Despite the new forms of tenancy introduced by the Agricultural Holdings (Scotland) Act 2003 (“the 2003 Act”) it remains possible to create new tenancies under the Agricultural Holdings (Scotland) Act 1991 (“the 1991 Act”). While new 1991 Act tenancies are rarely (if ever) used for open market lets, there remain a number of situations when parties will want to use them.
The 2003 Act introduced (as Section 10A of the 1991 Act) the right for tenants with a 1991 Act tenancy to assign their lease to a permitted class of assignees. A significant number of tenants with 1991 Act tenancies have now taken advantage of this.
Landlords will be all too aware of the Revenue’s increasingly robust approach to the availability of Agricultural Property Relief (“APR”). In particular, land which is subject to a lease granted before 1st September 1995 only attracts APR at 50%. Where landlord and tenant are facing in the same direction on the issue of assignation, it is not unusual for the landlord to ask the tenant if he would have any objection to using a new 1991 Act tenancy (rather than proceeding by way of statutory assignation of the old lease) so as to achieve APR at 100%.
The purpose of this article is to consider a number of areas where legislative amendment has created pitfalls for the unwary (both for tenants and landlords) when looking to set up new 1991 Act tenancies in this way.
Stamp Duty Land Tax
On 1 December 2003, a matter of days after the 2003 Act came into force, the old system of Stamp Duty for leases was swept away and was replaced with a new system called Stamp Duty Land Tax (“SDLT”). Stamp Duty has always been a form of duty that is payable by tenants (or the acquirers of rights). However, as most agricultural leases were for a term of a year and contained relatively modest rent, in practice Stamp Duty was rarely payable beyond ad valorem rates. SDLT is assessed very differently, and it is a tax. It looks at the value of a lease over time. That is to say, even if no SDLT return is required or any SDLT is payable on the date of entry, a return will be needed at some future unspecified date when the net present value of the lease reaches the taxable threshold. Once that threshold is reached then a return must be submitted and any tax due at that point paid. Thereafter, further returns (and payments of tax) are due each year within thirty days of the commencement of each period of continuance of the lease for as long as the lease continues. Given that 1991 Act leases frequently span the generations, this creates scope for a theoretically unlimited tax liability for the tenant.
Failure to submit SDLT returns (and to pay any tax due) within strict time limits can lead to severe penalties. The writer understands that the Revenue’s position on this is that a failure to submit returns constitutes avoidance at best and evasion at worst.
There are a number of practical difficulties surrounding SDLT returns, not least of all the fact that there is no reminder system that tells tenants (or the Revenue, for that matter) when a lease has become notifiable or when a further return needs to be made. A farm with a passing rent of £10,000 might reach the taxable threshold over 15 years after commencement (at which time the SDLT clause of the lease is likely to be a distant memory), with yearly payments thereafter being due at 1% of the passing rent. The administrative implications of this (not to mention the risk of penalties for late filing) are considerable for tenants and it is the writer’s opinion that this is something that the accountancy profession will need to take up as part of the yearly tax services that they provide to tenant farmers.
A tenant under a “new” 1991 Act lease entered into after 1 December 2003 will be subject to the SDLT regime and (subject to availability of reliefs) may need to comply with the requirement to submit annual returns once the taxable threshold is reached. It is a given that tenants with tenancies granted under the 2003 Act (LDTs and SLDTs) will operate under the SDLT regime.
As new 1991 Act tenancies are really for the landlord’s benefit (for APR), it follows that a tenant will expect his costs to be met and is entitled to a lease either identical or on no worse terms than the one that previously existed. Accordingly, a tenant with a new 1991 Act lease should also expect his landlord to reimburse payment of any SDLT, and possibly also the professional costs of submitting yearly returns.
To ensure that the fact that the landlord is reimbursing the SDLT and associated costs is not passed back to the tenant via rent, the clause dealing with SDLT should state that these amounts shall in no circumstances be treated as rentable at review. The omission of this provision could see tenants being rented on this obligation on the part of the landlord.
There is suggestion (but as yet no indisputable authority) that overlap relief as set out in paragraphs 5 and 9 of Schedule 17A and 5(2) of Schedule 19 to Finance Act 2003 can effectively reduce SDLT liability to zero in certain circumstances where leases are re-granted, with the only acknowledgement to the SDLT regime being the need to submit an initial (zero) return. If that is right, then this should allow tenants whose leases comply with these circumstances to safely accept new leases in lieu of statutory assignation. However, a note of caution should be sounded in that the legislation does not specifically exclude the possibility of such new leases being liable to SDLT, so it is possible that the position will work against tenants in future, if and when the law is clarified.
Tenants should also take tax advice before any tenancy is surrendered and re-granted, as a surrender by the ‘old’ tenant may have other tax (i.e. CGT) consequences.
Although Stamp Duty was, of course, something tenants paid (as is Stamp Duty Land Tax) it is the writer’s opinion that given that a new 1991 Act lease is (in the above scenario) entered into for the benefit of the landlord, the tenant should expect to be kept free of any tax liability as a result. After all, it remains open to the tenant to assign the old lease and avoid any charge to SDLT (provided certain conditions are met in the way the lease is assigned) if they want to avoid being liable for this tax. An indemnity from the landlord should be sought against tax that may arise from the use of a new lease. Indemnities will only operate as a matter of personal contract and are not binding on successor landlords. It may therefore be considered good practice to incorporate SDLT indemnities into the new lease (in the form of a clause stating that the landlord is to pay any SDLT that becomes payable, and costs) to counter the possibility of future clarification of the law in this area excusing successor landlords from this obligation and leaving tenants with an unexpected tax bill.
Repairing obligations
Another area that can cause concern for new 1991 Act tenancies is that of repairing obligations, particularly where the “old” 1991 Act lease has a post lease agreement (“PLA”) that adjusts the statutory provisions and places repairing obligations on the tenant. The 2003 Act provided that pre-existing PLAs could continue but that it was no longer competent (in respect of new leases) to contract out of the statutory provisions. It follows that a tenant on what is effectively a full repairing lease will pay a rent that takes account of the adjustment of these obligations under the PLA.
The 2003 Act has now been amended by the Public Services Reform (Agricultural Holdings) (Scotland) Order 2011. Amongst the changes it has introduced (as section 5(4B) of the 1991 Act), it provides that on the date that a PLA is nullified (at which point the rent is reviewed) either (i) the buildings and other fixed equipment are in a reasonable state of repair or (ii) that if the buildings and other fixed equipment were in an unreasonable state of repair when the lease was entered into, they are not in a worse state of repair than they were then.
Before a new 1991 Act lease is granted the parties should consider the state of the fixed equipment with regard to the rent currently passing and the liability for maintenance under any existing PLA. As it is not possible to contract out of the statutory repairing obligations under new 1991 Act leases, the parties could find themselves with a rent that has suddenly become “soft” with the landlord having taken on a significant repairing liability without the tenant having complied with the statutory tests that need to be met before PLAs are nullified. Had the process of nullifying a PLA been gone through on an old 1991 Act lease, the landlord may have been entitled to charge an increased rent. Equally for the tenant under a new 1991 Act lease, they may find themselves facing the prospect of a significantly increased rent at review to reflect the landlord’s increased responsibility which would not have applied had the old 1991 Act lease (with PLA) been kept alive via assignation.
Where there is a pre-1948 lease the changes in moving to a new 1991 Act lease are greater, as landlords under pre-1948 leases are only responsible for putting the buildings and fences into tenantable order at the start of the tenancy, with the tenant maintaining thereafter. Section 5 of the 1991 Act (which a new 1991 Act lease must comply with) is more onerous than the corresponding provisions of the previous Acts and this could have a potentially greater impact at review. Pre-1948 leases do not oblige landlords to take out fire insurance, which is another cost to be considered under a new lease.
Other changes
There are a number of other changes to the Holdings legislation that have an impact on new 1991 Act leases, such as the abolition of residency clauses, right to diversify etc., but if an old lease is re-typed with an old style residency clause it is simply void of meaning, there will generally not be economic implications arising from it.
Conclusion
The examples this article has considered represent some of the pitfalls for landlord and tenant alike. The implications of ignoring SDLT and repairing obligations can have significant economic implications for both parties. Where landlord and tenant want to work together there is no reason why new 1991 Act tenancies cannot work, but the parties entering into such arrangements are advised to take consideration of the issues relating to SDLT and potential adjustment of repairing obligations at the time the lease is entered into so that there are no unpleasant surprises in due course. As new 1991 Act leases entered into in lieu of permitted statutory assignation are really for the landlord’s benefit, the cost implications of using such tenancies must be borne equitably given the tenant’s option to assign the old lease and the landlord’s gain under APR on the new one. If a landlord will not wholly indemnify a tenant from being in a worse position then the advice to tenants would have to be to assign their current lease. The problem is that while indemnity might be given on CGT/SDLT, the statutory prohibition on contracting out of repairing obligations in new leases is less straight forward to cover off, irrespective of the wishes of the parties.
If you would like to discuss any of the issues raised in this article please contact Andrew Linehan.
