Lee Sharpe looks at circumstances involving the sale of land or property for development – so-called 'slice of the action' arrangements.
In the previous case study, I looked at what might happen if a landlord or landlady were to decide to develop their rental property for onward sale; and warned that, in some relatively common situations, a rather nasty immediate capital gains tax (CGT) 'deemed disposal' might arise, and income tax might be charged on the development phase.
I will now consider the scenario where the landlord decides simply to sell the property as a development opportunity for a third party to exploit (which could, in some cases, be the landlord or landlady's separate property development company). Often, it is not as simple as a sale for a fixed sum payable immediately.
‘Slice of the action’ arrangements
Where the property investor offers land (or buildings) for sale at a premium as a development opportunity, a developer may well accept that there is a good profit to be made once the property or properties have been developed and sold on, but the developer:
- may not have all the funds to buy the land for the full asking price immediately; or
-
may want the investor who makes such claims to bear some of the development risks, in case it does not quite live up to the hype.
The developer may, therefore, offer a good proportion of the vendor's asking price but then offer to pay the remainder once the developed properties have been sold. This is simply deferred consideration; the amount for the sale is agreed, but the vendor must wait for some of the money.
Alternatively, a developer may approach an investor with an offer to develop a prime plot and for the selling investor to participate in some of the uplift in value on post-development sale, almost (and very broadly) like a joint venture. I say 'very broadly' because the investor does dispose of the land or property to the developer, and has no input or stake in the development phase, save for a right to a share in the proceeds on onward sale.
HMRC refers to such latter transactions as having an entitlement to a 'slice of the action' – some of the developer's profits following the developer's buying the property and developing it. There is generally no question that the developer is trading. But HMRC argues that the original investor is also enjoying a right to income (of sorts) by being permitted to participate in the developer's profit. HMRC says that such arrangements fall within the ‘transactions in land’ regime.
Sale of property to a developer
Sean, the world-weary landlord whose travails we have been following through several case studies now, has lost interest in the possibility of developing his large Edwardian property after his foray into house in multiple occupation (HMO) lettings. However, he does have several property developer contacts who would be keen to take over the development of the property for resale.
Sean originally bought the property several years ago for £750,000. Sean has it independently valued at around £1 million and offers it for sale at £1.1 million, with the planning permission for conversion from an HMO back to a single dwelling.
He is considering two offers in particular, from unconnected property developers working on an arm's length basis.
Option 1: Extra proceeds?
Alfonse has a property development business and is confident that he can take Sean's vision and deliver a good quality conversion back to the original single dwelling. He is prepared to pay Sean's full asking price for the property and, given that Sean has paid for most of the professional fees, structural engineering work etc., he offers Sean a further £80,000 if the converted property achieves a post-conversion sale of £1.7 million or more.
Sean could therefore make £1.18 million in proceeds if all goes according to plan. Let's assume that Sean is already a 45% taxpayer and has allocated his CGT annual exemption on other residential property disposals in the year.
Option 2: Conditional payments
Beyoncé also has a property development business, but she has completely different plans for the property – extending it and converting it into two large apartments. Sean's time and costs for drawings, designs and planning permission don't amount to much for Beyoncé, but she is very keen on the location and hopes to achieve a significantly higher selling price (albeit after a higher conversion cost). She offers Sean a more typical approach:
- £900,000 immediately on sale.
- £100,000 when she achieves planning permission (common because it tends to 'unlock' finance for the developer).
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£240,000 if both apartments are sold for at least £1million each.
Sean stands to make a total of £1,240,000 from Beyoncé's offer if all goes well.
Comparing the options
Firstly, note that these scenarios are set out to help highlight the basic mechanics of 'slice of the action' projects. In the real world, the agreements are likely to be more complex, with a variety of conditions and sliding scales or percentages, rather than simple sums. This would usually make the precise quantum of the deferred consideration impossible to fix at the point of disposal, in turn requiring further adjustment or steps to accommodate in the CGT and income tax calculations.
Perhaps the most striking thing when comparing the two options is that, while Option 2 would initially seem to be more attractive to the tune of £60,000, the post-tax differential is negligible – a mere £16,000. This is because much more of Beyoncé's offer is subject to punitive income tax, as it is dependent on (arguably, participating in) profits from her own trading venture.
It is not simply the case that the final payment is subject to income tax; it is any amount that exceeds the pre-development market value of the property, as agreed between the parties. If Beyoncé had not offered the £100,000 ‘sweetener’ on getting planning permission for her own project, it is the amount subject to income tax that would have been reduced in Sean's calculation, not the amount subject to CGT.
Sharp-eyed readers may have spotted an apparent anomaly: if it's supposed to be the surplus over the pre-development market value, then why is the market value £1,100,000 in Option 1 (Alfonse) but only £1,000,00 in Option 2 (Beyoncé)?
The answer is that that the initial £1.1 million was not contingent upon Alfonse's development. In other words, it seems Alfonse thought the property was actually worth £1.1 million at the point of sale and, while he presumably had every intention of developing the property as per the plans, the money was Sean's, regardless. Sean just got a really good price for the sale of his pre-development asset.
Conclusion
These relatively simple examples show that the tax consequences on 'slice of the action' deals can become quite involved, require careful consideration and usually professional advice. But it also demonstrates that (while it pains me to say it!) tax sometimes has a quite minor role to play in the overall picture. Put simply, Sean would be crazy indeed to take Beyonce's deal; not because of the relatively modest net-of-tax margin, but because £1.1 million today is better than £900,000 and a hope of more, but reliant on someone else's efforts.
Finally, note again that most residential property gains will fall within the scope of HMRC's new 30-day filing and reporting regime, as applies from April 2020.
