SDLT & VAT on Surrenders and Regrants
Insight
There are a number of situations in which a landlord and tenant might want to surrender and regrant a lease, ranging from arms-length negotiations in a commercial or agricultural context to the grant of a longer residential lease to a leasehold tenant. Despite such transactions being commonplace, their tax implications can be surprisingly complex. This article provides a short summary of some SDLT and VAT issues that landlord and tenants should be aware of before entering into a surrender and regrant.
Stamp Duty Land Tax (SDLT)
The surrender and regrant of a lease takes place either as an express agreement between the parties or may be deemed to occur automatically by operation of law in other cases (including on a lease extension).
This surrender and regrant, whether express or implied, is treated as an exchange of interests in land for SDLT purposes. The consequence of this is that a purchase price equal to the higher of the consideration given or the market value of the interest acquired is deemed for SDLT purposes, with tax potentially payable on that sum. In practice the market value rule can be disapplied by surrender and regrant relief so that SDLT is often only payable on any other chargeable consideration given. Relief only applies where the new lease is granted in consideration for the surrender of the older lease and the transaction takes place in relation to substantially the same premises and between the same parties. In practice these requirements can lead to a few issues:
- Different parties – It is not unusual for the parties to agree that the new lease will be granted to a related party, whether that is to a subsidiary of a holding company or to a family member. Such arrangements don’t meet the conditions for surrender and regrant relief which can result in market value SDLT charges for both landlords and tenants.
- Discounts – Landlords may not make surrender payments in cash but offer a discount from market value on the grant of a new lease. If surrender and regrant relief does not apply, the fact that the landlord is applying a discount to the premium will not reduce the tenant’s SDLT liability as they will still be liable to tax on the market value of that lease.
- Connected Companies – Where the landlord and tenant are connected companies, a different market value charge applies (regardless of surrender and regrant relief). Subject to the application of group relief, companies where the landlord and tenant are connected might therefore prefer to enter into a reversionary lease, which can be more efficient for SDLT.
- Rent – Where rent is demanded under the terms of a new lease, SDLT will still be payable on the rental consideration. If a tenant is surrendering a lease on which SDLT was already charged on rent they may need to consider whether overlap relief is available. Overlap relief is designed to ensure that SDLT is not paid twice in relation to the same rent but is only available if the rent paid is in respect of the same or substantially the same premises. It can be complex to assess the position in practice.
- Consideration – SDLT’s definition of taxable consideration is broad which means that many forms of payment can be considered consideration for the acquisition of land, and subject to SDLT. If the agreement between the parties contains elements that the parties consider are not payments for the property itself, potentially including compensation, these should be separately detailed in any agreements and the parties should seek advice on their tax treatment.
Value Added Tax (VAT)
If the surrender and regrant is an agreement between the parties (as opposed to being deemed to take place by operation of law) it may be treated as a “barter” for VAT purposes. A barter arises where there are transactions for non-monetary consideration, which can include the grant of a lease by the landlord in return for the surrender of a lease from a tenant and vice versa. VAT will therefore need to be assessed based on the subjective monetary value that each party would have paid, had it not received the relevant lease.
In practice where both parties have not opted their underlying property to tax or the properties in question are residential, each supply is exempt with no practical implications for either party on the transaction itself. In the commercial and rural context, landlords may have opted a property to tax but tenants might not. In those cases, the landlord may need to charge VAT on the new lease but the tenant will not need to charge VAT to the landlord for their surrender, creating a VAT mismatch for the parties. If, however, a tenant has also opted to tax their property and the barter rules apply, then both parties would need to charge VAT on their supply to the other. Although each party would need to consider what value should be attributed to the supply and therefore the VAT to be charged, in an arms-length bargain where both parties can recover VAT in full it is likely that the value to each party and the VAT charged to the other will be the same and any resulting VAT will therefore be an administrative issue rather than an added cost overall.
The position is slightly different where a surrender is deemed to take place by operation of law. HMRC generally regard this as any other variation of a lease and do not consider that there are two supplies of property in the way described above. If any cash payments are made by either party, the VAT treatment depends on whether the parties have opted to tax their land. If there is the provision of non-monetary consideration by the tenant then the parties will need to consider whether the tenant is supplying something of value to the landlord over and above meeting their obligations under a lease, such as agreeing to undertake construction works. If so, the tenant may need to invoice the landlord on the value of those works.
Conclusion
The SDLT and VAT treatment of surrenders can be complex. An early understanding of the tax and valuation position and careful consideration of the terms of the deal is crucial to a transaction’s success.
This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.
© Farrer & Co LLP, October 2024