What does the Budget do for Real Estate? Finance Bill update

Following on from the Budget, which did not contain any unexpected headline grabbers, the draft Finance Bill issued on 11 March contains further details and clarifications of various previous announcements of practical importance to the real estate sector. Some good, some not so good, some on which we can expect some lobbying.  There may, of course, be changes as the legislation passes through Parliament, so the position should be monitored. 

Further proposals and consultations are also expected to be announced on so-called "Tax Day" on 23 March. This is seen by some as an opportunity for the government to raise proposals for future tax reform – we'll be updating you anything relevant to the real estate sector in due course.

A. Rise in corporation tax to 25%

Perhaps the biggest announcement at the Budget was on corporation tax - rising to 25% from the current 19% for larger companies for the year 1 April 2023 to 31 March 2024. There is no statement as to what may happen after that. The provisions published in the draft Finance Bill give us some more details: for example, that the marginal rate relief fraction for those with profits over £50,000 will be 3/200ths on profits up to £250,000. Given that the lower rates are, effectively, proportionately reduced for groups, we expect this will give scant comfort to many of those reading this, although many smaller-scale corporate landlords will be unaffected and those potentially impacted may wish to consider how they structure future acquisitions, if appropriate.

The new corporation tax rate is likely to be particularly unwelcome for non-resident landlords, who, from April 2020, became subject to corporation tax (rather income tax at 20%). As well as exposing such landlords to CT rate changes (this announcement being a great example), this reform potentially also brings them within the corporate interest and loss restriction rules and anti-hybrid rules, which do not apply to income tax-payers. The fact that the headline rate of corporation tax (19%) was lower than the basic income tax rate (20%) was at the time seen as a (small) silver lining for those landlords affected by this change. That consolation will disappear and be replaced with materially higher tax bills.

It appears also that some of the highly publicised reliefs, such as the super-deduction and other first year capital allowances, will not be available to landlords, who will also not be helped by the changes to the trading loss carry back rules (see below). Accordingly, and disappointingly, these will not give any prior buffer/ compensating relief, as some may have hoped.

The rise in the CT rate will, therefore, impact on returns for landlords and others in the sector and, ultimately, impact on net returns to investors. No doubt, the change will further increase interest in alternative holding structures, such as REITs, PAIFs and tax transparent structures, as appropriate.

B. Trading Loss Carry Back

It was announced in the Budget that there would be an extended 3 year carry back of trading losses for accounting periods ending in the period 1 April 2020 to 31 March 2022, of up to £2,000,000 per 12 month period. Draft legislation for this measure has been included in the Finance Bill. The extension of loss carry back will not apply to losses generally and, in particular, in the context of real estate letting businesses, will not apply to non-trading loan relationship deficits or other non-trading losses.

As such, while beneficial to those with trading losses, and, potentially, to some tenants (and developers), it will not be direct assistance to landlords. 

C. Capital Allowances: not the buffer the sector may have hoped for

While there has been much talk of the super-deductions of 130% and other first year allowances, including in freeports, which were announced in the Budget, the draft legislation makes clear that these will not apply to landlords or letting businesses (since there is a general exclusion from claiming FYAs for expenditure on the provision of plant and machinery for leasing).  We understand that this is a policy decision, rather than an oversight, and so any hope that these measures would offset to a degree the future higher corporation tax rate has seemingly fallen away.  However, the limitation does not reflect the reality of how many transactions are structured, so we expect to see some lobbying on this.

The reliefs should, nonetheless, be useful to corporate occupiers in qualifying operating businesses, incurring expenditure on new qualifying plant and machinery assets qualifying for main rate (18%), which may help landlords indirectly. There are various conditions to and restrictions on claiming the reliefs, including for the plant to be new (which makes sense from a policy perspective, as the government is trying to incentivise new investment). 

For those who can otherwise use it, the 50% first-year allowance available for qualifying special rate (including long life) assets will not be available in relation to contracts entered into prior to 3 March 2021, even if the expenditure is incurred after 1 April 2021. This will certainly be a disappointment to some.

D. Freeports

The Finance Bill has clarified the rules around the tax incentives for the new freeports regime:

• An enhanced 10% Structures and Buildings Allowance will be available for constructing or renovating non-residential structures and buildings within Freeport sites brought into use on or before 30 September 2026. This allowance will reduce the time it will take to relieve the qualifying expenditure from 33 1/3 years to 10 years. Unlike the first-year allowances, it appears, helpfully, that this should be available to landlords.
• While not available to landlords, enhanced first-year allowances of 100% are potentially available for companies investing in new plant and machinery for use in Freeport sites. This relief will apply to expenditure incurred on or before 30 September 2026. Clawback provisions will apply to the extent such plant and machinery is no longer used within the Freeport area. Landlords and tenants should think carefully how they deal with entitlement and expenditure to ensure that these allowances are not wasted.

SDLT freeports relief

Schedule 22 of the draft Finance Bill contains more detail on the operation of freeport SDLT relief. The relief is, as with other measures referred to above, intended to stimulate investment in qualifying activities and so has a limited time period - in this case, applying to relevant transactions with an effective date on or before 30 September 2026.

The commencement date for the relief will be the effective date of the transaction - only once the sites are designated as freeports.  Though the Finance Bill includes designating powers, the actual designation for the purpose of this tax relief has not yet happened.  This may be relevant to transactions. We are not aware of expected timescales, but as generally the areas are now known, hopefully this is imminent.

Helpfully, however, this relief should apply to those acquiring the land for development (whether with a view to selling once developed or letting), as well as to those seeking to occupy themselves for a commercial trade or professions. Indeed, reference to a trade or profession expressly include a property rental business (PRB).  There are, however, in the context of real estate, three notable exceptions to the relief:

• land used or to be developed or redeveloped as dwellings (or gardens)
• land which is held as stock of the business for resale without development or redevelopment
• those sites where the use of the land would give an "excluded rent", this being rent in classes 2 -6 Table of section 605(2) CTA 2010.  These are, broadly, rent from electric line wayleaves, pipelines for gas and oil, mobile phone masts and wind turbines (a similar exclusion exists for PRB in REITs).

The relief only involves a complete exemption from SDLT if 90% of the chargeable consideration is attributable to qualifying freeport land. If this proportion is less than 90%, and provided it is at least 10%, SDLT payable is reduced by the relevant proportion. No relief is available where less than 10% of the chargeable consideration is attributable to qualifying freeport land. Consideration attributable to qualifying freeport land must be determined on a just and reasonable basis.

Importantly, the relief needs to be claimed and there are certain conditions attached. In particular, the purchaser has to use the land exclusively in a qualifying manner (see above). The relief can also be withdrawn if, at any point within the "control period" (generally, the 3 years following the effective date) the land is not used exclusively in a qualifying manner.  Helpfully, relief is not withdrawn if, due to unforeseen circumstances outside a purchaser's control (the example being time needed to remediate), it is not reasonable to expect the qualifying freeport land to be used exclusively in a qualifying manner. So, this would not seem to trigger a clawback. It would appear that a disposal of the land would not trigger a clawback (assuming that the land otherwise meets the conditions), but more clarity is required around this and we await the guidance.

Those seeking to acquire or use sites in these areas should look carefully at the precise wording of the legislation (once enacted) here to ensure that they are able to claim relief to the fullest extent possible.

Construction Industry Scheme

We now have the drafting detail on proposed changes to the Construction Industry Scheme (CIS) which are to come into effect from 6 April 2021. Generally, the changes are as expected, following the review published in November and aimed at tackling abuse:

• simplifying the deemed contractor rules, such that, broadly, a person who is carrying on a business at any time will be a deemed contractor when their expenditure on construction operations in the period of one year ending with that time exceeds £3 million.  The provisions include also transitional rules to cover the change and a discretionary grace period for those needing to register
• clarifying the rules on deductions for materials purchased by a sub-contractor to fulfil a construction contract, aimed at stopping deductions for this being taken at each step along the line
• providing new powers for HM Revenue & Customs (HMRC) to restrict CIS set-off claims against other employer tax liabilities. The detailed rules on this will be in regulations and
• expanding the scope of current penalties for providing false information for registration to persons facilitating the application.

The guidance will be updated for this in due course - ideally before 6 April would be very useful, such that people can fully understand fully how the rules are to operate by the time they have to apply them.

SDLT - extension of zero-rate band 

The extension of the current nil rate band of £500,000 for residential property and the subsequent three month temporary threshold to 30 September of £250,000, as announced at the Budget, have been set out in the form anticipated, so that only the portion of the purchase price above those amounts will be taxed (please see our briefing here for a reminder of the rules).

The rate band will revert back to £125,000 on 1 October 2021.

As expected, the relieving measures will continue to work in the same way (running off completion, not exchange) and existing reliefs will continue to apply as before.

SDLT - 2% non-resident surcharge

Again, it is confirmed that this will come in from 1 April 2021, other than (1) where the contract is entered into and substantially performed before 1 April (even though not completed until on or after that date) or (2) is entered into before 11 March, but is not substantially performed or completed until or after 1 April and is not varied, assigned etc on or after 11 March. 

For residential purchases within the 2% non-resident surcharge, from 1 April 2021, 2% will be added to each relevant band (whether for normal residential purposes or for residential purposes within the 3% surcharge and in relation to rental).

Many in the industry will be disappointed that there is no exclusion from the operation of the provision for non-resident entities which are widely held or non-close (such as funds). Even for UK tax resident companies, complex provisions of whether a UK company is "close" and "non-UK controlled" (and so potentially caught) will no doubt cause much consternation and additional cost in practice.  Multiple dwellings relief and the "6 or more" rule will, therefore, likely be all the more important.  Again, we may see onshore vehicles looking more attractive where they provide a structurally efficient option.

Already announced and to be incorporated into the Finance Bill with retrospective effect, this is really just a tidying up amendment, to ensure that the corporate interest restriction rules operate as expected for those REITs with non-UK resident companies with UK business that came into the corporation tax net last year, putting them on a level footing here with other REITs.