UK: Taxing Reverse Premiums - U Turn by Inland Revenue?

Last Updated: 5 May 1999
Taxing Reverse Premiums - U Turn by Inland Revenue?

"The recipient of a reverse premium will often contend that the receipt is not chargeable to tax. This contention is often correct." (Para 70833 Capital Gains Manual)

"Such sums were often considered taxable before a recent adverse decision of the Privy Council" (Budget Press Release IR 32)

Whether the decision in Wattie [1998] STC 1160 was the real reason for changing the tax treatment of reverse premiums may be open to doubt. But, whatever the motivation, long standing practices in the property industry must now be reviewed as landlords and tenants adjust to the new regime.

Before the Budget, it was accepted that most reverse premiums were tax free in the hands of the recipient. This was the case even if the person making the payment could obtain immediate tax relief - for example, a property developer who treated the payment as an expense of his trade.

All reverse premiums are now taxable as income of the recipient. This is the case even if the person making the payment obtains no tax relief - for example, a property investor who would at best treat the payment as an addition to his CGT base cost (or who may be a tax exempt institution). An effective tax subsidy has been withdrawn and replaced with a tax charge.

What is a reverse premium? The Finance Bill defines it as a payment or benefit by way of inducement in connection with a transaction under which the recipient becomes entitled to an interest in land. Payments may be made for a number of reasons:

  • As in Wattie, the landlord wants to set a headline rental higher than current market rents. He pays the tenant an inducement to compensate for the high rent. If paid as a regular rent subsidy, the payments are (and always were) taxable. If paid as a lump sum, the payment will now be taxed in full.
  • A developer has budgeted to complete his building to a minimum standard of internal finish. The prospective tenant wants a higher standard of fit out which would involve replacing work done by the landlord. It makes sense therefore for the tenant to be responsible for all fitting out work, with the landlord contributing to the tenant's expenditure up to the amount the landlord would have spent. Such a contribution is now presumably taxable in full, even where it limits the tenant's ability to claim capital allowances - the Finance Bill is silent on the interaction between the new rules and section 154 Capital Allowances Act 1990.
  • The prospective tenant is vital to the success of the development (for example, a key store in a retail development). The developer is prepared to pay to get the tenant into the building and offers an inducement. Such a payment was often tax free in the hands of the tenant but will now be taxed.

Reverse premiums can be paid by someone selling an existing interest in land, perhaps a lease which has onerous terms. These are also caught by the new rules. Less clear is whether payments by a tenant to his landlord to induce acceptance of a surrender of the lease are caught - the landlord does not become entitled to an interest in land as a result of the surrender.

The new rules extend beyond cash payments to "other benefits". Does this catch rent free periods which are, after all, equivalent to a rent subsidy? It is not clear if the value of a rent free period is now to be treated as a taxable benefit in the hands of the tenant. Since the tenant is, by definition, not paying rent, he will have no corresponding deductible expense to offset any taxable receipt. Other non-cash benefits might include the value of works undertaken to the building by the landlord at the landlord's expense - as where the landlord incurs additional fitting out costs at the request of the tenant.

Some other points to note include:

  • There is an express saving for sale and leaseback deals - the payment for the sale will not be treated as a reverse premium for the lease (so clearly the Inland Revenue want the new rules to have a very wide application).
  • The Budget press release stated that the timing of the tax charge would be in accordance with accounting practice under which the receipt is recognised over a period of years. This is not provided for expressly in the Finance Bill - it presumably follows from taxing reverse premiums as Schedule DI or Schedule A receipts. However, it underlies an anti-avoidance rule that accelerates the tax charge where the reverse premium is paid between connected persons on non-arm's length terms.

The proposal to tax reverse premiums was a further blow to the property industry, coming on top of the recent substantial increases in stamp duty rates. The position is not helped by ongoing uncertainty over the correct VAT treatment of these payments. The Finance Bill leaves many questions unanswered and we are seeking clarification from the Inland Revenue. If you would like to hear what the Inland Revenue have to say, please contact us.

For further information please contact Mark Simpson, e-mail: Click Contact Link , 2 Park Lane, Leeds, LS3 IES, UK, Tel: + 44 113 284 7000

This article was first published in the Tax News - Special Finance Bill Edition issue of Hammond Suddards Tax News updates

The information and opinions contained in this article are provided by Hammond Suddards. They should not be applied to any particular set of facts without appropriate legal or other professional advice.

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