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Investment gain or revenue??

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I have a new client who is effectively a property developer and will be reporting under FRS 102.

As a very high level overview the business works as follows:

  • The client identifies a property to buy and develop into a care home
  • agrees a long term lease with a housing association
  • sells the property and the lease as a package to an investment fund.

The agreement with all parties (client, property seller, housing association and investment fund) will be signed on the same day. The client then has a commitment to develop the property to the required standard (but does not own the property).

The structure of the deal is as follows. The property is purchased into an SPV (effectively a £1 company set up by the client as a subsidiary) and the investment fund will purchase the shares (for say £1m) in the SPV and thus owns the property. (The SPV method is currently being used as a means to reduce stamp duty)

The question: In my opinion, the client has a gain on investment here of £999,999 as a result of the share sale. However, the client (also an accountant) is adamant that this could be viewed as revenue, on the basis that he will be completing several of these transactions each period and that the shares are merely set up as a vehicle for the property. He has also pointed me in the direction of a large company with exactly the same model, audited by a large audit firm, who treat similar transactions as revenue.

I'm struggling to see how this can be argued. Has anyone got any thoughts here, or similar experiences?

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By ms998
23rd May 2019 12:17

Ignore the SPV for the moment. If your client was buying a house doing it up then selling it on 6 months later would that be a capital transaction or revenue? Repeat this 10 times, does your analysis change?

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Replying to ms998:
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By [email protected]
23rd May 2019 13:11

I would say that if it was repeated 10 times, it would be considered a trade and therefore a revenue transaction.

However in this case the SPV would be considered a financial instrument (and therefore cannot be stock) and therefore regardless of the number of times the an SPV is set up and sold, it would still be a gain on investment.

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By Tax Dragon
23rd May 2019 12:35

Let me rephrase what I think you say is your opinion in a way I can understand: client acquires a company for £1 and sells it that same day for £1m and the £999,999 difference is all due to an increase in the share value.

Have I understood?

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Replying to Tax Dragon:
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By [email protected]
23rd May 2019 13:12

At the end of the day, the SPV will contain a property which has a long term source of rental income form a Housing association and also a commitment within the contract for the seller to refurbish the property to the level required for a care home.

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Replying to [email protected]:
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By Tax Dragon
23rd May 2019 13:17

Might part of the £999,999 be to pay for that commitment?

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Replying to Tax Dragon:
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By [email protected]
23rd May 2019 13:36

I agree, there is an element which relates to bringing all the parties together and also for the refurbishment and these will be recognised as revenue. My example was attempting to simplify as much as possible and therefore did not mention this.
However the purchase agreement always includes 50% plus of the payment for the share purchase. Which for me would be a capital gain.

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By Bobbo
23rd May 2019 14:42

If it's a newly set up £1 company how is the purchase of the property by the SPV financed? Is your client making a loan to the SPV of the funds required? If so, how is this repaid? - Does the £1m represent some of that?

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Replying to Bobbo:
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By [email protected]
24th May 2019 09:19

Correct, the client makes a loan to the SPV, so that the SPV can aquire the property from the client.
The loan repayment is financed by the investment company taking up a share subscription in the SPV, providing the finance and the ability to repay the loan.

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Hallerud at Easter
By DJKL
23rd May 2019 15:01

Presume at point of sale of SPV shares the SPV does not actually have title to the property but merely has a legal right to complete the property purchase, the purchaser of the SPV requiring to fund that property purchase once shares in the SPV acquired by them?

In addition the SPV company has a balance sheet which will only include a debtor on same (for the works the seller needs to subsequently perform) once that property purchase is consummated post share sale in the SPV?

Notwithstanding above, which are more my trying to follow the transaction in detail, I suspect you need to take a look at the pervasive principles of FRS102 re Substance over Form, section 2.

Where a particular treatment outlined in FRS102 (2.1A) contradicts the pervasive principles the particular treatment overrides the pervasive principle, I suspect those more versed than me re such matters can extol all the current thinking given I am more these days an accounting hack rather than a master of the delicate arts of standards interpretation and revenue recognition.

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Replying to DJKL:
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By [email protected]
24th May 2019 09:41

I think your understanding is correct, as long as you read it in conjunction with my responses to some of the previous comments.

Considering the pervasive principles, I would suggest that on the basis of substance over form and understandability, because the entity intends to buy and sell multiple SPVs as its key trade these are not investments and and a routine part of business. It could be argued that the cost of the SPV be recognised in COS and the gain be recognised as revenue. (Would this be disclosed in the notes as an FRS 102 departure?)

However, my understanding is that the pervasive principles can not override another section FRS 102 if there is a conflict. In this case the conflict being that Section 14 of FRS 102 requires investments in subsidiaries to be held at cost/fair value and therefore any gains/revaluations would not be shown as revenue.

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