If premises are ready for immediate occupation and use, the landlord and tenant can proceed immediately to the grant of a lease. In that case, the tenant will pay stamp duty land tax (SDLT) on the lease, based on the amount of the rent and any premium payable.
Where the parties wish to commit but cannot proceed directly to the lease, they may enter into an agreement for lease. This frequently occurs where new premises are being built, or where existing premises need to be converted or refurbished.
Despite the frequency with which agreements for lease are encountered, their SDLT treatment remains a mystery to many practitioners. The errors and outdated guidance within HMRC’s online Stamp Duty Land Tax Manual do not assist. But an analysis of the underlying legislation in the Finance Act 2003 (particularly paragraph 12A of Schedule 17A and section 81A) reveals a much simpler explanation.
Contracts are usually ignored for SDLT purposes. The starting point is that SDLT is triggered by completion of a land transfer rather than exchange of contracts, and by completion of a lease rather than exchange of an agreement for lease.
That changes, however, if the contract is substantially performed. Substantial performance includes the buyer or tenant taking occupation of the premises, paying 90% of the purchase price or starting to pay rent. While this can occur on a contract for sale, it arises much more frequently in the context of agreements for lease. A development agreement for lease will often allow the tenant early access to commence fitting-out works, which is sufficient to constitute substantial performance.
Because lawyers are not directly involved in the tenant taking occupation, it is easy for tenants to overlook substantial performance. Sometimes, it is not entirely clear whether and when substantial performance has occurred.
If an agreement for lease is substantially performed, paragraph 12A deems a notional lease to have been granted at substantial performance, for a term commencing on that date and expiring at the end of the term of the actual lease.
If the end date of the lease is known, the whole of the SDLT for the lease is due at this point. A land transaction return must be submitted, and any SDLT paid, within 14 days of substantial performance. This can be a tight timescale, especially if substantial performance has come as a surprise.
However, in many cases the end date of the notional lease will not be known at substantial performance. This will be the case where the tenant takes access for fitting out ahead of practical completion, but the lease term will be calculated by reference to the date of practical completion. If the term is unknown, the notional lease is treated as a lease for an indefinite term, and initially assessed as a lease for one year. Unless the rent (including any VAT) exceeds £150,000, no SDLT will be due at this stage and no return needs to be submitted.
As well as accelerating the date on which SDLT is payable, incorporating the period between occupation and lease completion into the notional lease will usually result in the notional lease being for a longer term than the actual lease. If the tenant commences fitting out three months ahead of practical completion and then takes a lease for ten years from practical completion, the notional lease will be for ten years and three months.
Once the actual lease is completed, the SDLT consequences will depend on what has gone before.
If the agreement for lease was not substantially performed, it is ignored for SDLT purposes and SDLT will be triggered by the grant of the lease in the usual way.
If the agreement was substantially performed, there is no longer any requirement to submit a return for the actual lease. Since the ‘simplification’ exercise in 2013, paragraph 12A confirms that the actual lease is disregarded (save for the purposes of finalising the SDLT due on the notional lease) and will never require its own return.
However, the SDLT position of the notional lease will need to be revisited:
- If the end date of the actual lease was known at substantial performance, and nothing has subsequently changed, then the return filed and tax paid for the notional lease following substantial performance should be sufficient and no further action should be necessary.
- If a return was filed following substantial performance but more tax is now due (perhaps the rent was increased in the actual lease to reflect measurement ‘as built’), then a further return (by way of letter) must be filed for the notional lease, and the additional tax paid, within 30 days of the lease being completed.
- If no return was filed following substantial performance (perhaps because the end date was unknown and the notional lease was therefore treated as a lease for one year) but the notional lease is now notifiable, a full return will need to be submitted, and any tax paid, within 14 days of the lease being completed. This will however still be a return for the notional lease, rather than a return for the actual lease.
A complex area
SDLT can be a complicated tax to understand and apply. The treatment of agreements for lease where substantial performance occurs is a particular minefield, and it would be helpful if HMRC could update and correct the Stamp Duty Land Tax Manual in this area. Ultimately, however, the reality is probably less complicated than many practitioners suspect.