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SDLT traps for commercial leases

Insight

Commercial office block

The SDLT can often be disproportionately complex, and landlords and tenants can easily find themselves facing unexpected tax consequences on what may appear to be relatively straightforward deals. This article summarises some simple but easily missed SDLT issues for parties to commercial leases.

SDLT on rent

When dealing with commercial leases, SDLT is typically charged on rent, a premium or both.

When negotiating the terms of a lease, parties should bear in mind that the SDLT calculation on rent is based on the agreed rent in the first five years of the term. If the parties agree to a break clause prior to the five-year mark no relief is given for the “additional” years of SDLT that have been paid if the break clause is exercised. A tenant might therefore prefer to agree a lease for a shorter term with a right to renew, which offers a similar commercial outcome. However, this can give tenants an SDLT benefit if the lease is renewed to its full term because tenants should then not have to pay SDLT for any years that the tenant is not in occupation if the lease is not renewed.

Parties should also remember that where rent is contingent, uncertain or variable in the first five years of a lease (such as rents linked to turnover) SDLT will still need to be paid notwithstanding that the final rental sum due might not be clear at completion. Instead, a reasonable estimate must be made of the rent for the purposes of paying SDLT and once the rent becomes certain the SDLT must be recalculated with a further return submitted. Parties should particularly bear this in mind when agreeing to variable rents or to the date for a rent review, as changes in the first five years can result in compliance complications for the tenant.

What is rent?

The question often arises as to what qualifies as “rent” for the purposes of the SDLT calculation, particularly in leases which might reserve service charge or other sums as “rent”.

The short answer is that SDLT is only paid on the consideration given for the acquisition of the property interest itself. In most cases service charges are not payments for the property but for a bundle of services and as such should not be treated as “rent” for the purposes of SDLT. The question to ask in each case is what the payment is for, as a matter of fact and pursuant to the terms of the lease (and any other relevant agreements).

Whatever the position, this should be accurately reflected in the drafting of the lease itself as failure to do so can result in items being taxed as rent that might not otherwise be. In particular, if a lease does not provide for an apportionment between rent and service charge or the service charge is not otherwise separately provided for in the terms of the lease such sums may be taxed as rent for the property, and therefore within the scope of SDLT.

What is the consideration?

Although commercial leases are typically granted in return for the payment of cash characterised as either a rent or a premium, it is not uncommon for parties to agree that a transaction will involve the giving of non-cash consideration. For SDLT purposes anything that is given in “money’s worth” will usually form part of the consideration and SDLT will need to be paid on the value of it as if it were a premium for the acquisition of the lease.

This is often missed where there is an agreement to carry out works by either landlord or tenant, or a payment made towards such works. Whether or not these will be liable to SDLT is complex, but the parties should consider as a starting point whether, as a matter of fact and under the terms of any agreements, the works form part of the consideration given for the acquisition of the lease.

Similarly, exchanges of freehold and leasehold interests give rise to a tax charge for both parties on the higher of the market value of the property acquired and the consideration given for that acquisition. In the context of commercial leases this is typically relevant where there is a surrender and regrant of a lease. While surrender and regrant relief does disapply these rules, the conditions for relief are stringent and the parties should take care to ensure that they are met in order to avoid incurring a market value charge.

Linked leases

The linked transactions rules provide that if there is a single deal between connected sellers or buyers, SDLT is calculated on the total rent and premium/purchase price for all the linked transactions. The effect of this is that each lease will not benefit from their own nil-rate band and as such there will normally be more SDLT to pay overall.

In a commercial context this can be relevant to successive grants of leases over the same premises, as well as grants of separate premises that form part of the same overarching bargain (among other transactions). The question of whether or not leases are linked is often a question of fact but where the transaction involves successive linked leases, parties should in particular be aware that the mere fact that parties may enter into multiple leases over the same premises will not always mean that those transactions are linked. In determining the position, consideration should be given to any rights to renewal, the terms of any negotiation and whether leases expired naturally.

Early occupation

Substantial performance takes place where a purchaser of property pays substantially the whole of the purchase price or takes possession of the whole or substantially the whole of the property. The significance of substantial performance is that it is the trigger for the filing of SDLT returns and payment of the SDLT.

In most transactions this is triggered by completion but where commercial leases are in play, the position can be affected by tenants looking to complete fit out works between exchange and completion, as this can trigger early substantial performance.

In practice, provided the parties are aware of this, the effect is only that SDLT needs to be paid earlier than expected and a return may need to be filed when the lease is then completed. If the issue is missed however the tenant may be liable for late filing penalties as well as interest on late payments. Where a party is considering taking early occupation, carrying out works prior to completion, or making early payments, they should take advice on whether this will trigger substantial performance.

This publication is a general summary of the law. It should not replace legal advice tailored to your specific circumstances.

© Farrer & Co LLP, January 2025

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About the authors

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Katjana Cleasby

Associate

Katjana is a corporate tax specialist, advising business and individuals on both direct and indirect tax matters. Against an increasingly complex tax landscape she provides considered advice to domestic and international clients who welcome her friendly and pragmatic approach.

Katjana is a corporate tax specialist, advising business and individuals on both direct and indirect tax matters. Against an increasingly complex tax landscape she provides considered advice to domestic and international clients who welcome her friendly and pragmatic approach.

Email Katjana +44 (0)20 3375 7652
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