Everything you need to know about Special Purpose Vehicles in UK Property

Background

The UK tax landscape is complicated. The optimal ownership structure will depend on a number of factors:

1. Is the property purely commercial or residential or mixed use? Or student accommodation or a care home?
2. Will the property be held as a long term investment or sold quickly?
3. For residential property; rented out or a home?

Set out below is a summary of the lifecycle of a currently tenanted commercial office block which is demolished and becomes a mixed use development.

Purchase

The seller could sell either the property or the shares in his offshore Special Purpose Vehicle (TargetCo) which owns the property.

In the context of property development, limited liability (i.e. property ownership through a Speciali Purpose Vehicle) is desirable.  Whilst this could be a LLP or a limited partnership etc, often the Special Purpose Vehicle (SPV) is a company (BidCo) as that is the easiest to establish, introduce investors/co-owners into, and ultimately sell.  Detailed analysis would be undertaken but corporate law and tax reasons may suggest either that BidCo is incorporated in the Channel Islands or in the Buyer’s home jurisdiction.

If the property is currently tenanted and BidCo is able to carry on that property rental business for (say) 6 months and other conditions are satisfied then the sale should be a transfer of a going concern (TOGC) and no VAT will be charged.   SDLT will be paid at commercial rates i.e. a top rate of 5% on the price paid.

A share purchase would not attract SDLT (just the 0.5% stamp duty on the share transfer) but BidCo acquires a company (TargetCo) with a history and potential labilities.  Due diligence (DD) will be undertaken by both the lawyers and the accountants.  From a tax perspective it is critical to verify that TargetCo has owned the property as an investment (not as trading stock) and has been centrally managed and controlled offshore so as not to be UK tax resident.  On those facts the past growth in value (i.e pre April 2019) of the property should be outside the scope of UK tax.  Tax warranties to flesh out the tax history of the company and a tax indemnity to protect against unknown pre-completion tax liabilities will also be negotiated.  Detailed DD in respect of the property should also be undertaken.

Despite the extensive DD exercise, typically the Buyer will procure that after BidCo acquires the shares in TargetCo, TargetCo is liquidated and the assets are hived up to BidCo.  With care, no SDLT should be charged on this transfer but the timing will have to be considered carefully so as not to prejudice the earlier TOGC analysis.

Development stage

The property was acquired as an investment but when the decision is taken to “sell” some units on long leases, that part of the property will be appropriated to trading stock.  There is a capital gain, but BidCo can elect to defer that gain until the apartments are sold.  The starting point for that gain will be the April 2019 market value.

BidCo will need to be registered as a contractor under the construction industry scheme (CIS) regime, VAT registered and opt to tax (OTT) the property.   It will be able to recover VAT that is charged by the contractors in respect of the commercial element of the building.

If the office block is demolished and a new building constructed most of the construction costs relating to the residential units will be zero rated for VAT purposes.  Using a “design and build” contract will mean that the architectural services are also zero-rated.  To the extent that BidCo intends to “sell” these units on long leases (over 21 years), it will make zero-rated supplies and should be able to recover the VAT charged to it (subject to blocking rules regarding “white goods” etc).  But to the extent that BidCo intends to grant ASTs, it will make exempt supplies.  VAT relating to that aspect is potentially irrecoverable.  If BidCo intends that the apartments will either be sold or let to third parties it will be entitled to a relief from the annual ATED charge upon completion of works

When the apartments and commercial units are let, Bidco will be subject to corporation tax (from April 2020) in respect of its rental income.

Disposal

The “sale” of the apartments will be a disposal of trading stock and subject to corporation tax under the 2016 Transactions in Land rules, taking into account the election made at appropriation. After many years of letting out the remaining property, the Buyer may decide either to sell the shares in Bidco or to procure that Bidco sells the property.  A sale of property or shares will be subject to corporation tax pursuant to the April 2019 rules taxing non-resident landowners’ capital gains

Residential apartment owners have the collective right of first refusal where their landlord proposes to dispose of its interest in the building.   This could hamper BidCo’s ability to enter into a sale quickly.  An additional SPV can be helpful here, as a headlease between BidCo’s interest and the residential apartments will block the right of first refusal.  This should be in place before the apartments are sold, so requires early planning.

Taxes and legal liabilities arise at every stage in the process and a detailed analysis is always needed.

This guest article was written by Helen Marsh and Elizabeth Small, who are partners at Forsters LLP.