Temporary? Maybe...: Elizabeth Small writes for taxation

Corporate Partner, Elizabeth Small, wrote for Taxation about how the new residential property developer tax will operate.

The article was first published on Taxation on 13 December 2021, and is available to read in full here: The residential property developer tax in practice.

Key points

• The residential property developer tax (RPDT) will be levied at 4% on property development companies with annual profits in excess of £25m.
• The tax is planned to operate for ten years – with an estimated £200–250m expected to be raised annually.
• The term 'residential' for RPDT purposes is broad.
• No deduction is allowed for any interest.

The autumn Budget on 27 October 2021 included the important announcement that the residential property developer tax (RPDT) will be levied at 4% on companies or groups of companies undertaking UK residential property development with annual profits in excess of £25m. It is expected to operate for only ten years, although keen historians might note that income tax, when first introduced on 9 January 1799 by William Pitt the Younger, was 'a temporary measure' and had a reassuringly low rate of just under 1% on annual incomes of £60 a year (about £7,000 according to the Bank of England's inflation calculator to 2020) although increasing on a graduating scale for higher incomes.

The policy objective of this new tax is clearly that there are: 'significant costs associated with the removal of unsafe cladding' and so 'the government believes it is right to seek a fair contribution from the largest developers in the residential property development sector to help fund it,' according to HMRC's policy paper published on 27 October 2021. The anticipated tax receipts, certified by the Office for Budget Responsibility, are shown in the table in RPDT receipts.

Since I last wrote about this new tax ('Learning from the past', Taxation, 10 June 2021, page 17), the draft legislation has been published (see Finance (No 2) Bill 2021-22, clauses 32 to 52) and a number of important points have been clarified.

Who will RPDT apply to?

The RPDT will apply to companies and groups of companies only. So, a group of individuals forming a limited liability partnership or a 1907 limited partnership with a general partner company entitled to only 1% of the profits, would fall outside the new tax.

The company has to be within the charge to UK corporation tax. This means that a company incorporated in the UK, or a company incorporated elsewhere in the world which is centrally managed and controlled in the UK, or which, for example, trades in the UK through a permanent establishment, will each be subject to RPDT if it undertakes 'residential property development activities' (residential property developer activities) and will be classified as a 'residential property developer'.

A residential property developer (or a related company) must have (or have had) an interest in land in the UK and the activities must relate to the development of residential property on, or in connection with, that land. While the definition of relevant activities is non-exhaustive and includes, for example, designing, constructing/adapting, marketing or managing, tying residential property developer activities to having an interest in land means that the independent – nonrelated company – architect, builder, agent and property manager will not be subject to this tax. Most of the time it should be relatively clear whether the property manager is related to the land owner as advisers are very familiar with the 'group' concept, although there are nonetheless some nasty bear traps, but it should be remembered that, in the context of RPDT, a relevant joint venture arrangement can be triggered by as little as a 10% shareholding.

The definition of interest in land has several useful exclusions which mean that neither a lending bank with security for its debt, or a builder which has a temporary licence to occupy the premises – to do the construction/conversion – will be within the scope of RPDT.

As useful as these exclusions are, the most important part of the definition of a qualifying interest in land for these purposes is that the interest must form part of the developer's (or a related company's) trading stock – typically an interest that is disposed of in the ordinary course of the trade of development. This means that those who develop land for investment, ie build to rent (BTR), are not within the reach of RPDT. Although this clarification is a huge improvement on the initial rules, caution will still be required as the boundary between trading and investing is not as clear cut as it could be. In addition, there is the further vexed issue of appropriation to trading stock that will have to be considered, as well as the question of warranties and indemnities which will be sought when buying or investing in the shares in a BTR company.

What is 'residential'?

The term 'residential' for RPDT purposes is wider than may be thought. As such, a further word of caution is required here, as developers in forward funding contracts may well have held an interest in the development property as trading stock and so will be within the RPDT scope (subject of course to their profit levels).

Even if the developer bought the land as a transfer of a going concern (TOGC), for example an office block which it then sells with vacant possession to the funding bank, that land may nonetheless be residential, as 'residential' – a chameleon term meaning different things for different taxes – for RPDT purposes. This has an extended meaning, for example 'land in respect of which planning permission is being sought or has been granted so that it, or a building on, interest in or right over it,' will be classified as a dwelling or gardens or grounds of a dwelling, according to the proposed paragraph 37(1)(d) of the draft legislation in Finance (No 2) Bill.

It would be easy to glance quickly at the dwelling exclusions for RPDT and assume that they are similar to either the stamp duty land tax rules or the original draft of the RPDT rules, but there are some subtle differences or changes, including the addition of the following two categories – which one suspects are pandemic-related:

1. residential accommodation for members of the emergency services or persons working in a hospital; and
2. temporary sheltered accommodation.

Amendments have also been made to the student accommodation exclusion. In my previous article, I referred to the difficulty of defining 'student accommodation' so it is interesting to note that the draft legislation drops 'purpose built' and instead concentrates on a building designed, adapted or being construed for use as student accommodation where:

1. the majority of the occupants will be undertaking a course of education (this to include school pupils); and
2. it is reasonable to expect that such persons will occupy for at least 165 days a year.

In a post-lockdown world, expected occupation is a sensible rule to be embedded up-front in the legislation, although public school terms may need to lengthen.

I had previously been concerned that 'purpose-designed supported housing with communal facilities providing accommodation with care' might not have been broad enough to capture the new wave of elderly care homes, but the revised wording of 'a home or other institution providing residential accommodation with personal care for persons in need of personal care because of old age' seems more restrictive and providers in this space may need to take bespoke advice.

How much – calculating profit

The draft legislation sets out detailed and prescriptive ways of calculating chargeable profits. As the requirement is now exact amounts attributable to the RPDT activities rather than apportionments as originally suggested, these will necessitate great attention to detail. The most noteworthy computational rule is that no deduction is allowed for any interest (or other debits pursuant to either the loan relationship or derivative contract rules), although admittedly (and fairly), neither are any such credits. But, the loss of interest deductions together with climbing interest rates is going to be a significant factor.

Group relief and internally generated losses may be accessed to the extent that they also relate to RPDT-able activities.

Key events

In a nutshell, here are the key points about the RPDT:

• When? April 2022.
• Why? To pay for cladding rectification.
• How (much)? 4% over £25m profit.
• Where? Potentially everywhere. It does not matter where a company is incorporated, it will be liable to UK RPDT if it develops residential land in the UK.

What should businesses likely to be affected by PRDT do next? They should recalculate their business plans, make sure they are compliant and not adopt any 'rinky-dink' tax planning because this tax carries with it (in my view) an element of corporate social responsibility having been borne out of the tragedy of Grenfell.

What else may happen?

It is understood that Michael Gove recently suggested that suppliers of products that were installed on Grenfell Tower and similar buildings could be subject to some form of levy. Could we therefore see another form of tax to deal with the cost of repairing cladding? This seems a distinct possibility as Michael Gove confirmed earlier this month that the government will 'pause' plans to make leaseholders pay to make cladding safe, questioning why they have to pay 'at all'.

With many people living in unsafe properties which have devalued and are inherently risky, it is perhaps not surprising that the government seems to favour hypothecated taxes. Ultimately, such taxes promise transparency, accountability and public support. And let's not forget that we already have a precedent – after all, income tax started in the UK as a bespoke tax to cover the cost of the Napoleonic wars.

Elizabeth Small is a Partner in our Tax team.