Sale of land at an undervalue in return for an income stream?

Sale of land at an undervalue in return for an...

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My contact is a design & build contractor ("Lake").  He has a client, ("River"), that wants to buy a parcel of land for development and use my client, "Lake", to undertake the work. 

River does not want to pay the full price as consideration for internal boardroom political reasons.  So, River has suggested that Lake buys the land from the vendor at the full market price, with the benefit of back-to-back contracts to River.

One of those contracts would be for the land but would be at the maximum value that his board would accept, i.e. less than the market value .  The balance of the price paid by Lake to the vendor, would be included in the other contract, which would be for the design and build work.  River would pay Lake's SDLT, which would be based on the full market value.

I cannot see any problem with this from an accounting point of view but am worried that I am missing something fundamental.

What do you think about the proposal from Lake's POV?  I am not concerned about River's position, although I think they have issues to address!

Replies (12)

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By johngroganjga
02nd Apr 2015 10:53

Presumably the fee for the design and build work is inflated, just as the land price is deflated?

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By duncanedwards
02nd Apr 2015 10:55

Am I missing something? Is it proposed that the directors are misled as to the nature of the complete transaction?

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Library Drinking
By Cambridge Business
02nd Apr 2015 12:05

The fee

Yes, the fee is wrapped up in that price.

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Library Drinking
By Cambridge Business
02nd Apr 2015 12:07

Misleading Directors

Only those of River's are being mislead and while I look askance at it, it is not my concern as that is their internal affair, as far as I can see.

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By johngroganjga
02nd Apr 2015 12:09

But the risk to your client is that one or more of the misled directors take issue with your client's design and build fee on the grounds that it is excessive, as of course it is.  How would he get out of that one?

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Replying to DJKL:
Library Drinking
By Cambridge Business
02nd Apr 2015 12:18

The risk to my client


You are right of course and that is a point that I know has raised with my contact.

They are looking at ways to mitigate that risk.  I suggested that they do not complete on the sale to River until the work was complete: but that adds other risks they might not want to take. It might well change the nature of the deal to a speculative design & build, which has other implications.

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paddle steamer
By DJKL
02nd Apr 2015 12:36

Follow the money

If your client Lake pays full price out day 1 but only recovers a part of this from River day 1 then is out of pocket at this juncture. Fine having the build contract but what happens if River runs into financial difficulties? 

Does Lake keep any security over the land once sold below cost to River? Given he has no interest in the land, except insofar as completion of the design and build contrac,t if this were put to us by River (we are a property group) I would be on the phone pronto to our solicitors but doubt I would be taking it to our directors for approval until I ironed out our exposure

It is a risk/reward proposition, and of course we do not have the numbers, but our cardinal rule is if plan A fails have a plan B. Currently not sure re plan B.

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Replying to leicsred:
Library Drinking
By Cambridge Business
02nd Apr 2015 13:06

Follow the money

Thanks DJKL.  Much appreciate your input.

It is something that has been taken to their lawyers, I believe.  I guess it is a matter for Lake to decide if they want to the risk.

Plan B, which is to become the speculative developer, is not attractive.  River is not a normal commercial organisation and has high ethical values and also happens to be well backed, so I doubt they will welch on the deal or get into financial difficulties.  I do know that at some stage, these things can go wrong.

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By Anthony123
02nd Apr 2015 13:10

tax

I am puzzled by this from a tax point of view.

Lake is going to buy a piece of land at market value and sell it to River for less.

Either Lake has a capital loss (or would the nature of its trade mean this is a trading loss?) or it has a no gain no loss situation for CGT (being all at deemed mv)

Then it is going to get a higher income stream than otherwise over the years on which it will pay more tax than otherwise (assuming of course all goes to plan).

Have you worked out if in real terms this is all pretty much tax neutral? It doesn't feel that way to me.

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By johngroganjga
02nd Apr 2015 13:17

Surely it will be tax neutral (apart possibly from timing) as the land purchase will be a trading expense.

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By paulwakefield1
02nd Apr 2015 13:25

Misleading the directors

and high ethical values. An interesting combination. :-)

Why won't (some of) River's directors accept full MV? Is it in fact an inflated value? I would suggest that Lake's solicitors are going to have to crawl all over this to mitigate the risk to an acceptable value.

 

 

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Library Drinking
By Cambridge Business
02nd Apr 2015 15:34

Many thanks everyone.

The solicitors for all parties are reasonably well known and I am sure they will look at it and advise Lake appropriately, especially pointing out the risks.

As for the tax side, their accountants are to be involved and I believe johngrongjga is right in that it is tax neutral.  I know nothing about either party's tax position, so will leave that to their tax advisors.

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