UK: Property Bulletin, October 2007 - Has The Sun Set On The Golden Years?

Last Updated: 18 October 2007

The subprime debate is hot news at the moment, but what other issues are of concern to the property sector? In this edition, we discuss trends highlighted in our annual survey, the benefits of green tax reliefs and new CIS penalties.

PROPERTY SURVEY 2007

Our fifth annual survey explores changing trends and attitudes within the property sector. Focusing on economic, financial and planning matters, our results highlight key topical issues.

We surveyed over 160 senior decision-makers who represent the views of chartered surveyors, lawyers, property developers, property investors, architects and other professionals in the industry.

Economy And Planning

In the current economic climate, with the subprime debate in the US impacting on the UK economy, we asked people what they thought are the key business issues facing the property industry as a whole over the next year. Not surprisingly, the uncertain performance of the UK economy is firmly at the top of the agenda. In second position, planning regulations continue to cause concern, while raising finance is considered the third most important. Legislative changes and tax issues also continue to be cited as being highly influential.

When asked about the business issues affecting their own organisations, the respondents answered that the ability to achieve company growth is the single most important issue, underlining concerns over economic performance. Managing the strategic direction of a company took second position. There have been a number of high-profile mergers of property service businesses in recent months, and the trend for large businesses to absorb smaller niche competitors, or to merge from a position of strength, may well continue over the next year, fuelled by concerns over the ability to achieve organic growth in times of economic uncertainty.

Not surprisingly, recruitment and retention of key personnel is a perennial concern, followed by the importance of improving the quality of projects and marketing issues.

Business Confidence

While business confidence in both the commercial and residential property industry remains generally good, people are clearly less optimistic than this time last year. There is a definite groundswell of thinking that after well over a decade of growth, the property market has finally peaked and the golden years may be over – at least for the immediate future.

Taking the commercial sector first; this year, 58% of respondents are very or reasonably confident in the business outlook, 14% are not very confident, and 28% are unsure. In contrast, last year 85% of our sample group were very or reasonably confident and only 8% were unconfident.

Recent reports from Savills, one of the City’s largest property agencies, confirm this. They believe that office vacancy rates could double next year to 10%, which would lead to a fall in rents as landlords scramble to let empty buildings. While there has been a lot of new development in the City in recent years, these properties may just come onto the market at a time when demand is on the wane. Are we about to see an increase in ‘rent frees’ and tenant inducements to maintain headline rents?

As far as the residential sector is concerned, people are a little less optimistic. Although 48% of respondents are very or reasonably confident about the outlook for the next year, 16% are not confident, and as many as 36% are unsure about the outlook. The ripple effect of problems in the US subprime lending market is starting to be felt in the UK, and although the market is not the same here, that does not mean that these jitters on the other side of the Atlantic could not put, at the very least, some form of a brake on the UK residential market.

But this brake is yet to be felt and, at the top end of the residential market, demand remains high for quality accommodation while London maintains its standing as an economic centre for Europe – all the more need for committing to long-term development projects, such as Crossrail. However, mainstream residential development seems to produce mixed messages. While the demand for affordable housing remains a priority, the ability to meet the housing targets that have been set is debatable.

Raising Finance

One significant area of change in comparison to last year surrounds the need to raise finance. Not only is there a marked increase in the need for external finance, but also changes in the preferred source.

This year, 42% of our sample group said that they expect to raise finance in the year ahead, whereas last year the equivalent figure was just 33%. Furthermore, while only 64% of this year’s respondents see the clearing banks as their prime source, last year 85% stated that this was their preferred route. Interestingly, 13% of this year’s sample group said that private equity is their first choice, while this only got 5% of the vote last year.

There does not appear to be any clear reason for this shift in opinion. However, we’ve recently experienced an increase in the level of joint venture activity, and it’s possible that this has resulted in developers turning to more sophisticated forms of structured finance.

Financial And Tax Issues

Our survey suggests that tax continues to have a greater influence on business decisions than is healthy, and it is undoubtedly a major factor in deciding whether or not to sell a property. A resounding 93% feel that tax would influence their decision (last year the equivalent figure was 91%, up from 88% in 2005 and 82% in 2004).

The role of the tax adviser remains ever important in any sizeable transaction, underlining the level of complexity to which tax legislation has risen during Gordon Brown’s period as chancellor. Many large regeneration projects headlined by the Government need the involvement of private investors and developers, but it seems that the tax incentives required to encourage such investment are sadly lacking.

The uncertainty over whether a planning gain supplement, or some alternative, will be introduced also seems to have had a substantial effect on investment, potentially distorting the market. A resounding 79% of respondents believe that any such future tax (for it is a tax, irrespective of the fact that the word ‘tax’ does not appear in the title) will act as a disincentive to investment, while only 10% felt it made little difference. No real surprises here.

Since their introduction in January, Real Estate Investment Trusts (REITs) have regularly been making the headlines. Although share values have fallen back as the initial REIT excitement has subsided and non-performing properties pregnant with large capital gains have been disposed of, some REITs are back to performing at a discount to net assets in the current turbulent market.

Our survey suggests that it’s still too early to predict their long-term potential for success, but the industry appears to be committed to these vehicles. While it is generally expected that REIT rules will be relaxed next year, investors should not forget that there are other property investment vehicles in the marketplace, and REITs may not always be the answer.

However, although 51% of respondents think REITs would enhance investment opportunities for the property sector, and just 7% don’t think they would be beneficial, a surprising 42% are unsure about the impact they would have. This might refl ect the uncertainty experienced in the share prices.

We also canvassed opinions on Stamp Duty Land Tax (SDLT), and views were split. Just over a third (37%) feel SDLT has affected their business, while 32% reported that it has not been an issue and 32% are unsure.

It is certain that steps taken by the chancellor last year, whereby we now effectively have a general anti-avoidance rule for SDLT, mean that the level of planning in this area has been significantly reduced. Exchanging a 4% charge for a 0.5% duty on the sale of shares in a special purpose vehicle is undoubtedly the simplest, safest and most straightforward planning structure left, assuming it is possible to put yourself in this position.

“51% of respondents think that REITs would enhance investment opportunities”

London

With several major construction projects currently underway in the South East, we asked a number of questions to gauge respondents’ views on how they think their own businesses will be affected. Our survey suggests that the majority of those working in the industry feel that the impact of these projects will be positive, however, there is some uncertainty.

We explored the introduction of Crossrail, and 55% of those polled think the project will have a positive or very positive effect on their business. Only 4% feel there would be a negative effect, while the remaining 40% think that Crossrail will have little impact. As we’ve already noted, projects like Crossrail are generally regarded as essential for London’s economic wellbeing as a centre for commerce.

40% of respondents think that the Olympic Village will have a positive or very positive infl uence on their business and only 8% anticipate negative effects. However, 55% seem ambivalent. The regeneration and legacy issues for London and the Olympics continue to be debated widely, and, as we feel this debate is important, we recently hosted a seminar on this topic.

We also asked about the development of the Thames Gateway, and 39% are positive or very positive about this project and just 1% of respondents are negative. The remaining 60% anticipate little effect for their own organisation.

Comment

Predicting the mood of the property industry remains notoriously difficult. For every view and opinion there is a counter argument, complicating the identification of trends. The best observers in the industry have called the top and bottom of the property cycle at different times, yet most only comment wisely with the benefit of hindsight!

It is certain that the heat from the boom of the 1990s through to current times has been turned down, but to what extent remains uncertain. The press continues to promote the latest futuristic buildings – ranging from shards of glass to cheese graters – with the level of proposed and speculative development expected to come onto the Central London market in the next three years being in the region of 12m square feet.

It will be interesting to see how the market performs over this period to judge whether the concerns of those surveyed are real, and to identify new challenges the industry will have to face.

John Voyez
Chair of the Smith & Williamson Property Group

PLANNING AHEAD - HAVE YOU CONSIDERED THE FUTURE TAX IMPLICATIONS OF YOUR CURRENT BUSINESS STRUCTURE?

Through the implementation of tax planning procedures, our Property team in Bristol helped a client reduce a potential liability – saving more than £27m.

Our Property team recently advised a new client on planning procedures for inheritance tax (IHT) and capital gains tax (CGT). The client was operating his business through a group comprising two limited companies, and he also held substantial personal assets. He had not considered IHT planning to any major extent. Furthermore, the companies had a number of income streams comprising a mixture of trading and investment activities, with a particular emphasis on property. Planning ahead Have you considered the future tax implications of your current business structure?

The Potential Liabilities

As there were substantial investments within the group, the shares in the parent company did not qualify as a trading entity for the purposes of IHT business property relief (BPR). Furthermore, the future sale of the subsidiary would produce a substantial chargeable gain, taxable at 30%. If the status quo had not been questioned, the client's executors would have faced significant tax liabilities, including a potential IHT liability of around £27m and a CGT liability of approximately £5m.

Solving The Problem

Our team was appointed to help, and our specialists in corporation tax, IHT and VAT worked together to identify a solution. We suggested that the group be restructured into two separate entities.

  1. A trading group eligible for BPR, therefore making the shares exempt from IHT. This also introduced the possibility of applying the Substantial Shareholdings Exemption to any chargeable gains arising on a future sale of the trading subsidiary, so that no corporation tax would be payable.
  2. A property development group, including a restructuring of assets held. This entity would be eligible for BPR as its business does not consist wholly or mainly of dealing in land or investments.

This new arrangement effectively removed the whole of the value of the shares from the chargeable IHT estate, leaving IHT potentially payable on only personally owned assets. However, exposure to this liability can be mitigated through the use of trusts.

Through the use of these tax planning procedures, we helped reduce the client’s potential tax liability from more than £30m to less than £3m.

Planning For The Future

It is important to consider the totality of your business and investment activities to determine if they have been structured to mitigate future IHT and CGT liabilities. If you are unsure, it is best to seek professional advice to help you identify the optimal structure.

We deal with the tax affairs of a large number of owner-managed businesses with substantial property activities. Our experience allows us to help companies and their owners minimise their potential tax exposure.

GO GREEN
GOOD FOR THE ENVIRONMENT, BUT ALSO GOOD FOR YOU

Green tax reliefs are increasingly underclaimed, especially in the property sector.

Companies that make use of green reliefs can potentially reduce their overall construction costs through the tax savings. As such, green tax reliefs should be considered before, rather than after, the event.

Land Remediation Relief

Land remediation relief (LRR) was introduced in 2001 to provide businesses with an incentive to bring contaminated land back into productive use. The relief allows companies a 150% deduction of qualifying expenditure for the costs of cleaning up contaminated land.

Businesses may also elect to have qualifying capital expenditure, for which a capital allowances claim cannot be made, treated as a deduction in computing profits. This then also qualifies for the 150% rate of relief. Furthermore, if the enhanced expenditure creates or increases a loss, companies may be able to qualify for a payable tax credit equal to 16% of the loss surrendered.

Currently, land only qualifies as contaminated if there are potentially harmful or polluting substances present.

However, HM Revenue & Customs (HMRC) has recently proposed that LRR should be extended to include vacant and derelict land where buildings, rather than contamination, act as a barrier to development. The relief would then also cover the costs of removing or making good obsolete utilities and creating adequate access to the site, in addition to the demolition and removal of the existing structures.

HMRC may also extend the scope to cover expenditure incurred to remove Japanese Knotweed. It is worth noting that presently relief should not be available for cleaning up natural contaminants – a point which HMRC intends to clarify.

These proposals are likely to be linked to planning consent and are still subject to consultation. In the interim, companies should ensure that they have claimed all existing reliefs available since 2001.

Alongside these enhancements to LRR, HMRC has proposed the removal of the landfill tax exemption for waste from contaminated land. The intention is to discourage ‘dig and dump’ in favour of the remediation of contaminated soils.

Proposals For Other Green Tax Reliefs

  • The Landlords Energy Saving Allowance provides unincorporated landlords with a deduction for the cost of acquiring and installing certain energy-saving items into residential properties that they let. Once European Union state aid approval has been obtained, this relief will also apply to corporate landlords.
  • The Enhanced Capital Allowances regime currently enables businesses to claim a 100% capital allowance on expenditure incurred on designated energy saving and environmentally beneficial plant and machinery. HMRC has put forward a proposal to significantly expand the list of qualifying assets and possibly introduce a repayable tax credit.
  • The Business Premises Renovation Allowance provides a 100% first year capital allowance for expenditure incurred on or after 11 April 2007 when renovating unused business premises in assisted areas.

These enhanced tax reliefs for green expenditure are becoming increasingly significant and should not be ignored, particularly in light of the abolition of Industrial Buildings Allowances and the reduction of capital allowance rates from April 2008.

PENALISING CONSTRUCTIVELY

Contractors will now incur steep fines for failure to submit returns on time.

The new Construction Industry Scheme (CIS), introduced on 6 April 2007, brought with it a hard-hitting penalty regime, including penalties for late submission of contractors’ monthly returns.

As of 20 October 2007, HMRC will issue an automatic interim penalty of £100 for each monthly return due between 6 April and 5 October 2007 that is not submitted on or before 19 October, and again on the 20th of each month thereafter until the return is submitted.

Returns showing payments to more than 50 subcontractors will be subject to a further penalty of £100 for each additional 50, or part thereof. Returns for the tax months ending after October 2007 will be treated as late if they miss the normal 14-day deadline.

In addition, contractors who are also subcontractors need to be aware that if one return is submitted more than 28 days late, or more than three late returns are made in any 12-month period, they will lose their gross payment status. The late payment of tax withheld under CIS or Pay As You Earn could also lead to loss of gross payment status if there are too many short delays, or one delay of more than 14 days.

Contractors need to examine the details of the new scheme carefully to ensure that they are recording and reporting the necessary information correctly and on a timely basis.

Businesses that are unsure of what is required should seek advice on record keeping and their obligations before it is too late.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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