MANAGING LEASES IN THE FACE OF COVID-19
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The Coronavirus Bill 2020 provides for a moratorium on lease forfeiture (termination); landlords will effectively be prevented from forfeiting leases for non-payment of rents until 30 June 2020 (or longer if the government deems it necessary). However, they may still issue petitions for the winding up of tenant companies if rents remain unpaid for long periods. In addition, the moratorium is only temporary and any unpaid rents will remain due once the moratorium is lifted.
In this context, it is likely that leases will be re-negotiated and possibly restructured. We expect re-negotiations to focus on rent-free periods, rent reductions and/or lease extensions (to further stagger rental payments), but in some cases, tenants will walk-out and either surrender or assign their lease.
1. Rent Reductions
A rent reduction will only trigger a tax liability if a payment is made by one of the parties to the lease.
Some landlords may agree rent reductions for no consideration, for example on properties let at above current market rates or where the landlord lets a number of properties to the same tenant and hopes to prevent the tenant’s insolvency by reducing the rent.
Two main taxes are in point on a rent reduction; SDLT and VAT.
If the tenant does not make a payment for the rent reduction, advisers still need to consider whether any conditions attached to the deleverage are consideration provided by the tenant or indeed, whether anti-avoidance provisions may deem consideration to have been paid (in particular FA 2003 ss 53 and 75A).
If the tenant does make a payment for the rent reduction, there may be a chargeable transaction for SDLT purposes (FA 2003 Sch 17A para 15A) and the tenant may be liable for SDLT.
The VAT consequences of a rent reduction depend on whether the reduction is effected as an informal gesture on the part of the landlord or whether it is effected formally through a variation of the lease.
If the landlord simply agrees that the rent does not need to be paid or can be reduced without a formal variation, due to the fact that a lease is treated as a continual supply for VAT purposes, the landlord will still have to account for VAT on the rent which was due (although if the rent chargeable is not received within six months they ought to be able to make a claim under the bad debt provisions.
Where a reduction is agreed, and recorded in a deed of variation to the lease then the landlord will not have to account for VAT unless the tenant has provided some form of consideration for that variation (whether by cash or provision of some other service).
If the tenant does provide cash consideration, a charge to VAT should only be triggered on the payment if the landlord has opted to tax his interest.
2. Payment of total rent over a longer term
This is usually achieved by reducing the amount of actual rent payable, but extending the term of the lease.
An extension of the term of an English or Welsh lease takes effect by operation of law as a surrender and regrant (Friends Provident Life Office v British Railways Board  1 All ER 336).
As the extension of the lease will be treated as a surrender and re-grant this can give rise to SDLT and VAT charges.
A surrender and regrant between the same parties involving substantially the same land is not treated as an exchange for SDLT purposes and therefore SDLT only becomes chargeable if the net present value of the new lease is higher than the old. However, in most cases overlap relief will be available to reduce the amount of SDLT payable (if any).
Similarly, HMRC issued a practice statement by agreement with the Law Society for cases where there is a deemed surrender and regrant of a lease by way of variation. Similarly to SDLT (although a little more generous in its terms) HMRC ignore a deemed surrender and regrant and consider that VAT is only chargeable if consideration is given for the variation. Note actual surrender and regrants are treated differently and can give rise to VAT charges.
3. Surrender of the lease
On surrender of a lease, a liability to tax will only be triggered if either the tenant or the landlord (which is unlikely) makes a payment in relation to the surrender. If a payment is made, three taxes are likely to be in point; SDLT, VAT and CGT.
A lease surrender, i.e. the early termination of a lease by the tenant, is not a transaction subject to SDLT, even if the tenant pays a reverse premium (FA 2003 Sch 17A para 18(2)(c).
It should however be noted that the surrender will not entitle the tenant to a refund of any SDLT paid in relation to the rents. It may therefore be preferable for the tenant to assign the lease (if this is allowed under its terms and achievable in the current economic climate) and let the new tenant renegotiate with the landlord.
If the landlord asks for a payment from the tenant to accept the early surrender of the lease, he will be treated as granting an interest in land but the surrender will be exempt from VAT (VATA 1994 Sch 9) unless the landlord has opted to tax the property.
Capital Gains Tax
If the tenant pays the landlord for accepting the early surrender, the tenant is unlikely to get a tax deduction for the payment as it neither enhances the asset or will be allowed as ‘an incidental cost of disposal’ (TCGA 1992 s 38) but part deduction may be possible in some cases. It is likely however that the landlord will have a CGT bill for the receipt of the payment.
Finally, a tenant may decide to assign a lease as part of a business sale.
If the assignee pays consideration, it will be chargeable to SDLT in the normal way on any premium paid for the assignment.
In most circumstances an assignee of a lease would have no liability to SDLT on the rental element. However, even if no premium is paid, the assignee can find themselves liable to pay SDLT in respect of the rents if either:
(a) the previous tenant claimed a relief from SDLT (as the assignment is treated as the grant of the lease – (Para 11, Schedule 17A FA 2003)); or
(b) the assignment is within the first 5 years of the term and the rents were uncertain such that an adjustment will be required (Para 12, Schedule 17A Finance Act 2003).
We always recommend that if possible the assignee should seek a copy of the Assignor’s SDLT return or ask the assignor to warrant that they did not claim a relief.
If the lease is assigned as part of the sale of a business, this should not trigger any VAT as long as the sale qualifies as a ‘transfer as a going concern’ or ‘TOGC’ (VATA 1994 s 49).
Otherwise, the assignment of the lease may trigger a charge to VAT if the tenant has opted to tax in relation to his interest.
If a lease is to be restructured we recommend advice should be sought at the outset to ensure that the most tax-efficient route is chosen.
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