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A possible letting strategy for house builders

31 July 2008

In the current economic climate many house builders are faced with the problem of surplus stock. Holding on to the properties until the economy improves is not generally an option.

Whilst Housing Associations may be prepared to take some of the stock, and even with the government’s additional £200 million for the HA sector, in many cases this will not be appropriate, either because the property is not the kind of property the RSL is looking for, or it is not built to the standard required by the RSL, or more simply because the parties cannot agree on a price.

At the same time the rental market is booming, so many house builders will be considering renting out their stock houses and flats on assured short-term tenancies (“ASTs”) until such time as the market improves.

Indeed the press has recently confirmed that a number of house builders are considering funded JVs to jointly hold and let excess stock, possibly with a view to the stock being transferred into residential REITs at some point. Whilst superficially attractive, in giving rise to immediate cash-flow unless done properly these schemes can result in some nasty surprises.

A house builder will have recovered all the VAT it incurred (“input VAT”) when acquiring the land and on its building and professional costs (although the majority of the building costs would not have suffered VAT). This is because it would have been making an onward zero rated supply of the property by selling the freehold or granting a long lease (more than 21 years).

If the house builder grants ASTs these are treated as exempt supplies and HM Revenue & Customs (“HMRC”) will claw back all of the input tax recovered to date. If later on the house builder does sell the freehold or grant a long lease then it should be able to recover a proportion of the input VAT. Nevertheless, this would be a significant and unexpected cost.

In order to get round the problem of VAT being clawed backed the house builder could instead set up a separate subsidiary company (“Letco”) to which it transfers the freehold or grants a long lease.

The subsidiary should not be grouped for VAT purposes with the house builder. This means that for VAT purposes the supply is treated as zero rated with the result that there is no claw back of VAT. Letco will then grant the ASTs. ASTs are exempt supplies for VAT purposes, which means that Letco cannot recover its input VAT. In due course Letco can sell the property, again this would be an exempt supply. The principal input tax that Letco is likely to incur will be on professional costs.

From a corporation tax perspective, the transaction between the house builder and Letco is likely to be deemed to take place at market value, so that a corporation liability would arise on the disposal of the property. However, depending on the company’s year end and its corporation tax payment profile it may be that by the time it has to pay the tax, the property has been sold on in which case it will be in funds to pay the tax.

The final piece of the jigsaw is the stamp duty land tax (“SDLT”) position. Provided, broadly there are not arrangements for Letco to leave the group or for funding to be provided by third parties, it should be possible to transfer property to Letco with no SDLT cost. Otherwise SDLT at up to 4% on the market value will be payable.

There are a number of other options that can be explored depending on the facts and circumstances of each case, which can mitigate against the cash flow disadvantages of holding stock, and the above proposal is just one of those options. It is possible with some careful thought to maximise returns in what is a poor economic climate, but a number of traps must be avoided.

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Steve Wiltshire

Partner
T: 08700 86 8378
I: +44 (0)1908 48 8378
E: steve.wiltshire@shoosmiths.co.uk