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TaxationWeb by Julie Butler, FCA

Julie Butler FCA of Butler & Co outlines some current tax implications of ‘slice of the action’ sale agreements involving land development profitWith the current continuing demand (and need) for housing combined with relatively high property values the need for all property owners to try to achieve any future ’slice of the action’ development profit (‘overage’) has never been stronger.

What is ‘overage’?

‘Overage’ is securing the rights to future value. ‘Overage’ is making a statement in the sale agreement as follows, ‘You may realise additional value and if you do, you will pay me for it’.

At first glance ‘overage’ might just appear to be farmland that might be developed at a future point. It can however include a much larger amount of property e.g. private dwellings with large gardens, low key business and residential property that might at some stage enjoy development value.

Types of ‘overage’

These can take the form of restrictive covenants, reverse options, lease with option to purchase freehold and Ransom strips. The key is to put a structure in place to ensure a tax efficient overage payment.

The need to protect the right to future development profit

Every person involved in property disposals must consider the need for clauses which protect the vendor’s right to a share in the future development profits. There have been cases where solicitors, land agents and estate agents have been sued for negligence for not bringing the opportunity for ‘overage’ to the vendor’s attention.

It is therefore important that all land and property sales not only include the protection to a right to future profits but a need to ensure that when the monies are received they are taxed efficiently. Firstly the key is to capture the ‘profit’ as a capital asset for capital gains tax with all the potential tax relief advantages e.g. the annual exemption, principal private residence relief, indexation, business asset (and non-business asset) taper relief and rollover relief.

The potential income tax trap

The potential income tax trap is that Section 776 ICTA 1988 assesses gains on the sales of land to income tax not CGT.

Section 776 applies where:

• land is developed with the sole or main object of realising again from the sale of the land when developed;

• land or any property deriving its value from land, is acquired with the sole or main object of realising a gain from disposing of the lands’; or

• land is held as trading stock.

Charities

Charities can suffer under section 776. There is no exemption from s 776 therefore it is essential to ensure that overage is structured as a capital payment.

An alternative is to use an incorporated trading subsidiary which is a UK limited company. The key is then to make gift aid payments of the company’s profits to the charity to try and ensure that no liability to tax arises.

Non-UK residents

Non–UK residents are not chargeable to capital gains tax; however they are chargeable to income tax from UK property. These non-UK residents would therefore be subject to section 776 on the sales of UK land chargeable to income tax under section 776.

Early tax planning

Clearly it is important to maximise receipts to in the hands of the vendor and this included minimising the tax liability. The tax planning should be put in place before the contract is agreed perhaps via the heads of agreement, which checks what the tax position is.

Companies

Companies do not enjoy Business Asset Taper Relief (BATR) so it is not so important for the ‘overage’ to be under the ‘capital’ structure as opposed to an income structure.

Restrictive covenants

A restrictive covenant is property. It derives its value from land and therefore the payment for release of a covenant should be assessable to capital gains.

On disposal the vendor receives consideration which is the purchase price and the restrictive covenant is not a business asset and therefore not eligible for BATR but it will achieve non – business asset taper relief. Clearly, this is an improved tax position on the top rate of income tax.

Slice of action contracts

In the ‘slice of action’ cases the vendor is to receive an agreed percentage of the future development profits. The initial consideration is the disposal of capital assets and is therefore subject to capital gains tax. However, the subsequent consideration is the disposal of a new asset – the right to the contingent consideration (the ‘slice of action’) at a later date. It will be caught under section 776 as the contract is acquired with the sole or main object of realising a gain from the development of the land. It will therefore be taxed as income tax.

The key is not only to secure the share of future profits but to secure that right tax efficiency.


June 2005

Article supplied by Julie Butler FCA, Butler & Co, Bowland House, West Street, Alresford, Hampshire, SO24 9AT. Tel: 01962 735544. Email; j.butler@butler-co.co.uk.

Julie Butler F.C.A. is the author of Tax Planning for Farm and Land Diversification ISBN: 0754517691 (1st edition) and ISBN: 0754522180 (2nd edition) and Equine Tax Planning ISBN: 0406966540. To order a copy call Tottel Publishing on 01444 416119.