UK: Property Bulletin, September 2009

Last Updated: 10 September 2009
Article by Nick Cartwright

EDITOR'S COMMENT - GET YOUR HOUSE IN ORDER

This has already proved to be a long hard year in the property sector but a few seasoned veterans and players are actively preparing the ground for new and exciting property ventures.

However, there is still a lamentable lack of bank debt available for property development, despite the best efforts of Her Majesty's Government. Most banks are quite frankly not interested in lending against property development. Furthermore, the refinancing of debt is a growing concern for investors in real estate as well as private equity. Many banks are shrinking their property loan portfolios, tightening lending criteria and raising interest rates and other fees, resulting in a genuine threat of default for some property companies. Never have accurate accounting, cashflow controls and banking relationships been more important.

Property developers and investors have been hit by a severe correction in UK property values, leaving holes in their balance sheets.

In addition to the raw commercial pressures, these devaluations also bring accounting challenges and tax planning opportunities, which should be addressed sooner rather than later.

Some UK property companies have been forced to dispose of assets and undertake considerable share issues in order to raise funds in an effort to reduce pressure on loan-to-value covenants. However, war chests are being raised by those waiting and able to take advantage of the buyers'market. We are once again helping clients structure funds, conduct due diligence and plan acquisitions, which bodes well.

The outlook is still uncertain but now is not the time to despair but rather to prepare for the future and attend to essential housekeeping jobs including tax planning reviews and reorganisations that will provide benefits in an otherwise difficult time.

Nick Cartwright
Head of Property

ACCOUNTING FOR PROPERTY VALUES

The values of most investment and development properties have deteriorated over the last year or so.

Falling values have had a significant impact on the balance sheets and tax positions of property companies. Directors are more than ever having to consider, plan and account for changes in property values.

In June 2008, the Financial Reporting Review Panel (FRRP) announced that it would be reviewing the accounts of all companies containing qualified audit reports. Although the FRRP has not written to every such company as a result of this review, it has been writing to a selection, drawing attention to the directors' responsibilities under the Companies Act to prepare accounts that comply with the law and accounting standards.

Even private company directors need to be aware that the FRRP may now take an interest in their accounts.

In addition to the need to comply with the appropriate accounting standards, particular care is required for accounting and taxation purposes when appropriating property between stock and fixed assets and booking write downs.

The FRRP has the power to apply to the court for an order seeking the revision of defective accounts. To date it has not needed to exercise this power as the companies which have fallen under its investigative remit have always revised their accounts voluntarily. It is worth noting that if the matter goes to court and the FRRP is successful, the court costs could fall to be paid by the directors of the company personally.

Accordingly, we strongly recommend that directors of property companies consider their responsibilities under the Companies Act. The costs of revising accounts would be particularly unwelcome at the moment.

It is also worth noting that HM Revenue & Customs (HMRC) is becoming increasingly sophisticated in its approach to enquiries and is challenging figures in audited financial statements. A qualified audit report is an open invitation to HMRC to have a good look around your accounting records and ask a few leading questions. Even without an adjustment, the cost of such an enquiry can be considerable.

There is a silver lining for trading companies, if for example property stock has had to be, or will at the balance sheet date need to be, written down, tax relief is likely to be available. With careful planning and timely action, much needed repayments of tax can be extracted from HMRC by means of the appropriate loss carry-back and repayment claims.

CLEAN UP YOUR ACT

Land remediation tax relief has been significantly amended by Finance Act 2009.

Land remediation tax relief (LRR) is available to companies for certain expenditure on contaminated land in the UK that has been acquired for the purposes of a trade. It takes the form of an enhanced deduction for capital and revenue expenditure, where this relates to the remediation of contaminated land acquired for the purpose of a trade carried on by the company. It is a valuable relief that should not be overlooked.

The Relief

The rate of relief is 150% of the qualifying expenditure. Loss-making companies may, as an alternative to claiming this enhanced deduction, claim a tax credit repayment of 16% of the qualifying loss from HMRC, based on an amount equal to the smaller of:

  • the current trading loss or schedule A loss that cannot otherwise be relieved
  • or 150% of the qualifying expenditure.

The amount of loss carried forward will be reduced by the amount of any loss used in a tax credit claim.

While the relief can only be claimed by companies, a company that is a member of a partnership can claim relief for its share of relevant land remediation costs.

Entitlement

The land must be in a contaminated state when acquired. From 1 April 2009, the interest in the land must be a 'major interest', and in relation to a lease, is a term of at least seven years.

A company buying contaminated land by acquiring another company would not be able to claim relief, if the company purchased (and therefore connected from acquisition) had caused the contamination. In such a situation it may be more effective for the acquiring company to purchase the assets rather than share capital in order to qualify for LRR.

For expenditure incurred on or after 1 April 2009, where the polluter has retained a relevant interest, the person incurring the expenditure will not be able to claim LRR. Relief may also be excluded where the polluter receives an amount of consideration that to any extent reflects the impact, or likely impact, on the land of the value of the remediation tax relief.

Qualifying Costs

Expenditure qualifying for LRR is that which is incurred only because of the need to remediate contaminated land. Preparatory costs qualify where these are for assessing the land and the work is actually carried out.

Only certain costs meet the criteria for land remediation relief:

  • employee costs
  • materials directly used in the remediation
  • remediation costs paid to subcontractors.

No claim can be made for subsidised costs.

Remediation work may be undertaken by the company itself, or on its behalf. This point is likely to be relevant when structuring deals to acquire and remediate contaminated property.

No claim can be made for relief for capital expenditure if that expenditure could have qualified for an allowance under the Capital Allowances Act, whether or not a claim is actually made.

Long-Term Derelict Land

For expenditure incurred on or after 1 April 2009, LRR has been extended to 'long-term derelict land'.

The land must have been derelict from the earlier of 1 April 1998 and the date the major interest in the land was acquired by the claimant.

The types of expenditure eligible for relief in respect of derelict land will include actual and preparatory work for the removal of:

  • post tensioned concrete heavyweight construction
  • building foundations and machinery bases
  • reinforced concrete pilecaps
  • reinforced concrete basements
  • below ground demolition of redundant services.

Contamination

Land is in a contaminated state if substances in, on, or under land are causing harm or pollution. Since 1 April 2009, expenditure on the removal of Japanese Knotweed formally qualifies (but not where it spread to a site during the ownership period of the claimant, for example by fly-tipping). Outstanding claims for LRR can now be settled on the basis of this new interpretation. In addition, arsenic and radon now qualify as contamination, expenditure on the removal of which can qualify for relief.

As of 1 April 2009, land is not regarded as being contaminated if that contamination was present other than 'as a result of industrial activity'. This includes construction activity, so for example asbestos installed in an office, building or shop as a result of construction will qualify as contamination meeting this condition for access to LRR.

TAX TIPS FOR BUY-TO-LET LANDLORDS

The primary tax concerns for property owners include income tax, loss relief, CGT and deductible expenses.

Income Tax

Interest on loans to acquire, refurbish, or improve let properties is an allowable deduction against the rental income. Landlords acquiring new properties and those with existing properties should consider the tax benefits of loan finance (if available) compared to using their own capital funds.

A landlord who uses his/her own funds to wholly or partly finance the purchase of a let property may wish to release capital. A loan secured on the property should qualify for interest relief. However, that relief will be limited to the interest that would be payable on a loan figure equivalent to the capital contributed to the rental business. This principle will apply to a property that a landlord introduces to his/her letting business e.g. a former main residence.

In view of the Finance Act 2009 changes to the treatment of furnished holiday lettings and the extension of this treatment to properties located in the European Economic Area (EEA) until April 2010, it may be appropriate to review whether properties you hold in this region qualify for the regime. This may be useful where losses have been incurred and there is income available from other sources against which to set those losses.

Joint Ownership

There are important property law implications where property is held jointly which should always be taken into account.

Depending on the tax profile of the parties, it may or may not be desirable, from a tax point of view, for property to be owned jointly. Where property generating rental profits is held jointly there is the possibility to use two sets of income tax personal allowances, and basic rate bands.

However, with the removal of the personal allowance from 6 April 2010 for those with income over £100,000, and the new 50% tax rate for those with income over £150,000, sole ownership may now be preferential where one spouse/civil partner is within these rules and the other is not, even if the lower earning spouse is a 40% taxpayer.

On the sale of the property there is also the opportunity to use two capital gains tax (CGT) annual exemptions. Where there are joint owners, CGT letting relief is potentially available to each owner. Letting relief is discussed in brief elsewhere in this article.

There are inheritance tax implications where property is owned jointly and also special rules for spouses/civil partners who let property owned jointly which should be considered.

CGT

Property, including the family home, is a chargeable asset for CGT purposes. There is, however, a specific CGT provision to exempt from tax gains or losses on the only or principal residence of a typical individual. These provisions mean that on a standard residence where the whole of the property has been used throughout the period (or until the last three years) of ownership as the individual's main home there is generally no tax to pay on any gain realised on the sale.

The rules can be complex and where there are multiple residences or letting is involved, individuals should seek specialist advice.

There is the potential to claim a significant amount of relief where a property which has been let out as residential accommodation was, or becomes, the principal residence of the landlord.

In broad terms, the maximum relief an individual can claim under this heading is a deduction from the chargeable gain equal to the lower of either £40,000 or the gain attributed to the letting period(s). A letting relief claim is in addition to the private residence relief attributable.

Neither private residence relief nor letting relief can turn a gain into a loss. The reliefs will only restrict the gain to nil.

With respect to the Finance Act 2009 announcements on furnished holiday letting properties, there are a number of CGT factors that should be considered before the advantages of this regime are removed in April 2010. For example: selling the property before April 2010 may give access to entrepreneur's relief (an effective CGT rate of 10% instead of 18%), which may not be available for a sale after that date. If a qualifying furnished holiday letting property located in an EEA country was sold prior to 5 April 2008 then business asset taper relief may have applied (potentially significantly reducing the rate of CGT applicable); it may therefore be worthwhile considering whether an amended claim can be made for this relief.

LESA

Private and corporate landlords can claim the costs of buying and installing specific energy-saving items (loft, cavity wall, solid wall and floor insulation, as well as hot water systems and draught proofing) in residential properties they rent out, as 100% deductions against their taxable profits. Landlords can claim tax relief on up to £1,500 of expenditure for each dwelling house (including each residential flat within a block of flats).

However, landlords can't claim the Landlords Energy Savings Allowance (LESA) for properties where they are already claiming an allowance under the rent-a-room scheme, or for properties rented out as furnished holiday accommodation, or if the energy saving item is installed in a property during the course of construction.

To claim the allowance landlords must have a relevant interest, and there are certain other restrictions on the timing of expenditure which qualifies for LESA.

Top Tax Tips

  1. For property rental losses generated by capital allowances, consider loss relief against income or profits from other sources.
  2. Where several properties are rented out in the same tax year, offset the loss from a loss-making property against the profit from a profit-making property.
  3. For jointly held profitable lettings, consider whether joint ownership is now efficient for income tax purposes where one party to the 'marriage' has total income of over £100,000.
  4. Review payments on account of tax liabilities to see whether a reduction is appropriate.
  5. Offset the interest you pay on your buy-to-let mortgage against rental income to reduce the amount of tax you pay. Check to see if there is scope to reorganise total borrowings to increase tax relief.
  6. Claim tax relief on appropriate expenses such as repairs (not improvement expenditure), insurance and letting agency fees. Where a property is furnished you can currently either claim a wear and tear allowance or a deduction against income for replacing furniture and equipment.
  7. Offset your accumulated UK rental losses against future UK rental profits.

HOW BIG IS YOUR FOOTPRINT?

New legislation aims to lower the carbon footprint of larger firms.

From April 2010, any organisation that consumed more than 6,000 mega watt hours (MWH) of electricity during 2008 (an annual spend of approximately £500,000) will be legally obliged to participate in the Carbon Reduction Commitment (CRC).

A UK holding company will need to consider the electricity use of all its subsidiaries to assess whether the group as a whole is within the scheme.

The CRC is intended to encourage energy efficiency and increase awareness of the cost of climate change. Some organisations estimate that they will see an increase in energy costs of around 10% from April 2011, when credits must first be acquired.

Participants will have to buy carbon allowances each year (presently at a rate of £12 per tonne) to cover their emissions.

At the end of each scheme year, actual emissions will have to be reported and sufficient allowances surrendered to cover the CO2 output. If emissions increase, further allowances will need to be acquired. Participants will be rewarded for reduced emissions and early action.

The Government is writing to entities it believes are in the scheme but the obligation is on the organisations concerned to register, or they will be fined.

Likely issues for property companies include:

  • negative cashflow
  • the lack of any relevant provisions in existing leases
  • the need for apportionment of costs
  • joint action by landlords and tenants.

By way of example, if a landlord is a participant in the CRC and the energy contract is in the landlord's name, it will have to account for the emissions even though the energy has been used by its tenants. The ability of the landlord to pass the additional cost onto individual tenants would need to be addressed.

In addition to the financial costs, there will also be significant data capture, record keeping and other compliance costs for property companies. Organisations using more than 3,000 MWH per annum will be obliged to keep records of consumption.

The British Property Federation has published a guide for landlords and tenants explaining the CRC at http://www.bpf.org.uk/pdf/21401/CRC%20Guide%20A4.pdf

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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