer will use reasonable endeavours to recover the arrears and must then pay them to the seller following receipt, sometimes with a deduction for costs.
On a share sale, if the buyer is unwilling to take the risk of non-recovery of the rent arrears, the parties usually agree that the seller will get the benefit of the arrears, but only if and when the company has recovered them.
Typically, the buyer will procure that the company takes reasonable steps post-completion to recover these arrears. The buyer will then pay an equal amount to the seller (less costs) following receipt by the company of the arrears, in a similar way to a direct property sale.
This payment from buyer to seller will be treated as an increase in the price of the shares.
Service charges
On a share sale, service charges also tend to be removed from any completion accounts mechanism.
This is right and proper. The service charge is a fund run for the benefit of the tenants and positive balances are monies held for and on behalf of those tenants who have paid their contributions and/or are entitled to credits from previous service charge years.
On a direct property sale, service charges cannot finally be apportioned between buyer and seller unless and until the accounts for the service charge year in which the completion date occurs have been finalised.
The parties usually agree to complete on the basis of a best estimate prepared by the property managers. Once finalised, the parties can then simply apportion on the basis of when in the service charge year completion took place.
A completion on 31 March in a service charge year running from 1 January will mean that the seller will contribute, on a straight-line apportionment basis, 25% of any contributions payable.
However, there must be provision for all surplus service charge funds to be paid to the buyer.
Other matters
There are many more complexities which need to be addressed and dealt with appropriately in a corporate transaction – for example, continuing rent reviews and lease renewals at the time of completion, but which relate back to a period prior to completion.
The principles are the same as in a direct property sale so long as one remembers that in a corporate deal the landlord entity remains the same.
In conclusion, if the parties decide to sell the property company rather than the property itself, similar apportionment positions in respect of rent, rent arrears and service charges can be achieved. However, the sale is structured in a different manner.
Key points to consider
■ Similar apportionment results can be achieved on a share sale and property sale
■ Post-completion balancing payments on a share sale are treated as an increase or decrease in the purchase price of the shares
■ Parties should take legal and tax advice before determining how to structure their sale
Main image © Michael Weber/imageBROKER/Shutterstock
Melissa Needham is a senior associate in the corporate department at Fladgate
