Construction work can be subject to stamp duty land tax (SDLT)
13th December 2024
Posted in Articles, Stamp Duty Land Tax by Andrew Marr
It is fairly common for a lease to include an obligation to construct a building on the land which is the subject of the lease. It would usually then be the case that the rental is set at a lower rate in recognition of the fact that the tenant will incur costs on construction. Although there are special rules about how to calculate SDLT on rental costs, in these scenarios there is also the question about whether the tenant triggers an SDLT liability in respect of the construction costs.
The default position where some consideration consists of construction work is that the consideration will be subject to SDLT unless each of the following three conditions are met:
1. The works need to be carried out after the effective date of the purchase. Although the effective date will usually be completion, any ‘substantial performance’ can accelerate the effective date. For example, if a tenant takes possession of the property, then this can give rise to substantial performance.
2. The works are carried out on land acquired or to be acquired under the transaction or on other land held by the purchaser or someone connected with them.
3. It must not be a condition of the transaction that the works are carried out by the vendor or a person connected with them.
Any tenant will clearly want the above conditions to apply when there are any construction works.
Agreement for a lease
Quite often a landlord will not want to enter into a lease until the construction works are completed. Prima facie, this makes the first condition hard to meet. How can the works be carried out after the effective date when the lease is conditional on the construction works being completed? In these circumstances the tenant will be hoping that substantial performance can come to the rescue. This is possible because the rules state that substantial performance of an agreement for a lease is enough to meet the first condition when construction takes place thereafter.
Example
On 1 April 2024 Chemical Co Ltd signs an agreement for lease under which it is to construct a chemical plant for £20m and take a 50-year lease at a rent of £300,000 per annum and a £200,000 premium. The lease will be granted 30 days after practical completion of the building which will be in about two years (although the exact date is not known). Chemical Co Ltd substantially performs by taking possession on 1 May 2024 and completion of the building ultimately takes place on 1 October 2026, with the lease being granted on 31 October 2026. Here (because nobody knows at the outset when the lease will start), there is a deemed one-year lease (just go with me on this as the rules are complicated) on 1 April 2024, although it is not likely that any rent will be payable and so no SDLT would be payable in respect of the rent. HMRC’s view here is that SDLT on the premium is not payable until the lease is entered into, but this is probably a concessionary treatment and arguably this should be paid when the agreement for lease is entered into. Each year that goes by means that there is another deemed one year-lease until the actual lease is entered into and SDLT will be payable under the lease rules. The company will clearly hope to avoid SDLT (of £1m) in respect of the construction works on the basis that the three conditions above are met.
Forbes Dawson view
Usually HMRC would be arguing that substantial performance has occurred early so as to accelerate the date that the SDLT is due. In the above case it would be in their interests to argue the opposite because that would give rise to an additional £1m of SDLT. In practice the above company will want to do everything in its power to ensure that it has possession when the agreement for a lease is entered into, and it should ensure that it has widespread powers to occupy the land in the broadest way possible. Furthermore, although HMRC would be likely to accept in the above example that the first SDLT return that is due is in respect of the 31 October 2026 (actual) lease, we would advise them to follow the strict legislative rules and submit a return in relation to the 1 April 2024 agreement for lease which includes the £200,000 premium. Although this would accelerate the payment of £1,000 of SDLT (non-residential SDLT rates on £200,000), this is a small price to pay for the opportunity to demonstrate to HMRC that substantial performance has taken place before the construction works. If there were no premium, then we would advise that a letter is sent to HMRC explaining that substantial performance has taken place but no return is due. The issues here can be very complicated and advice should always be sought.
