PIM1222 - Other sums treated like premiums: Charge on assignment of lease granted at undervalue
A charge to tax may arise when:
- a lease for 50 years or less is granted,
- the consideration for granting the lease is less than market value (that is a premium could have been charged, or if one was charged it could have been greater), and
- the lease is then assigned at a profit.
The charge is under ICTA88/S35 or ITTOIA05/S282.
When does a charge arise?
The conditions for a charge under ICTA88/S35 or ITTOIA05/S282 to arise are as follows.
- A lease of 50 years or less has been granted, and the terms are such that the landlord (the grantor) could have required a premium to be paid, or a larger premium to be paid, on the assumption that the negotiations were at arm's length.
- The lease is later assigned to someone else at a profit, that is:
- if the lease has not been assigned before, for more than the original premium, or
- if the lease has been assigned before, for more than the consideration for which it was last assigned.
How much is the charge?
Compare two figures:
- the amount which the original grantor of the lease could have charged, but did not, called the amount foregone in ICTA88/S35 and the undervalue in ITTOIA05/S282,
- the profit made on the assignment of the lease, as explained above.
and take the smaller figure. A proportion of it is charged on the person who assigned the lease at a profit (the assignor). The proportion is the same as would have been charged on a premium when the lease was first granted. See example 1 below.
If the charge arises on a later assignment of the lease, rather than the first assignment of it, the figures to compare are:
- the profit on the latest assignment of the lease, and
- the original amount foregone reduced by the amounts of any profits charged on previous occasions.
See example 2 below.
How is the charge imposed?
The chargeable amount is treated as income of the assignor's rental business in the year in which the assignment takes place. If he already has a rental business it is treated as part of the same business, unless it is in a different capacity such as trustee, personal representative, partner etc (see PIM1020).
On 1 June 2002 Quentin grants a 21 year lease of a shop to Rachel for no premium and a rent of £100 per annum. In an arm's length deal he could have asked a premium of £50,000.
Rachel assigns the lease to Simon on 2 June 2002 for a premium of £40,000.
The amount foregone by Quentin was £50,000. Rachel is charged under Schedule A for 2002-03 on £24,000, calculated as follows:
|Smaller of profit and amount foregone||£ 40,000|
|less £40,000 x (21 - 1) / 50||£ 16,000|
|Chargeable amount||£ 24,000|
On 1 October 2004, Simon assigns the lease in the same shop to Thomas for £155,000. Simon has made a profit of £115,000. The original amount foregone was £50,000 of which £40,000 was covered when Rachel assigned the lease. Simon is chargeable under Schedule A for 2004-05 on £6,000 calculated as follows:
|Lesser of Simon's profit and balance of original amount foregone||£10,000|
|less £10,000 x (21 - 1) / 50||£ 4,000|
|Chargeable amount||£ 6,000|
If Thomas were later to assign the lease at a profit, no further charge under ICTA88/S35 or ITTOIA05/S282 would arise, as all the original amount foregone has now been covered.
The point of this legislation is to prevent avoidance of the charge on premiums by means of the landlord granting a lease at undervalue to an associate, who then assigns it to the intended tenant at a figure close to the premium that could have been asked. A charge is unlikely to arise where the lease was originally granted at arm's length.
If, for example, the lease was granted to a sitting tenant entitled to a new lease under the Landlord and Tenant Act 1954, the landlord might well not have been able to get the premium he could have got if the property were offered to someone else with vacant possession. You do not need to assume the hypothetical situation of an empty property. If the tenant later assigns the lease at a profit, with vacant possession, no charge arises under ICTA88/S35 or ITTOIA05/S282 if the original landlord got the best deal he could from his sitting tenant. He did not forego any value.
Liaison between offices
Where a lease is assigned at a profit, and you think that avoidance is involved, you should contact the office dealing with the assignee and with any other previous holders of the lease. You will need to find out:
- whether the lease was granted at less than market value, and the amount foregone,
- the amounts previously charged to tax under ICTA88/S35 or ITTOIA05/S282.
If the amounts previously charged do not add up to the amount foregone, there will be a charge under ICTA88/S35 or ITTOIA05/S282. You should pass details on to the office dealing with the assignee so that they can make a further charge under ICTA88/S35 or ITTOIA05/S282 on any later assignment, and correctly allow relief claimed by the assignee (see PIM2300 onwards).
Obtaining Valuation Office Agency advice
Advice as to the amount of the premium that could have been charged in an arm's length transaction may be obtained from the Valuation Office Agency. Please follow the guidance in PIM1232 when seeking their advice.
Application for a certificate
Any of the parties involved may submit to HMRC a statement showing whether a charge arises under ICTA88/S35 or ITTOIA05/S282 and if so the amount involved. If you are satisfied that it is accurate, you may issue a certificate to that effect (ICTA88/S35 (3) or ITTOIA05/S300). If you receive such an application, proceed as follows.
- Draw the applicant's attention to ICTA88/S42 which requires HMRC to give notice of the intended determination of amounts chargeable under ICTA88/S34, ICTA88/S35, ICTA88/S36 or under Chapter 4 Part 3 of ITTOIA05 to all the parties concerned.
- Invite the applicant to show that the other parties are all in agreement with the determination sought.
- If the other parties are in agreement, give the certificate (unless it is not an arms length figure and a tax advantage is obtained as a consequence - e.g. an exempt body agrees a chargeable amount to give the tenant an extra deduction).
- If the other parties are not in agreement, refuse the certificate. Then check the details with the offices dealing with the assignee, and all previous persons who were lessees under the lease to establish the amount chargeable under ICTA88/S35 or ITTOIA05/S282.
You can find out more about ICTA88/S42 in PIM2340.