Birthday announcement by Revenue Scotland
The Revenue Scotland website recently announced (emphases added):
“The Land and Buildings Transaction Tax (Scotland) Act 2013 sets out the legislative requirement for a tax return to be submitted for leases in Scotland in specific circumstances including:
Every three years from the effective date of the lease
The first three-year review point for leases subject to LBTT is 1st April 2018.”
Land and Buildings Transaction Tax in place of Stamp Duty Land Tax
The first “three-year review point for leases [being] 1st April 2018” is because Land and Buildings Transaction Tax (“LBTT”) – the Scots form of Stamp Duty Land Lax (“SDLT”) – was born on 1st April 2015. So, 1st April 2018 will be its third birthday.
Whilst, in general, LBTT pretty much copied the scheme of SDLT one significant departure was in relation to commercial leases. In order to fit better with Scots property law the LBTT rules included a requirement for the tenant in a lease which had been included in an LBTT tax return to submit a further return following every third anniversary of the lease. So this will affect tenants from 1st April 2018.
The impact will be significant. Next month’s BPU will pick up on some of the implications of the requirements of three yearly tax returns. But, first, to give some context to that this BPU will say something about the general scheme of LBTT for leases.
The general scheme of LBTT for leases
“Net present value”
- The general approach is to see the landlord’s ownership of the lease as the right to a flow of rents to the landlord over the period of the lease. If the landlord sells the landlord’s interest in the lease, the assumption is that such an interest should command as a price in the market an amount equivalent to the sum of the rents that would be payable over the term of the lease but discounted to the present to take account of the fact that some of the rent won’t be payable for many years. This capital sum is called the “net present value” (“NPV”)
- The general approach therefore is to tax the tenant entering into a lease treating the NPV as something equivalent to the price the tenant would have to pay to buy out the landlord’s interest in the lease. In principle, there is a logic in this.
Attractions to tax authorities
- There are attractions to the tax authorities of this general approach. In particular, the economic activity associated with leases comes within the tax net and much of the tax is paid up front; and before SDLT (now, for Scotland LBTT) was introduced stamp duty on lease documents was charged on the average rental depending on the length of the lease – a crude but simple approach. By switching to the NPV of total rents over the length of the lease instead of a tax on average rents, the tax burden on commercial tenants was increased significantly.
Square peg in a round hole?
- But the approach doesn’t really fit very easily with the way leases generally function. Only in a situation where the length of the lease and the actual amounts of the rents payable over the length of a lease are known in advance, does it deliver a result that closely mimics the economics of the taxation of the transfer of outright ownership of land.
- The problem with leases include:
- the length of the lease may not be known for certain in advance;
- it is also unusual today for leases of any substantial term not to have provisions for variation of the rent from time to time;
- if a “break clause” (i.e. a clause allowing for early termination) is exercised and there is early termination, does the tenant still have to pay the NPV of the rents over the full length of the lease, even if it was always within the contemplation of the parties that termination was more likely than not?
- if there is transfer (assignation) of a lease, does the original tenant stay liable for the tax or is the liability taken over by the incoming tenant?
- if rents are subject to a contingency, is the NPV based on the contingency being fulfilled or is the tax payable only if the contingency materialises?
- As far as these issues are concerned LBTT has largely followed the approach taken in the UK SDLT legislation. The only substantial innovation which has been introduced to the Scottish legislation is to have a rolling review every three years of tax payable against actual rentals. That takes us back to Revenue Scotland’s birthday announcement about “the legislative requirement for a tax return to be submitted .. every three years from the effective date of the lease.”
- That will be the subject of next month’s BPU.
Note: This material is for information purposes only and does not constitute any form of advice or recommendation by us. You should not rely upon it in making any decisions or taking or refraining from taking any action. If you would like us to advise you on any of the matters covered in this material, please contact Joyce Moss: email@example.com