A tax trap for the unwary. Leases and Stamp Duty Land Tax

Might you unwittingly be doing something which could lead you into problems with the Revenue's Stamp Office? The risk is I think best illustrated by a fictional example.

David and Jeremy run a successful business which they want to expand. They decide to acquire new premises. They are advised to purchase in their own names and then let to their trading company. By this means they ring fence the freehold asset in the event of the company running into problems. The company pays a rent which discharges the mortgage they raise to buy and there are various tax efficiencies in the arrangement. David and Jeremy declare the rent in their personal tax returns and the company shows it as a charge against income in the accounts.

These entrepreneurs decide not to trouble with a written lease but instead rely upon a verbal arrangement between them and the company which, after all, is wholly owned by them.

The rent is £80,000 a year.

What's the problem?

Stamp Duty Land Tax (S.D.L.T. which replaced Stamp Duty in 2003) is a much more aggressive, complex and expensive tax than was Stamp Duty when it comes to the lease regime and especially in the case of leases for an indefinite period. This applies just as much as leases by word of mouth was it does to written leases or other forms of tenancy be they called licences or tenancy at will.

The Finance Act which introduce S.D.L.T. has created a "tax fiction".

It does this by saying that for S.D.L.T. purposes a lease for an indefinite term is treated initially as if it were a lease for a fixed term of one year. If it continues after the end of the year, it is treated as a lease for a fixed term of two years. Continuation beyond the second year produces a lease for a fixed term of three years and so on. It does not matter if the continuation is for one day only, that day is treated as a year for these purposes. These provisions override any other Act of Parliament relating to leases for indefinite terms.

There are two consequential traps.

First, the need to make a return at the appropriate stage and second, the liability to pay S.D.L.T. once the total value (called "net present value") rises above the threshold at which S.D.L.T. starts to be payable - currently £150,000.

The effect of all this is that at the end of the first year of the verbal tenancy created by David and Jeremy they must first file S.D.L.T. returns and second, pay tax of £19. If they fail to do both these things within 30 days, penalties become payable which can amount to double the tax in addition to a penalty for failure to send in a return and on top of that interest accrues. Although the tax is only £19 at this stage the amount increases so at the end of the year two the tax is £741 and it continues to escalate year on year.

How would anyone know, you might ask?

The arrangement is oral, the tax is dealt with transparently both by the company and those who receive the rent.

That is just the problem. The Inspector of Taxes who looks at the company accounts and the personal tax returns sees the arrangement and calls for a copy of the lease. Unfortunately for David and Jeremy he doesn't get round to doing this until five years have gone by. By that time the failures to file returns and non payment of tax have mounted significantly.

This comes as a complete surprise when it was thought taxes were being dealt with in a proper way and unfortunately the business and its owners find themselves very much on the wrong side of HMRC.

What can you do?

If you are operating the sort of arrangement outlined above you should immediately seek professional advice. If you are planning to do so, the best course is often (although not always) to enter into a proper written lease, pay the tax at the outset and know that you can sleep easily at night without worrying about Inland Revenue transgressions.

If, having thought about this, you think that your arrangements may be on the wrong side of the Revenue's requirements, we shall be pleased to review the situation, advise on the implications and recommend a course of action. This might best be done in conjunction with your accountants.

It is a daunting prospect but if you think there might be a problem it is best addressed now since it will not go away. If you would like an initial "diagnostic" discussion we offer for a fixed fee of £500.00 plus VAT to review your present arrangements, discuss the situation briefly with you and recommend a more detailed plan of action.

If that offer is of interest please either send copies of any documents there may be or, if none, an outline of the arrangements, or telephone or send a letter or fax, whichever suits you best.

Contact Paul Venton on 020 8300 9321 or pventon@wmk-law.com alternatively Contact Us