Our response to the Revenue's stamp duty consultative document

Modernising stamp duty on land and buildings in the UK

We welcome the opportunity to respond to the consultative document "Modernising Stamp Duty on land and buildings in the UK" published in April 2002. We also expect to respond to subsequent rounds of the consultation. We note the objectives of the reform and would not argue with the suggestion that stamp duty is in need of modernisation but would like to make a point in connection with the stated objective of "fairness". The Government registers its concern with the increased extent to which stamp duty is being avoided and no doubt the Government is by now fully acquainted with the types of scheme that have been used to achieve this.

Following the publication of the consultative document we decided to conduct a survey inviting members of the property industry to give their views and opinions on selected issues. The aims of the survey were, broadly: (i) to gauge the extent to which stamp duty saving schemes have become a feature of the commercial real estate market; (ii) to obtain the property industry's perception of whether increases in the rates of stamp duty had adversely affected the market; and (iii) to obtain initial feed back on some of the ideas floated in the consultative document. (NB a copy of our survey findings was sent to the Revenue as well as notifying them of the article featured in Property Week on 9 August 2002).

Our own experience supports the Government's own conclusion that there is widespread use of stamp duty avoidance schemes and the responses to questions 3 and 4 of the survey also bear this out.

What the survey also shows is that the stamp duty "tolerance threshold" in the marketplace is around 2%. Our experience is that although the widely used schemes have been around for a number of years there was always a reluctance on the part of most taxpayers to use them until the top rate of duty became unacceptable (perhaps comparable to the increased use of income tax avoidance schemes when the marginal rates of income tax became unacceptably high in the 1960s). A top rate of 2% was not liked but was regarded as something that could be lived with. Further increases simply made it necessary for taxpayers to find a way of reducing acquisition costs. Of the typical 5.75% acquisition costs on a real estate purchase 4% now represents stamp duty. In the space of 3 years the top rate of duty has increased from 1% to 4%. A government cannot expect to raise a tax by 400% in 3 years and at the same time expect taxpayers to meekly accept it. But for the availability of these schemes and the buoyancy of the property market over the last few years the high rates of tax may have severely damaged the property industry and indeed the economy more generally.

It is incongruous to talk about the unfairness of some using avoidance schemes whilst increasing the rate of tax by an amount that can at best be described as unfair and more accurately as penal. Unless we see a reduction in the rates of stamp duty alongside the modernisation of the stamp duty regime then the Government should not be surprised by the development of alternative schemes to avoid or mitigate duty or, if this proves not to be possible, reduced liquidity in the UK commercial real estate market coupled with a shift away from investment in UK property into other assets including overseas real estate.

Introduction and Outline (Chapter 1)

Clearly, if stamp duty is to be transformed from a tax on documents into a tax on transactions then a major reform of the legislation will be necessary. We would therefore hope that the existing primary legislation will be repealed and replaced with a new self contained code that adopts the Tax Law Rewrite project's new approach to writing tax legislation. To do otherwise would be a missed opportunity and would be inconsistent with the creation of what is a new tax (in all but name). That said, to do so (and to allow proper time for consultation) may call into question whether the legislation could feasibly be included in the Finance Bill 2003. Nevertheless, as this exercise is being carried out in the name of modernisation and will replace some of the oldest tax legislation on the statute book the priority ought to be to put in place clear and comprehensive legislation; this is too important to be rushed through. If the Government believes that the Finance Bill 2004 is too far away then it ought to be prepared to set aside Parliamentary time for a separate Stamp Duties Bill.

Scope (Chapter 2)

We welcome the proposed removal of Goodwill from the scope of stamp duty in this year's Finance Bill following on from the previous removal of intellectual property from the scope of the charge. The proposed removal of debt and receivables from the scope of the charge will also help to simplify the tax. Abolition of the fixed duties will also assist simplification unless an obligation is imposed to notify the Revenue of those transactions that would have attracted fixed duty under current rules. We would therefore urge that the transactions that will need to be notified be kept to a minimum and consist only of those where the Revenue have a clear need to be informed.

Whilst simplification of the tax is not a stated aim we assume that it is one that the Government would like to pursue provided that there is no significant cost to the Revenue. The consultative document proposes that interests in land such as rights of way and fishing rights will be included Purely from the point of view of simplification there is merit in their exclusion. However, we regard this as a matter for the Government since ultimately it is a question of how much revenue would be at stake.

We do have concerns about some of the statements made in the consultative document relating to the scope of the charge given that the new stamp duty regime as set out in the consultative document does not explicitly state as one of its aims increasing Government revenue. Not only is the scope being enlarged by the redefining of what constitutes "consideration" but the requirement for there to be a "sale" (on transfers) is to be removed. Therefore it is proposed that stamp duty should apply to both transfers of property on an exchange. Paragraph 2.17 also suggests that a release of rights over land will fall within the scope of the new charge (though it does not currently do so because it is not regarded as a transfer since the right is extinguished) because, presumably, it will amount to "an arrangement affecting the value of land with another person in return for value". Paragraph 2.20 suggests that the wide definition of "money or money's worth" that is used in the Taxes legislation will be adopted but will be extended so as to include not only services but also "consideration that cannot usually be ascribed a monetary value". If it cannot be ascribed a monetary value how is a monetary value to be ascribed to it or will it be equated to the value of the property transferred for the consideration? If so, is it intended to bring gifts within the scope of the new regime?

We are concerned about the impact of these changes on development arrangements, particularly PFI/PPP schemes. Typically, in the context of a development land is exchanged for works or for consultancy services but duty is not payable because the works or services are not consideration for the purposes of stamp duty. In some development structures the valuation of works and services of this nature (as well as land pooling arrangements) will be highly complex. Is the Government's aim to increase the level of stamp duty payable in connection with Property development or is there a willingness to preserve the status quo? Quite apart from this a charge on the value of "money or money's worth" will increase considerably the costs of administration and compliance for the taxpayer and will make the case for a system of pre-transaction rulings much stronger since taxpayers will in this context at least want to have certainty as to the stamp duty cost. It must also inevitably result in a higher burden for the Revenue and there would be concern if the Revenue did not have the resources to deal with taxpayers properly and quickly.

In PFI transactions there has long been concern that the Revenue might argue that the payment of a unitary charge (or service charge) by a tenant to a private sector landlord who has built the relevant facility could be regarded as payment of the "price" by the tenant for the use of the land. Clearly, the incidence of stamp duty will not affect government departments that are entitled to an exemption but would significantly increase the costs for other entities. We find it difficult to comment further on the scope of the charge to stamp duty in relation to development and PFI/PPP projects without knowing what it is that the Government wishes to bring about. Since the consultative document does not list as one of its aims the raising of taxes we do not see why the concept of "money or moneys worth" is being introduced since it seems to us that this may well alter the status quo. If transactions are being structured with the purpose of ensuring that the consideration provided is in a form that does not trigger a charge to stamp duty (rather than because, commercially that is the form that is most natural) then surely the problem can be specifically addressed even if this means including a general anti-avoidance provision.

On the question of consideration we would urge that where VAT is chargeable on consideration that is brought into account for the purposes of stamp duty that the amount representing VAT is excluded from the amount or value that falls within the charge to stamp duty. It should be obvious that tax should not be levied on a tax.

You invite views on whether certain short-term leases should be excluded from the charge to stamp duty. There is some rationale for aligning the length of the term of a lease that is required to be stamped with that of one that is required to be registered at the Land Registry (once this applies to leases for 7 years or more). That said we doubt whether this would be acceptable to the Revenue. Commercial leases for 3 years or less are not especially common and it is not possible to circumvent a stamp duty charge through the creation of a perpetually renewable lease of 3 years so as never to become liable for duty (since this would operate to make the perpetually renewable leases a lease for a term of 3000 years). Nevertheless, it would be possible to grant a lease for 3 years with an option to renew for a further 3 years (but without the option to renew) thereby securing a total period of 6 years. You are also referred to the section headed "Rate Structures" below where we suggest that if the proposals for lease duty are adopted there is likely to be a drive towards shorter leases, at least on the part of tenants, since in many cases the charge on the grant of a new lease with a term of reasonable length will be prohibitive.

You ask whether there may be difficulties in retaining the charge on agreements for lease but not re-enacting the rules permitting the delay in presenting the agreement for stamping until the lease has been executed on the ground that a charge will only arise if and when there is a transfer of value. We see no particular difficulties with this proposal if duty is required to be paid whenever there is a transfer of value save that in order to preserve the substance of the current regime the new code should permit the recovery of stamp duty paid on transactions (together with compensatory interest) that are never completed. Currently this is achieved through the provisions permitting stamping to take place only after execution of the lease.

We have doubts about the need to introduce the proposed rules concerning "special purpose vehicles". The types of avoidance schemes that have been widely used have not involved the use of an SPV as that term is usually understood (i.e. an SPV holding property legally and beneficially) but instead have simply involved transferring the legal title to a property into one or more nominee companies, contracting to sell (usually, the beneficial interest in) the property and transferring the shares in the nominee companies in order to ensure that the purchaser secures complete control of the property. An SPV is not involved. With the introduction of measures to combat this type of scheme no doubt the Revenue have one eye on the next generation of schemes that might be developed. However, with the changes to section 42 Finance Act 1930 relief and section 76 Finance Act 1986 relief it is difficult to see how corporate SPVs may be used to "dress up" a transaction that would otherwise go ahead as a property sale as the sale of a company. For example, we refer to a report in the property press concerning the transfer of property to Trillium "via" an SPV that would not now be possible without payment of ad valorem duty given the changes to s42.

Of course, the Revenue's concern here may not have anything to do with the use of "artificial arrangements" and be more to do with preventing a behavioural shift towards buying and selling companies instead of property. If this is the case then in order to preserve the status quo there ought to be exemptions from the SPV charge. An exemption for listed companies is an obvious one but another deserving category would be "portfolio investors". To bring within the scope of the charge a company simply because it is a property company rather than because it has been used in order to effect a property transaction is extending the scope of this charge further than is necessary in order to combat avoidance (even if one adopts a liberal view of what constitutes avoidance). Clearly, how one defines a "portfolio investor" is something that will need to be considered further in order to address Revenue concerns that a company whose main purpose is to hold a high value property might qualify as a portfolio investor by satisfying an objective test by holding several low value inconsequential properties. It should be possible to legislate for this even if it were necessary to incorporate a general anti-avoidance test. If existing vehicles are to be subject to the charge, we would like to see transitional provisions giving relief from the charge for companies transferred pursuant to a contract entered into prior to the enactment of the legislation (or, at the very least prior to the date of the issue of the consultative document announcing the proposals for the charge). We are aware of a number of contracts that have been entered into for the grant of an option to acquire a company that may fall within this charge and which may not be exercised until after the introduction of the charge.

The Process (Chapter 3)

Views are sought on how to ensure that a transaction-based charge will in most cases crystallise on completion, as now, rather than when a deposit is paid. Clearly, the simplest way of achieving this is to provide that duty that becomes chargeable as a result of the payment of a deposit on entering into a "relevant contract" shall not become payable until "completion" provided that the deposit does not exceed a sum equal to [10%] of the price payable in respect of the relevant property. You express a concern that this type of formula could be manipulated to achieve a non-chargeable deposit equal to the market value of the property transferred. This suggests that your concern is that a seller contracts with a buyer to sell a property with a value of 100 for 1000 with the buyer paying a 10% deposit (which equates to the value of the property) and that the buyer takes a transfer (or, perhaps rests on contract) and that there is a mechanism in place that ensures that the seller is not able to sue for the remainder. This seems fanciful but if this is the concern it would be possible to incorporate provisions that make it clear that in calculating whether the deposit exceeds 10% of the price the price includes only transfers of value that will pass on or before completion.

A more complex issue that is raised is how to deal with instalments and contingent payments given that the new stamp duty regime that is proposed would seek to charge duty each time that there is a transfer of value. It seems to us that there is only a problem where it is not certain which stamp duty rate band applies at the time that the first transfer of value is made because the total value that will pass on a transaction cannot be determined at that time. Where the consideration is ascertainable, not contingent but deferred stamp duty may be applied to each instalment on the assumption that all instalments will be paid so that the appropriate rate of duty can be applied to the first and all subsequent instalments. If the consideration is contingent and/or unascertainable but is payable all at once then again there should be no problem since duty will only be payable once it becomes ascertained and due so that at the relevant time the appropriate rate of duty will be known.

Where the consideration is contingent and/or unascertainable and is payable in instalments then the new regime will need to incorporate a means of applying the appropriate rate of duty to the transfer of value. Where the first instalment brings it within the top rate of duty (currently for transfers in excess of £500,000) then again there should not be a problem. We would suggest that given the introduction of a CTSA style compliance regime it may also be appropriate to adopt a regime for these types of payments that is similar to the quarterly payments regime for corporation tax that applies to "large companies". Very broadly, large companies are required to pay their corporation tax liability for a particular accounting period in instalments and the first 2 instalments are required to be paid at a time when it is not known what the profits of the company for that period will be and therefore it cannot be known what the corporation tax liability will be for the year and therefore neither can it be known how much the instalment is that is required to be paid. Instead the company must pay an amount that represents a bona fide estimate of the instalment that is payable which requires the company to estimate what its taxable profits for the year will be. Where there has been an underpayment of tax interest is payable to the Revenue and where an instalment proves to be an overpayment the Revenue makes a payment of interest to the company; interest payments are simply designed to compensate the relevant party for being out of the money.

There is also a separate penalty regime that operates where a company has not made a bona fide estimate. We would suggest that a similar regime could be adopted here. The onus would be on the taxpayer at the time the first transfer of value is made to estimate the amount of subsequent transfers of value that are likely to be made and pay duty at the appropriate rate. In most cases the task for the taxpayer will be considerably easier than the task that faces large companies under the instalment regime because it should only be necessary for a taxpayer to estimate which stamp duty rate band he will fall into rather than to estimate the total transfers of value that will be made; duty will only become payable as and when the transfer of value takes place. We would also suggest that provisions are included along the lines of the "transitional rules" that usually apply to transfers stamped pursuant to a contract executed prior to a change in the rate of duty and where the transfer would otherwise attract the new rate of duty, it having been executed after the rate change. This would ensure that transfers of value made after a change in the rate but in relation to a transaction completed before the rate change will attract duty by reference to the date of the transaction. This would reflect the general principle that changes in law should not have retrospective effect. We anticipate however that such a regime may represent a step-change for in house tax advisers and accountants who may have formerly left stamp duty issues to their colleagues involved in the transactions and their lawyers. We envisage the need for the Revenue to devote significant resources to educating and informing the taxpayer fully about the proposed scheme at or about the time the new regime is introduced.

Grant of New Leases (Chapter 4)

We believe that of all the proposals set out in the consultation document this is one of the most contentious and potentially one of the most damaging, not only to the property industry but also to the economy as a whole. The consultation document advances two possible alternative methods for the reform of stamp duty on the grant of a new lease one of the stated aims of both being to equate a stamp duty charge on the grant of a new lease with the stamp duty charge on the transfer of an existing freehold or leasehold interest for a capital sum.

One approach (not favoured by the Government) is to levy duty at the existing rates for the transfer of an interest in land on the "value" of the leasehold interest and the other (favoured by the Government) is the application of a standard formula.

Leaving aside for the moment the issue of whether the adoption of either approach has merit from the point of view of logic, fairness or otherwise the adoption of the formulaic approach (whilst attractive from the point of view of administrative convenience) will very substantially increase the stamp duty payable by an incoming tenant on the grant of a new lease and which would inevitably lead to behavioural changes in the market place.

Example

Mr and Mrs Startup have been planning for some time to open a restaurant in the area in which they live and on the basis of a carefully drawn up business plan have secured funding from a local bank. They have negotiated a ten year lease with the landlord at a rent of £60,000 (inc. VAT) per annum; their business plan takes into account the fact duty of £1,200 will be payable. Before the lease is granted the proposed standard formula for stamping new leases is enacted and Mr and Mrs Startup now find that the stamp duty charge is calculated as follows:

10 x £60,000 = £600,000 ; 4% x 600,000 = £24,000. If we assume that a discount rate of 3% is included to arrive at a net present value figure then the duty will be reduced to £17,856.

This still represents a 1,388% increase in the duty payable. Mr and Mrs Startup abort the venture.

This, of course, is but a simple example. The economy generally is likely to be affected in many ways that may not necessarily be foreseeable. What is clear is that duty cannot be raised to this extent without there being consequences. We have already referred to the fact that the widespread use of avoidance techniques was a direct consequence of an unprecedented 400% rise in the top rate of duty on transfers. If a new increased lease duty cannot be avoided then it will instead mean that commercial decisions will be changed to mitigate the tax cost; the "tax tail" wagging the "commercial dog". Tenants will be calling for shorter leases although this may not be in their interests. For example, Mr and Mrs Startup may be uneasy about taking a two-year lease (with the hope of renewing) knowing that they may lose the goodwill built up in operating the restaurant in that location and being unable to amortise the cost of expensive kitchen equipment over the term of the lease (which a tenant would normally need to do) if after two years they find themselves having to look for alternative premises. On the other hand, landlords may not regard the ownership of premises as an attractive investment where it becomes necessary to grant shorter leases.

But is it right, in the interests of fairness, modernisation and countering avoidance that an attempt should be made to equate leases with freeholds? We do not pretend that the existing lease duty regime is perfect but we would favour the existing regime rather than the proposals put forward to replace it. We believe that it is wrong to attempt to equate a leasehold interest without any capital value with that of a freehold (or leasehold) that has intrinsic value; they are different animals.

Rack rent leases without any intrinsic capital value are typically granted to tenants that intend to occupy them for operational purposes, for example, shops, offices, warehouses (retail or storage and distribution) and light industrial units. For such tenants taking a lease represents a burden in the form of an obligation to make quarterly payments throughout the term regardless of how the business performs and can only be regarded as an asset in a purely ethereal sense in that it facilitates the conduct of a tenant's business and therefore supports the value of any goodwill that might be built up. Such tenants will sometimes derive an income by sub-letting, but this is usually to accommodate operational requirements and not because the lease is being treated as an investment. Sub-letting of part may occur at the outset, essentially on a temporary basis in order to accommodate future expansion, or it may subsequently be necessary to sublet to offset a reduction in the tenant's requirements; assignment of part invariably being prohibited because of the technical difficulties involved in apportioning liability. With sub-letting of this nature the tenant will generally be content if he is able to recover a due proportion of the rent and any other costs attributable to the sub-let part from the sub-tenant; making a profit is not the object and is unlikely. Imposing stamp duty in a way that equates such leases with freeholds (or leases with intrinsic capital value) can only serve to increase production costs and reduce operational profits for such businesses as well as acting as a disincentive to the start up of new businesses. This surely runs in the face of other measures that have been introduced by the current government with the expressed aim of promoting enterprise.

An alternative scenario is that tenants will put pressure on landlords to reduce rents to reduce the impact of the increases in stamp duty. If rents fall, the value of the landlord's reversionary interest as an investment will also fall putting further downward pressure on the property investment market. If rents do not fall, tenants will try to pass the additional costs on to their customers by raising prices for their goods and services, which may have an inflationary effect. If the cost cannot be passed on then for some businesses this may contribute to their ultimate failure.

The proposed changes attempt to place a value on the occupation of property disregarding the attendant liability to make annual payments of rent or other onerous obligations or threats to security on the part of tenants. The formula approach does however use the rent payable under the lease to arrive at the value of occupation over the term of the lease. But if one disregards the asset itself (the lease) and focuses on the value of occupation of the property (a lease granted at a market value rent has no intrinsic value e.g. the tenant cannot assign it for a capital sum ) should not the freehold interest be taken into account? Stamp duty is payable on the acquisition of a freehold, the value of which may be more if it is fully let on leases attracting a market rent than an unencumbered freehold where the purchaser is required to find tenants. If the freehold is acquired and it is fully let on leases where the passing rents are below market value this will depress the price obtainable on the freehold (and therefore the stamp duty payable).

It cannot be right that stamp duty should be payable on each disposition of a freehold subject to full market rent leases as well as on the value of occupation of the premises (disregarding the attendant liability to pay rents - which increase the value of the freehold).

To apportion fairly the stamp duty payable in relation to a particular property (both on freeholds and leaseholds) would be too complex to operate in practice. Instead, we believe that the current regime should be largely preserved and that if the proposals contained in the consultation document are implemented it would only be seen as a revenue raising measure and labelled as a "stealth tax". It is difficult to see how it could be justified on the grounds of countering avoidance; the replacement of the existing regime with the proposed formula would not affect any schemes involving leases that might be used.

If these proposals are adopted another unfortunate consequence will be the stamp duty necessity of keeping leases alive even where it would make commercial sense to surrender and take a new lease. Because a lease would have value purely by virtue of the fact that duty had been paid for the relevant period of occupation landlord and tenant dealings would become more restrictive.

You will see from the copy of the survey that we have enclosed (and which we referred to earlier) there was very little support for the adoption of a valuation approach. It should also be pointed out that neither was there a majority in favour of adopting a standard formula and that from the comments that we received as part of the survey and at our workshop it was clear that those that favoured a standard formula did so purely on the basis of administrative convenience. From the comments that we received there seems to be little support for a change from the existing regime as well as there being widespread concern about the effect that this may have on the economy generally if the new formula means that tenants will be required to meet substantial increases in stamp duty.

In conclusion whilst we accept that there is a need for the existing stamp duty regime to be modernised we would caution against using the exercise as a means of substantially broadening the scope of the tax in order to raise revenue. Of particular concern are the proposals (and comments made in the consultative document) to extend the scope of the charge through the introduction of the concept of "money or moneys worth". We would like to have clarification from the Revenue on what is intended and we would not like to see property development in its various guises subjected to additional tax in the pursuit of countering avoidance. Also of major importance are the proposals concerning the grant of new leases and we would strongly urge a reconsideration of these proposals and an acceptance that it is not correct to equate the grant of a rack rent lease with that of a freehold (or lease) with real value.

Whilst the Government will no doubt wish the new regime to be introduced by the Finance Act 2003 we would caution against putting in place a revolutionary new regime without full consideration and consultation. In the direct taxes field we have had recent examples of good and bad consultation exercises. The capital gains substantial shareholdings legislation is the result of several rounds of consultation over a reasonable time frame that allowed all concerned time to highlight inconsistencies or unintended consequences and which has resulted in sound legislation. This might be contrasted with the changes made to the legislation dealing with foreign tax credits where the consultation on difficult legislation was both poor and hurried and which required subsequent amending legislation and which left those who took part in the consultation process not a little disillusioned with it all.

CMS Cameron McKenna
19 July 2002

For further information, please contact:

Richard Croker
Corporate tax partner
Phone: + 44 (0)20 7367 2149
Email: [email protected]

Michael Boutell
Professional support lawyer
Phone: + 44 (0)20 7367 2218
Email: [email protected]