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Replies to Queries - 2 - Lease disposals

06 February 2002
Issue: 3843 / Categories:

An individual purchased a lease in 1983 with 26 years left to run. The original lease was for a period of over 80 years. In early 2000 when the remaining period of the lease was informally valued at £60,000, he negotiated a new extended lease commencing in 2000 for a period and paid £100,000 for it.

An individual purchased a lease in 1983 with 26 years left to run. The original lease was for a period of over 80 years. In early 2000 when the remaining period of the lease was informally valued at £60,000, he negotiated a new extended lease commencing in 2000 for a period and paid £100,000 for it.

The new leasehold interest has now been sold. The two ways of calculating the capital gains arising are to (a) treat the cessation of the first lease and the commencement and disposal of the second lease as two separate capital transactions or (b) to take advantage of Extra-statutory Concession D39 and ignore the first disposal.

Looking at the 'normal position', the Inspector has said by means of a post transaction ruling that for capital gains tax purposes the proceeds to bring in are both the £60,000 residual value and the £100,000 paid by the individual for the new lease with no deduction. Where consideration is given, surely this cannot be the case? We conclude that the first gain is measured based on the market value at the date the old lease was surrendered (£60,000 – subject to the District Valuer agreeing the value) less any remaining unwasted cost, etc. The new lease has a base cost of £60,000 plus the £100,000 paid.

Are we on the right track?

(Query T15,949) – Bulldozed.

 

A lease is said to be 'surrendered' when it is disposed of to the holder of the immediately superior interest in the property.

The surrender of a lease involves both the disposal of that lease by the tenant and the acquisition of it by the landlord. This is the case even though when a lease is surrendered, it normally merges with the superior interest and ceases to exist.

The terms of a particular lease may provide for its extension if the tenant so requests. If such a request is made, the extension of the lease does not have any immediate capital gains tax consequences.

The Inland Revenue Capital Gains Tax Manual notes at paragraph CG 71241, however: 'the extension of a lease outside its original terms entails the surrender of the old lease and the grant of a new one. The surrender of the old lease is a disposal for capital gains tax purposes with the consideration received being the value of the new lease'.

I think the Inspector has been misled by this statement, which would be true if nothing was paid for the new lease. Where nothing is paid for the new lease, the consideration received for the disposal of the old lease is the value of what is received in exchange for the disposal, i.e. the value of the new lease. That consideration is, however, reduced by a pound, for every pound paid by the lessee.

The question then is what is the value of the new lease? Is it the £100,000 agreed to be paid by the client, or would anyone other than the client have had to pay £160,000 for the new lease, i.e. the value of the unexpired term of the old lease before it was 'extended' plus the £100,000 paid for the 'extension'? This is a point that needs to be referred to a valuer, and agreed with the District Valuer.

If the value of the new lease is £160,000, and the client has paid £100,000, then the only consideration the client has received for the disposal of the old lease is the difference between these two figures – £60,000. If the value of the new lease is £100,000, and the client has paid £100,000 for it, there is no consideration received by the client for the surrender of the old lease. The value of the new lease may of course be anywhere between £100,000 and £160,000, or indeed in excess of £160,000, and the consideration received for the disposal of the old lease will be the value of the new lease, less the £100,000 the client has paid for the new lease.

The gain would then be calculated by deducting from this consideration the acquisition costs, reduced according to the rules for wasting assets, plus indexation allowance, and any incidental costs of acquisition and disposal. The resulting gain will then be subject to a deduction for taper relief at the appropriate rate.

The consideration given in money is the £100,000 paid, and the consideration given in money's worth is the surrender value of the old lease – £60,000. – Taxplanet.

 

Section 43, Taxation of Chargeable Gains Act 1992 (assets derived from other assets) is concerned with various situations, including that where the value of an asset is derived from any other asset in the same ownership. That section was considered to some extent in Bayley v Rogers [1980] STC 544. Attention was also given to what is now paragraph 16(9) of Schedule 2 to the Taxation of Chargeable Gains Act 1992, whereby the period of ownership to be recognised on disposal is favourably extended.

Lacking sufficient particulars of the duration of the leases to offer computations, it may be helpful to refer to a back copy of Taxation (11 July 1991 at pages 396 and 397) where Readers' Forum replies to Query T13,819 provided an example of the calculations necessary to benefit from the costs of the earlier lease.

As indicated by Inland Revenue Extra-statutory Concession D39, disregard of the concession would imply acceptance of a possible chargeable gain at the time of the agreement with the landlord. The purchase price in 1983 (not subject to wasting) could fall short of the terminal value (£60,000). From the Revenue standpoint, the workload related to the two parties is lightened by the concession which need involve little loss of tax overall.

Subject to possible short lease wasting, it is agreed that the new lease should have a base cost of £160,000 (in the context of an assignment to a third party). – Lane.

 

Extract from reply by 'JdeS':

Extra-statutory Concession D39 is confined to situations in which an actual, i.e. expressed, surrender of the old lease has taken place. Option (a) would only be the 'normal' state of affairs in these circumstances.

Where the surrender of the old lease has taken place by operation of the law, i.e. because a superior interest in time is being acquired by the lessee, then it is only possible to make sense of Extra-statutory Concession D42 (merger of leases) by construing such a transaction as within section 43, Taxation of Chargeable Gains Act 1992. This is considered to be the case despite the widely accepted view amongst conveyancers that the old lease is treated as having been surrendered by implication of law immediately before, rather than contemporaneously with, the grant of the new lease.

Under section 43, the old lease is treated as being absorbed into the new lease without a disposal of it having taken place. While this would result in a different computation, there would be no question of the £100,000 having to be brought in on the wrong side of the minus sign.

Issue: 3843 / Categories:
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