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12 December 2008
Stamp duty land tax (SDLT) came into force on December 1 2003. Many leases granted on or after that date that work on a five-year cycle will shortly have their first rent review. If after December 1 2008 a tenant under such a lease suffers a substantial rent increase on review, it will now be subject to an SDLT charge under new provisions relating to abnormal rent increases.
At a time when many tenants are seeking rent concessions, this burdensome liability, imposed in addition to the increase itself, may be a financial outlay too far. Despite having had a five-year lead-in period in which to finalize legislation in this area, Her Majesty's Revenue and Customs (HMRC) has only recently acknowledged that the rules which came into force on December 1 2008 are unworkable and require amendment, which will not take place before the 2009 Budget. In the meantime, many tenants are in the unenviable position of being required to file SDLT returns and pay SDLT on the basis of rules which do not work, further increasing their tax risk and administrative burden.
Where a lease was granted after December 1 2003, the SDLT charge on the rent payable under the lease is calculated by considering the rent payable for the first five years and deeming the rent payable for each year thereafter to be the highest rent payable in any 12-month period during the first five years.
If the rent has been reviewed or has been subject to a relevant variation during the five-year term, the tenant should review its SDLT position and submit a further SDLT return if necessary. Variations or increases after the initial five-year period are not usually assessed for SDLT purposes. However, the abnormal rent increase rule is an exception.
If the amount of rent payable under a lease granted after December 1 2003 increases abnormally after the fifth year of the term, whether pursuant to a rent review provision or not, the rules interpret this as a deemed grant of a new lease in consideration of the excess rent, on which SDLT will be payable and for which an SDLT return must be filed.
The legislation provides that the deemed lease is assessed on the basis that:
What Constitutes an 'Abnormal' Increase?
The legislation broadly provides that an increase is considered abnormal if the rent payable has increased by over 20% year on year; thus, if the rent payable under the lease has remained the same for five years, the increase in rent must be 100% of the rent previously payable.
However, HMRC has acknowledged that the rules do not produce the intended results from an SDLT perspective. Furthermore, the statutory drafting raises a number of basic questions, including the issue of when an SDLT return should be filed in respect of an abnormal rent increase.
HMRC has stated that it cannot amend the legislation before the 2009 Budget. In the meantime, it is working with the industry to resolve the outstanding issues. In a welcome move, HMRC has indicated that tenants subject to an SDLT charge due to an abnormal rent increase between December 1 2008 and the 2009 Budget will be treated sympathetically if the rules have had a “disproportionate or burdensome" effect. The meaning of this phrase remains unclear.
Turnover Rents, Geared Rents and Stepped Rents
The rules apply where an increase in rent occurs as a result of the application of provisions in a lease for turnover rents, geared rents or stepped rents.
In order to circumvent the rule, tenants may include a cap in the rent review clause by stipulating that, upon review, the revised rent is below a specified figure. In view of market conditions, landlords may be prepared to agree to such a concession, although the uncertainty over how HMRC will amend the rules does not assist tenants in this regard.
When rent is reviewed on a five-year basis, further returns and SDLT payments may need to be made after each review. Tenants must ensure that they carry out the appropriate calculation after every review to determine whether the rent increase is abnormal, as a late filing of the required SDLT return may result in penalties and interest payments.
Given the uncertainty in this area, if a tenant suffers an abnormal rent increase before the 2009 Budget, it should consider whether it has been affected in a disproportionate or burdensome way, in which case it may wish to contact HMRC. However, tenants should not necessarily assume that HMRC will correct the legislation in Budget 2009 or will not pursue taxpayers under the law as it stands. R (on the application of Wilkinson) v Inland Revenue Commissioners  STC 270 made clear that HMRC's ability to provide an extra-statutory concession - by whatever name - is limited.
Landlords may be more willing to offer concessions to their clients in view of the economic climate. However, providing tenants with reassurance, such as an initial cap on rent, may put landlords at a financial disadvantage if the market recovers and market rents increase abnormally. Landlords should therefore consider possible concessions in light of their long-term financial plan for the property.
The rules on abnormal increases were introduced as an anti-avoidance provision to prevent tenants from using a loophole in the calculation of the SDLT charge on rent by artificially deflating the rent payable in the first five years and thereafter paying a higher rate of 'catch-up' rent. However, the rules will affect leases that were not part of such schemes. Tenants must consider the potential SDLT charge where the rent payable under their lease is increased. Unfortunately, this will be an uncertain and burdensome obligation, particularly until the 2009 Budget.
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