Aside from the commercial reasons why a landlord and tenant may want to undertake a surrender and re-grant of a lease, there are a number of tax issues which must be borne in mind when considering an express surrender and re-grant of a tenancy.
A surrender and re-grant involves two acquisitions for SDLT: the landlord makes an acquisition on the surrender as the freehold is enlarged, and the tenant makes a separate acquisition when they are granted the replacement lease. A surrender and re-grant is therefore a land exchange.
The SDLT rules on land exchanges (where one of the limbs of the exchange is a major interest, such as a freehold or a leasehold) are ostensibly very punitive: SDLT is payable on the higher of the consideration passing (if any) or the market value of the interests acquired.
Some tax relief is available provided that the new lease is granted in return for the surrender of the existing lease and the surrender and re-grant are between the same parties. If so, the market value rule is switched off and SDLT is only payable by reference to any other chargeable “consideration” (i.e. money or other benefit) provided (for example, cash). Overlap relief on rent under the new lease may also be available.
VAT can be complex as the transaction is a barter transaction (a supply of land is made from the tenant to the landlord and vice versa and the consideration for these supplies is not wholly in cash). Whether VAT actually arises depends on whether the landlord and tenant have “opted to tax” their interests. An option to tax is an election a party will have made in relation to that party’s interest in land, which means that VAT is charged on “supplies” of that land or property, such as when the party sells it or rents it out to a tenant.
On a barter transaction, even though no cash may be changing hands, VAT must still be charged and accounted for by the party that has opted to tax. Valuing the consideration which the landlord gives to the tenant for the supply on the surrender (and which the tenant gives the landlord on the re-grant) is a difficult exercise and should be considered carefully. If both parties have opted and where no cash is changing hands, actual accounting for VAT can be simplified by using VAT-only invoices.
A typical surrender and re-grant scenario will not generally have any IHT implications unless there is a transfer of value under s3 Inheritance Tax Act 1984. There may be a transfer of value where there is a surrender for no consideration and no commercial negotiations. A transfer of value may also arise where the tenant and landlord are connected parties, for instance under the “close companies” provisions of the IHT legislation. Each case will turn on its own facts, so it is important to take proper advice from the outset.
The CGT position is generally more complex. For the landlord, the re-grant will usually amount to a part disposal of the freehold of the property out of which the new lease is granted. The landlord’s position will also depend on whether they receive a premium from the tenant or whether the circumstances are such that a notional premium may be imputed.
A surrender is usually considered to be a disposal by the tenant for CGT purposes. Generally, the consideration for the surrender will be the value of the new lease granted by the landlord, in addition to any consideration actually provided. However, this will not necessarily be the case where the parties are connected.
Where there is a disposal, whether there is CGT to pay will depend on whether there is a chargeable gain. This will be a question of valuation in each case. Certain reliefs may also be available to mitigate any tax liability. The tenant can often rely on HMRC’s Extra Statutory Concession D39. Where the five conditions set out in the Concession are met, the surrender by the tenant will not be regarded as a disposal. The five conditions can be found here: CG71240 – Leases: disposal: extension of lease: ESC D39 – HMRC internal manual.
In addition, the Concession will only apply where the new lease extends the term of the previous lease. Again, a case by case analysis of how the CGT rules apply to the facts is key.
Overall, a number of complex tax issues can arise on a seemingly straightforward surrender and re-grant, particularly where the parties involved are connected, the land in question is opted to tax or where one of them is a company.