Laura Oliver and Christopher Hyde assess the SDLT and VAT consequences of rent top-ups and sellers’ rental guarantees
A well-advised seller may market a property on the basis that it will top up any rent-free periods that its tenants are enjoying, or provide a rental guarantee to make up the rental shortfall for any empty units or for any units where the rent falls below an agreed, acceptable level.
In these circumstances, the property will probably be valued on the basis that it is fully income-producing. From an investor’s point of view this may be the logical analysis for assessing the property’s investment potential. It can therefore come as a surprise that, by contrast, for tax purposes rent top-ups and rental guarantees given by sellers are treated as reductions to the purchase price rather than income.
The character analysis
To understand why this is the case, it is necessary to consider the fundamental characteristics of rent top-ups and rental guarantees. Crucially, they are not payments made for the use of land (unlike payments from a tenant to a landlord) so it is conceptually impossible to describe them as payments of rent or licence fees as a matter of general law.
Contractually, a rent top-up commonly takes the form of a one-off allowance to the buyer which is applied on completion. The amount of the allowance is the rent shortfall calculated from the completion date until the date that the full rent is payable. It will therefore vary according to when completion occurs, in the same way that rent apportionments vary. However, the underlying mechanism results in a reduction to the purchase price.
A rental guarantee is slightly different in that it will usually not be fixed at completion because it requires the seller to make payments to the buyer for the duration of the agreed guarantee period following completion, or until the property is producing the required level of rental income. While it will also result in a discount to the purchase price (in the form of rebates given by the seller), it will remain an uncertain amount until the end of this period.
In both cases the overall effect is that an adjustment is made to the purchase price.
The tax position
The following questions arise in relation to top-ups and rental guarantees:
- Is stamp duty land tax (“SDLT”) paid on the headline purchase price or the reduced price after allowing for top-ups and rental guarantees?
- Where value added tax (“VAT”) is chargeable on a sale (for example, because the property is vacant and therefore not a transfer of a business as a going concern) is VAT charged on the headline purchase price or should top-ups and rental guarantees be taken into account? If so, how?
SDLT
It seems clear that SDLT is charged on the reduced price, after taking into account top-ups and rental guarantees. This is consistent with the way in which SDLT is charged on the consideration actually given for a land transaction. Guidance suggests that HM Revenue and Customs (“HMRC”) will look at the reality of the amount paid even where doing so involves a reduction in the SDLT payable. For example, when calculating the amount of SDLT payable in respect of rent, HMRC’s guidance directs rent-free periods to be taken into account regardless of whether documented in the lease or elsewhere. Statements in the sale documents as to how these payments are to be treated should not alter the underlying analysis. A second SDLT return for rental guarantees should be submitted at the end of the guarantee period either to recover overpaid SDLT or to pay any additional SDLT.
VAT
The better view is that the same treatment applies for VAT: top-ups and rental guarantees should be recognised as one-off discounts and ongoing rebates respectively and taken into account as such when determining the amount of VAT chargeable. Under normal circumstances this should apply irrespective of how they are treated in the sale documentation.
This view is not without controversy. HMRC historically insisted (in guidance that was apparently withdrawn more than 13 years ago) that rental guarantees would only be treated as adjustments to the purchase price for VAT if expressed as such in the sale documentation. Otherwise they would be ignored for VAT purposes. This view is still widely referred to in tax commentary (understandably, being the most recent view expressed publicly by HMRC on the issue) but it is inconsistent with statements made in HMRC’s current guidance relating to discounts and price rebates generally.
One explanation for HMRC’s apparent change in policy is the fact that the historic guidance appears to be based on obiter comments made in case law (see Iliffe and Holloway v Customs and Excise Comrs [1993] VATTR 439, LON/92/2859; [1994] 2 CMLR 450) that no longer represent good law in many respects following the paradigm shift created by the ECJ’s judgment in Customs and Excise Commissioners v Mirror Group plc (C-409/98); [2001] All ER (D) 102 (Oct).
The most obvious difficulty with treating a top-up or rental guarantee as anything other than an adjustment to the purchase price is working out what else it could represent for VAT purposes. The situation might be different if there were mutual supplies being made between buyer and seller, but on conventional transactions there will be no supply other than the sale of the land. In absence of any other supplies, it is difficult to see what else the top-ups or rental guarantees can represent other than a component of the net purchase price.
A counter-argument might be that rent apportionments are subject to different treatment. These, however, are arguably the exceptions that prove the rule. HMRC’s policy that apportionments should effectively be disregarded for VAT purposes has remained clear since 1991, and continues to be expressed in current versions of guidance. Any attempts to apply a different approach for SDLT, thereby reducing the SDLT payable, would run against the near-universal approach of practitioners. Claiming that top-ups and rental guarantees should be treated as rent apportionments would be unsustainable in the absence of equivalent HMRC guidance.
Other options?
It would only be possible for the headline purchase price to be unaffected by top-ups and rental guarantees for tax purposes if a lease or licence were granted back to the seller. For example, the buyer may grant an overriding lease of the property for the guaranteed period, reserving the guaranteed level of rent.
This is unlikely to suit either the buyer or the seller in practice. The rents paid would be taxable supplies for VAT purposes (assuming the buyer had opted to tax), independent of the sale of the property. The SDLT treatment would be determined by the exchange rules, and would therefore need to be considered on a case-by-case basis. SDLT could in principle arise for the seller in addition to that payable by the buyer. The direct tax implications for each party would also need to be considered. It would also cause difficulties in relation to property matters, for example repairing obligations and service charge.
The sale contract
The tax analysis should remain unaffected whether or not the underlying sale contract acknowledges that the top-ups and rental guarantees take effect as a reduction in the purchase price. Sellers are often keen to see the headline purchase price reflected in the contract, but best practice is to include a statement in the drafting that it is “subject to adjustment” to account for the top-ups and rental guarantees. This will ensure the tax treatment that the seller purports to apply is consistent with the VAT treatment expected by the buyer and the basis on which the buyer applies SDLT.
The bottom line
If the application of top-ups and rental guarantees as a reduction in the purchase price were applied in a wider sense (and not just in relation to VAT and SDLT) this could have quite a significant impact on the apparent value. For this reason, both sellers and buyers may well want to apply a different analysis for investment purposes, which is an analysis often supported by accounting practices.
For the time being, therefore, it could suit all parties to use values in the marketing brochure as stated, but on an informed basis, identifying elements of the value that reflect top-ups or rental guarantees. If the approach adopted for VAT and SDLT proved to be a precursor to a more widespread shift, the impact could instead be felt on the bottom line.
Laura Oliver is a senior associate and Christopher Hyde is an associate at Hogan Lovells International LLP
