Overage covenants (or “clawback” provisions) allow a seller of land to share in any future uplift in value. For example, if planning permission is granted post-sale, the buyer may owe an additional payment. While these arrangements can be valuable, they also carry significant tax implications for beneficiaries. Overage covenants form part of the estate for Inheritance Tax (IHT) purposes; they do not qualify for Agricultural Property Relief (APR) and overage receipts may be subject to income tax.
The benefit of overage covenants usually remains with the transacting party, not the land. If it appears unlikely that the overage will be triggered during an individual’s lifetime, assigning these rights to the next generation could be a sensible step.
How to assign the benefit of overage covenants:
Step 1: speak to the Tax, Trusts & Succession team
The benefit of an overage covenant is treated as part of the estate for IHT purposes. It will be subject to the full IHT rate on death or a lifetime transfer on the value over the available nil-rate band (currently £325,000), subject to any relief. Crucially, these rights do not qualify for APR so it is likely that 40% of the value of the overage covenants could be payable in IHT.
Transferring the benefit of these covenants by way of gift to the next generation would take advantage of the Potentially Exempt Transfer regime for IHT. This means that after seven years, the value of the gift would be outside the estate for IHT purposes and taper relief would apply to reduce the rate of IHT after three years. There are, however, important rules to ensure that the benefit passed on has truly been given up.
While gifting the overage can offer IHT benefits, this should be balanced against Capital Gains Tax (CGT) on the transfer. The gift would be a disposal for CGT purposes, so any increase in value could be taxed at 24%. It also means that the estate would not benefit from the CGT ‘uplift’ that normally applies on death for assets within the estate. All the facts must be considered in each case to establish the most appropriate course of action.
Step 2: valuation
Valuing the overage covenant is a key part of understanding both the CGT and IHT implications. In many cases, transferring the asset sooner can be beneficial. Waiting until planning permission looks likely to be granted means that the value of the covenant may well be greater. This could lead to a higher CGT bill on the transfer, and – if the full seven-year period is not survived – a higher potential IHT charge as well.
Step 3: documenting the assignment
The first step is to check in the original agreement that the covenants are not expressed to be personal and may be transferred. It is also important to check for any restrictions, such as a requirement for the whole benefit to be transferred rather than allowing partial assignments.
Provided the original agreement allows for it, a deed of assignment can be drawn up between the original beneficiary of the overage (Assignor) and the person chosen to receive covenants (Assignee). This document will include important protections, making sure the Assignor is not responsible for any obligations under the original overage agreement after the transfer.
Step 4: deed of covenant
In most cases, the original overage deed will require the Assignee to sign a deed of covenant with the buyer, agreeing to comply with the obligations set out in the original agreement.
The deed of covenant will need to include matching commitments from the buyer to the Assignee, so that the Assignee is properly protected.
Step 5: update Land Registry and Companies House
Overage is often protected by a restriction registered at HM Land Registry. This means that, before the land can be sold or transferred, any new owner must enter into a deed of covenant (as set out above) with the overage beneficiaries. The Land Registry record should then be updated to reflect the names and addresses of any new beneficiaries.
In some cases, overage is protected by a legal charge over the land. If this is the case, the original charge will need to be released and replaced with a new charge in favour of the new beneficiaries. This needs to be registered at HM Land Registry and, where the beneficiary is a company, may also need to be registered at Companies House.
Additional step: review the overage terms
Assigning the benefit of overage provides a good opportunity to review the terms of the overage agreement, check that interests are protected and identify any potential improvements.
When negotiating overage:
When selling land with an overage provision, it’s worth planning ahead:
1. Consider ownership from the outset
If estate planning is a priority. think about putting the benefit of the overage in another person’s name immediately.
2. Include assignment provisions
Most overage agreements allow assignment unless expressly prohibited. For clarity, include wording confirming that the benefit of the overage covenants may be freely assigned without cost. This preserves the ability to transfer the overage benefit in the future as part of any estate planning.
Final thoughts
Assigning the benefit of overage covenants can be an effective estate planning tool, but it requires careful drafting and compliance with the original agreement. Each step must be handled correctly to protect interests and avoid unintended liabilities.
Always seek specialist legal and tax advice before proceeding to ensure the assignment achieves the intended objectives, minimises risk, and delivers the best outcome both for individuals and their families.
