In this edition we take a look at what’s ahead for the COVID-19 restrictions on commercial landlords; a proposed new Building Safety Levy; the Court of Appeal’s definition of “vacant possession”; and key tax changes for the real estate sector.
COVID 19: Restrictions on commercial landlords – roadmap announced
On August 4, 2021 the Government published a policy statement entitled Supporting businesses with commercial rent debts.
The policy statement follows a call for evidence, the outcome of which was also published on August 4. The aim of the call for evidence was to help inform the Government as to the best way to withdraw or replace the temporary restrictions imposed on landlords of commercial premises in response to the impact on tenants’ businesses of COVID-19 and related measures.
The policy statement provides that the Government will introduce legislation to ring-fence rent debt accrued by tenants forced to close as a result of COVID-19 business measures between March 2020 and until trading restrictions are removed.
The ring-fencing will be coupled with a process of binding arbitration to be undertaken between landlords and tenants in respect of the ring-fenced rent debt. This is intended as a last resort if negotiations between landlords and tenants fail. Details of the arbitration process will be released “in due course”.
In the meantime, the Government intends to update and revise the existing voluntary Code of Practice for commercial property relationships during the COVID-19 pandemic. The update will set out the principles that landlords, tenants and arbitrators are expected to adhere to and which will ultimately be enshrined in the legislation.
Section 82 of the Coronavirus Act 2020, which prevents landlords of commercial properties from being able to evict tenants for the non-payment of rent, will also continue until March 25, 2022, unless the proposed legislation is in place before then.
The restriction on the use of the Commercial Rent Arrears Recovery (CRAR), which restricts the ability of landlords to seize goods owned by the tenant in lieu of rent owed unless the tenant has more than 554 days’ worth of rent arrears, has been similarly extended. In addition, the restrictions against serving a winding-up petition on the basis of a statutory demand implemented through the Corporate Insolvency and Governance Act 2020 have been extended until September 30, 2021.
While seemingly weighted in favour of tenants, the policy statement emphasises that those tenants who have not been affected by closures and who have the means to pay rent, should pay. Landlords and tenants should also bear in mind that, as confirmed in recent case law (see our May Real Estate Focus), there is no limitation on simply suing for arrears of rent.
The proposed legislation has been promised for this Parliamentary session.
A new Building Safety Levy
The long-awaited Building Safety Bill, introduced in Parliament last month (see our July Real Estate Focus), gives the Government the power to impose a new levy on developers wishing to construct certain high-rise buildings. If introduced, the new levy will contribute to the Government’s costs of remediating certain building safety defects, such as unsafe cladding.
A consultation was launched on July 21, 2021 to take this forward. It seeks views on the design and calculation of the proposed levy and also asks for evidence of its possible impact on housing supply, regeneration and the housebuilding industry more generally.
The current intention is that the levy will apply, with some exclusions, to developers in England seeking building control approval to construct a “higher risk building” under a new more stringent regime. Higher risk buildings are defined as buildings with at least two residential units, care homes and hospitals that are at least 18 metres in height or have at least 7 storeys. Proposed exclusions from the levy include affordable housing and refurbishments requiring building control approval, but suggestions are invited as to other categories of development or developer that should be excluded.
When calculating the levy, the Government is mindful that it needs to be transparent, simple and objective. Views are sought on two options:
- A charge per square metre of the entire internal floor area, subject to certain exclusions; or
- A fee per residential unit in scope of the levy.
Again, alternative proposals are invited. Evidence (such as an overview of typical cash flow over the lifecycle of a building project), is also sought to assist with setting the levy funding level and payment mechanisms.
The principal sanction for non-payment will be to withhold building control approval to prevent building work commencing, although other sanctions are also explored.
Subject to the passage of the Building Safety Bill, the Government expects the levy to come into force in 2023. It will sit alongside a new tax on developers in the residential property market, which is set to raise at least £2 billion over a decade towards the costs of making buildings safer (see our May Real Estate Focus for further details).
The consultation on the proposed levy closes on October 15, 2021.
What is vacant possession?
Delivering “vacant possession” can be critical for a tenant at the end of its lease or when seeking to exercise a break clause that is conditional upon doing so. But what amounts to “vacant possession”? That was the question before the Court of Appeal in Capitol Park Leeds plc v Global Radio Services Ltd  EWCA Civ 995.
The tenant of commercial premises purported to exercise a break clause in its lease. One of the conditions for doing so was that the tenant “… [gave] vacant possession of the Premises to the Landlord on the relevant Tenant’s Break Date.”
The “Premises” were defined in the lease as including “all fixtures and fittings at the Premises whenever fixed, except those which are generally regarded as tenant’s or trade fixtures and fittings, and all additions and improvements made to the Premises”.
Before vacating the premises the tenant stripped out not just the tenant’s fixtures but also other fixtures and features at the property including ceiling tiles, floor finishes, window sills, lighting, radiators, and pipework. The tenant’s intention had been to reinstate these in accordance with its repairing obligations but work stopped in anticipation of a dilapidations settlement with the landlord which never materialised.
The landlord claimed that vacant possession had not been given on the relevant date so that the break clause had not been validly exercised.
The court at first instance agreed, holding that vacant possession did not merely extend to the absence of people and the tenant’s possessions. By including fixtures and fittings and all additions and improvements in the definition of the “Premises” the landlord was ensuring that a tenant could not simply hand back an empty shell of a building which was unoccupiable. The tenant had not given the landlord vacant possession of the “Premises” and the purported exercise of the break clause failed.
However the Court of Appeal took the contrary view. In all the circumstances and construing the break clause in the context of the lease as a whole, the tenant was required to return the "Premises" as they were on the break date free of the "trilogy of people, chattels, and interests". On that basis, the tenant’s exercise of the break clause was effective. The building may have been left in a dire state, but that did not preclude the valid exercise of the break clause. The landlord’s remedy was to seek compensation for whatever loss it may have suffered.
A lucky “break” for the tenant given that it would otherwise have been locked into an unwanted lease until November 2025.
Tax update: key tax changes for the real estate sector
The recent publication of draft legislation to be included in the Finance Bill 2021-22, alongside a number of consultations and responses, bring the possibility of a number of tax changes for the real estate sector.
Real Estate Investment Trusts (REITs)
Changes are expected to some of the REIT conditions with effect from April 1, 2022.
The key changes proposed include:
- Removing the listing requirement for UK REITs, where at least 99% of the shares are held by “institutional investors” (which includes sovereign wealth funds, UK and overseas pension funds and life companies, limited partnership collective investment schemes and UK REITS, UK authorised unit trust schemes and OEICS (and, in each case, foreign equivalents));
- Amendments to the penalty charges for a REIT in respect of property income distributions (PIDs) paid to shareholders who have 10% or more of the shares in the REIT, where such shareholder is entitled to receive the PID gross;
- Amendments to the scope of “institutional investor” for overseas equivalent REITs; and
- Amendments to the “balance of business” test.
The proposed amendments are welcome, particularly for “private” REITs which may have met the requirement to be listed or traded on a recognised stock exchange by listing on The International Stock Exchange, or which do not have a trading requirement. They will also be welcomed by REITs whose investors may have considered fragmenting their holding so that it is held by a number of subsidiaries, none of which hold more than 10%.
It was hoped that there would also be changes to the “close company” rule, perhaps by extending the scope of who qualifies as an institutional investor or allowing a “look-through” approach, similar to that used in the non-resident capital gains tax rules. The draft legislation does not include changes in this respect, but these may be considered as part of the wider funds review which remains ongoing.
UK Qualifying Asset Holding Companies (QAHCs)
Following extensive consultation, a new measure is expected to introduce a regime for the UK tax treatment of QAHCs from April 2022.
The QAHC regime is part of a wider review looking at enhancing the UK’s competitiveness in the funds sector and is intended to make the UK a more attractive location for asset holding. The overarching aims of the new regime are, broadly, to tax investors as if they invested in the underlying assets and that intermediate holding companies do not pay more tax than is proportionate in light of the activities they perform.
The new regime offers a number of preferential tax treatments to holding companies which meet the QAHC criteria in relation to their qualifying investment activity. Key benefits of the regime are that:
- Gains on disposals of overseas land or shares (other than shares in UK property-rich companies) will be exempt; and
- The income profits of an overseas property business of a QAHC will be exempt where those profits are subject to tax in an overseas jurisdiction.
- Deductions will be allowed for certain interest payments that would usually be disallowed as distributions.
- The late paid interest rules will be switched off so that, in certain situations, interest payments are relieved in the QAHC on the accruals basis rather than the paid basis.
- The obligation to withhold basic rate income tax from payments of interest to investors in the QAHC will be disapplied.
- Premiums paid when a QAHC repurchases its share capital from an individual will be allowed to be treated as capital rather than income distributions where, broadly, these derive from capital rather than income from underlying investments.
- Repurchases of share and loan capital previously issued by a QAHC will be exempt from stamp duty and stamp duty reserve tax.
In order to qualify as a QAHC, the holding company must be at least 70% owned by diversely owned funds managed by regulated managers or certain institutional investors (including sovereign wealth funds and pension funds). It must also exist to facilitate the flow of capital, income and gains between investors and underlying investments.
At first glance this is a complex regime, both in terms of entry criteria and the application of the preferential tax treatment to the QAHC. At the same time as the introduction of QAHCs, the REIT regime is being amended to address a number of features that had made it unattractive. It may be that, for some funds in the real estate sector and particularly in light of the exclusion from the key benefits of UK real estate income and gains, and gains on disposals of shares in UK property-rich companies, the attractions of the established REIT regime will outweigh the complexity inherent in accessing the benefits of the new QAHC.
Other tax points to note
VAT grouping: the Government has consulted on proposals for key changes to the UK VAT grouping rules. However, it has confirmed in its response to the consultation that it does not intend to proceed with these amendments.
Updated guidance in respect of the VAT treatment of lease break and dilapidations payments remains awaited, almost a year after the September 2020 Business Brief (which stated that they considered lease break payments and dilapidations payments to be within the scope of VAT).
In the meantime, HMRC has stated that any change in view would no longer apply retrospectively and taxpayers can rely on the original guidance. We understand that the updated guidance should be available shortly.
For further details please contact Tax partner Julia Lloyd.