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Interaction of PPR relief and ESC D39

Can ESC D39 give effective CGT re-basing as well as PPR relief on a new lease?

A husband and wife bought a leasehold flat in 2013 for £500,000, as tenants in common, with the husband owning 99.9% and the wife 0.1%. They lived in the flat as their main residence for the first two years, after which it has been let out.

In 2017 they participated in a ‘collective enfranchisement’ of the building of which the flat was part. This involved a new company being incorporated (owned by the leaseholders in the building) to acquire the freehold interest. Under the terms of a Participation Agreement between the leaseholders and the company, each leaseholder was responsible for paying the share of the acquisition of the freehold interest (plus share of other costs) that was attributable to their flat, and the company undertook, once the freehold interest was acquired, to accept the surrender of the existing leases and grant each leaseholder a new 999 lease at a peppercorn rent, in respect of their flat. Each leasehold also subscribed for a £1 share in the company at par value.

The costs attributable to the flat in question were £10,000, which was paid directly by the leaseholder (on behalf of the company) as their share of the costs of acquiring the freehold. A few months after the company acquired the freehold, the surrender and re-grant of the lease was completed (in accordance with the Participation Agreement).

The conditions for ESC D39 appear to be met. In particular, the transaction should be regarded as being on arm’s length terms; the company acquired the freehold interest (with all costs being borne by the leaseholders) subject to the obligation to grant new 999 year leases over all flats in the building – hence there was negligible residual value in the freehold interest. And the costs borne by the leaseholder were the result of a negotiated settlement with an unconnected third party.

The wife (0.1% owner) intends to file her tax return on the basis that ESC D39 applies and there was no disposal of the leasehold interest on the occasion of the surrender and re-grant.

However, the husband (99.9% owner) intends to file his tax return on the basis that he does not wish to avail himself of the concessionary treatment and that a chargeable disposal occurred as a result of the surrender and re-grant, with consideration being the market value of the new 999 year lease – estimated to be £750,000. The gain of £250,000 is expected to be fully covered by Principal Private Residence Relief (including the final 18 months before the disposal) and Letting Relief.

The husband would then have CGT base cost of £750,000 in the property, on the basis of the market value at the time of the surrender and re-grant.

Now, suppose the flat is then sold in 2020 for £900,000, and immediately before the sale, the husband transfers his 99.9% share to the wife. It is treated as a nil gain, nil loss transfer and the wife would therefore have CGT base cost in the property of £750,000. Furthermore, the wife would still be able to claim PPR and Letting Relief on the £150,000 gain, based on her full period of ownership of the property, since 2013 (since as a result of ESC D39 no disposal is deemed to have taken place of her 0.1% share in 2017).

Crucially, under s222(7) TCGA 1992 the period of ownership, where an individual has had different interests at different times, is taken to begin from the date of the first acquisition. Furthermore, s222(7)(a) would not apply, since at the time of the transfer of the 99.9% share to the wife, it is not the husband’s main residence – and has not been his main residence at any point since his acquisition of it (at the time of the surrender and re-grant of the lease).

The effect of the legislation appears to be that in this case the husband and wife can effectively get both a tax-free rebasing for CGT to market value in 2017 and PPR relief (pro rata) based on the full period of ownership from 2013 when the flat is eventually sold.

Any thoughts on whether this analysis is correct, or any other comments on this fact pattern would be much appreciated!

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18th Nov 2017 21:53

I don't think it is correct. Read the appropriate collective enfranchisement provision, and take particular not of the words "on their behalf" that you will find there. Remember that CGT is all about beneficial ownership. I'd have expected the participation agreement to mention legal and beneficial ownership.

Finally, also read TCGA 1992, s 222; in particulare the bit in s 222(7) about the individual having different interests at different times.

Then you'll hopefully realise that ESC D39 is redundant in these circumstances. Neither husband nor wife has a disposal.

How much did they pay for their "share" in the freehold.?If it was less than £750K, and your analysis is correct, then the company has a corresponding gain, which is taxable, and has made a distribution to the shareholders (also taxable).

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By jimbo27
to Portia Nina Levin
19th Nov 2017 14:42

Thanks for your comments. Like you I would have expected the participation agreement to refer to the beneficial / legal ownership, but unfortunately I does not say anything on the matter.

Although the collective enfranchisement was underpinned by the rights of the leaseholders and an initial notice was served on the previous freeholder under s13 Leasehold Reform, Housing and Urban Development Act 1993 (which does indeed referred to a "nominee purchaser"), the actual freehold purchase was the result of a subsequent negotiated settlement and associated paperwork on the acquisition did not make any mention of the company being a nominee. So I would say, at the very least, there is some ambiguity over the beneficial ownership in this case. My understanding would be that there is a presumption that the legal owner is the beneficial owner, unless there is evidence to the contrary.

Even if the beneficial ownership was with the leaseholders, I'm not sure that it would not necessarily follow that the surrender and re-grant was a not a disposal; each leaseholder would have a partial beneficial interest in the whole of the building, not a 100% interest in the part that comprised just their flat.

I would be interested to know more about the point on s222(7) you mention. As noted in my initial post, my reading of this was that the period of ownership (and PPR calculation) for the wife on what would, at the point of sale be a 100% interest would be measured from the date she first acquired the 0.1% interest.

Finally, on the company tax position, I agree there would be a disposal for the company, but not sure there would be any gain. The company would have proceeds of £750k on the surrender of the old lease, but surely would also have £750k costs deductible against that - being the new lease that it had to grant in consideration?

Thanks again for your help.

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to jimbo27
20th Nov 2017 10:41

On the company front, the surrender of the old lease is just the consideration provided by the leaseholders for the grant of the new leases.

However, since that must, by definition, be worth less than £750K (because it's shorter, otherwise what's the point?), and so you have a bargain otherwise than at arm's length.

Accordingly, you have deemed sale proceeds of £750K, and a part disposal out of the recently acquired freehold interest. There may or may not be a gain.

The difference between the value of the new lease and the value of the old lease would also be a distribution, if the proper analysis is that the company is the beneficial owner.

Personally I am dubious that that is the p[osition though.

You are correct that there is a general presumption in law that the legal owner is the beneficial owner, but the courts will look behind that (eg where the funds for the purchase were provided by somebody other than the legal owner).

In this respect, it is worth noting that, whatever happened in the negotiations, the only persons with the right to acquire the freehold under the collective enfranchisement provision are the leaseholders or a person acting on their behalf.

To be enforceable though a trust over land should be evidenced in writing.

The solicitors acting should be invited to comment on the position, before any accounts are prepared showing the freehold as the company's asset. I've seen this cocked up countless times between solicitors and accountants who haven't got a clue.

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