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Replies to Queries -- 3 - Landlord and tenant

28 February 2001
Issue: 3796 / Categories:
Replies to Queries – 3

Landlord and tenant
Our client has disposed of farmland for development (as a part disposal). He owns the land with his aunt.
He also farms the land with his mother in partnership, the partnership having an old style agricultural tenancy. In looking at the 1982 valuation for capital gains tax purposes, are we restricted to just including the value of the freehold land subject to tenancy, or can we include the value of the tenancy as well?
(Query T15,762) – Tenanted.
Replies to Queries – 3

Landlord and tenant
Our client has disposed of farmland for development (as a part disposal). He owns the land with his aunt.
He also farms the land with his mother in partnership, the partnership having an old style agricultural tenancy. In looking at the 1982 valuation for capital gains tax purposes, are we restricted to just including the value of the freehold land subject to tenancy, or can we include the value of the tenancy as well?
(Query T15,762) – Tenanted.

There are a number of issues here. The client is not entitled to call in aid Lady Fox's Executors v Commissioners of Inland Revenue [1994] STC 360, in order to value a combined part of freehold plus part of tenancy 'asset' as at 31 March 1982. As at that date, he has two separate assets, half a freehold and half a tenancy. As a rule of thumb, the former will have been worth 45 per cent of the vacant possession value of the farm.
If, as seems to be implied, it is only part of the farm which has been disposed of, a Notice to Quit under Case B following the obtaining of planning permission will not have been available to the landlords.
If the tenancy agreement contained a term enabling the landlords to terminate in relation to part of the land following the obtaining of such permission, then statutory compensation will have become payable to the tenants. While the payment will be deductible under section 38(1)(b), Taxation of Chargeable Gains Act 1992 by the landlords, it will not have been substantial when compared to the development value.
In the hands of the tenants, compensation under either head (i.e. Case B in relation to the whole or under the contract in relation to part) will not have been taxable, under Davis v Powell [1977] STC 32.
The tenancy would have had some 1982 value, but whether this should be calculated on

(a) the 'going concern' basis held appropriate in Walton's Executor v Commissioners of Inland Revenue [1996] STC 68, or
(b) 25 per cent of vacant possession value, as in Baird's Executors v Commissioners of Inland Revenue [1991] 9 EG 129, 10 EG 153

cannot be ascertained from the information given. The client's half share would have to be discounted by 10 per cent.
It is a nice point whether the termination of a tenancy under a Notice to Quit is a 'disposal' but, in principle, this should be the case. The loss of part of the land should therefore have given rise to a capital gains tax loss, on a part disposal basis as against the 1982 value of the tenancy. The client will have incurred half this loss.
The question which then arises is whether section 18(3), Taxation of Chargeable Gains Act 1992 prevents the use of that loss against the gain made on the sale to the developer of his half of the freehold. It seems that it does not because:

(i) as to the part attributable to the quarter disposed of to his aunt, she is not a relative within section 286(8), Taxation of Chargeable Gains Act 1992; and
(ii) as to the part attributable to the quarter disposed of to himself, section 286 does not address the situation, and, because of the co-ownerships, no merger takes place within section 43, Taxation of Chargeable Gains Act 1992.

It remains to consider the situation which would have arisen if the tenancy agreement did not permit the landlords to terminate it in relation to part of the land after obtaining planning permission. The only way in which vacant possession could have been made available would have been for the developer to buy the freehold subject to tenancy in a transaction linked with an agreement for the assignment or surrender of the tenancy by the tenants. In this event, the freeholders would have received a lower value, because part (and possibly as much as 25 per cent) of the sale price would have had to be paid to the tenants. The tenants would be able to set their indexed base value against this.
For taper purposes, both interests will qualify as business assets under paragraph 5(2)(a) of Schedule A1 to the Taxation of Chargeable Gains Act 1992. – WJdeS.

The land will have been sold to developers with vacant possession and the tenants will have surrendered their tenancy to the freeholders. The client owns the freehold jointly with his aunt and the tenancy jointly with his mother. The surrender of a tenancy is a disposal for capital gains tax. The client cannot make a disposal to himself but his mother will be deemed to have disposed of her share of the tenancy to him (and his aunt) because they are connected persons (see section 286, Taxation of Chargeable Gains Act 1992).
The sale of the freehold is a part disposal, so the cost will be calculated by reference to the value at 31 March 1982 x A/A + B, where A is the disposal proceeds and B is the market value of the remainder of the land. If the sale proceeds are high relative to the value of the remainder, this can help to reduce the gain because a disproportionate amount of the March 1982 value will be utilised against this disposal.
As far as the March 1982 value itself is concerned, the client has an interest in the freehold and the tenancy. Some guidance on this type of valuation was given in the inheritance tax case of Gray (surviving executor of Lady Fox) v Commissioners of Inland Revenue [1994] STC 360; it was held that where a taxpayer has an interest in a freehold and a tenancy, his interests should be combined for valuation purposes. Therefore the March 1982 value will be freehold value less an amount payable to mother to surrender the tenancy and less a discount for the difficulty in obtaining vacant possession.
The client will no doubt be considering ways of reducing the capital gains tax payable. There are various possibilities. He may be able to roll over the gain under section 152, Taxation of Chargeable Gains Act 1992 into an acquisition of farmland or buildings or fixed plant and machinery in the period one year before and three years after the disposal. Furthermore, he may have trading losses which he can set off against the gain under section 71, Finance Act 1991. Also certain tax privileged investments (such as the enterprise investment scheme) require reinvestment of only the gain and not the full proceeds. – G.S.


Issue: 3796 / Categories:
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