Setting the scene…
A common structure amongst property developers is to acquire each development site through a separate special purpose vehicle (‘SPV’), owned by a holding company.
The reasons for doing so are well known. It can assist with risk management, financing, and ultimately with the sale of completed developments or development opportunities.Occasionally, however, events do not unfold as originally intended.
A developer may acquire a site, obtain planning permission, carry out preliminary work and then receive an unsolicited offer from a third party before any meaningful construction work has commenced. If the offer is attractive enough, the developer may decide to sell rather than proceed with the development. In those circumstances, a question often arises. Should the property be sold by the SPV, or should the shares in the SPV itself be sold? In many cases, the tax consequences can be dramatically different.
The Substantial Shareholding Exemption
Where a holding company disposes of shares in a trading subsidiary, the Substantial Shareholding Exemption (‘SSE’) may apply. Broadly, where the conditions are satisfied, any gain arising on the disposal of the shares is exempt from corporation tax. The detailed conditions are beyond the scope of this article, but in many property development structures the principal question is not whether the parent company satisfies the shareholding requirements. Those requirements are often relatively straightforward.The more difficult question is whether the company being sold is a trading company.This can be particularly important where the development has not yet progressed beyond the acquisition of the site and the obtaining of planning permission.
Has the Company Started Trading?
Many advisers instinctively assume that a company which has not yet commenced physical development cannot yet be regarded as carrying on a trade. The position is not necessarily that simple. For SSE purposes, a trading company is broadly one carrying on trading activities which do not include non-trading activities to a substantial extent. The legislation does not define precisely when a property development trade begins. However, HMRC’s published guidance acknowledges that the acquisition of land can itself constitute a trading activity where the land is acquired as trading stock by a property developer.
The distinction is between land acquired for development and resale as part of a trading operation, and land acquired as an investment with a view to generating rental income or long-term capital growth. The intention behind the acquisition is therefore of considerable importance. Where a company acquires a site with the intention of obtaining planning permission, carrying out development work and ultimately realising a trading profit, there is a strong argument that trading activities have already commenced even if construction work has not yet started.
At first sight, this conclusion may appear surprising. Tax advisers are accustomed to debating precisely when a trade commences, particularly in the property sector. Indeed, for a variety of tax purposes it is often argued that a property development trade does not begin until a much later stage, perhaps when active development work starts. However, the question for SSE purposes is not necessarily identical. The legislation is concerned with whether the company is carrying on trading activities, rather than with identifying the precise commencement date of a trade for every tax purpose. As a result, activities which might be regarded as preparatory in another context may nevertheless support the conclusion that a company is a trading company for SSE purposes. It is important not to assume that authorities dealing with the commencement of trade question will automatically determine the SSE analysis.
The Importance of Evidence
As is often the case in tax, the outcome will depend heavily upon the facts. Evidence supporting a trading intention may include matters such as the preparation of development appraisals, planning applications, professional fees incurred in connection with the proposed development, financing arrangements, board minutes, and the activities of other companies within the group. The obtaining of planning permission may be particularly persuasive. It is difficult to argue that a company was merely holding land as an investment when it has actively pursued planning consent for redevelopment. Equally, where the wider group has an established history of carrying out property developments, that fact may lend further support to the contention that the land was acquired as trading stock rather than as an investment asset.
Property Sale Versus Share Sale
If the property itself is sold, any profit will normally be taxed in the SPV as a trading profit. Corporation tax will therefore be payable in the ordinary way, subject to any available reliefs. By contrast, if the shares in the SPV are sold and SSE applies, the gain may be exempt. The difference can be substantial.
There may also be commercial advantages for a purchaser acquiring shares rather than property. In particular, the purchaser will generally incur stamp duty at 0.5% on the acquisition of the shares rather than SDLT on the acquisition of the underlying property. Of course, purchasers are often reluctant to acquire companies because they inherit the company’s history, together with any actual or potential liabilities. As a result, the commercial negotiations may ultimately determine the structure adopted.
Conclusion
It is sometimes assumed that SSE is unavailable where a property development company has done little more than acquire a site and obtain planning permission. That assumption is not always correct.
Where the land has been acquired as trading stock with a genuine intention of carrying out a development, there may be a strong argument that the company is already carrying on trading activities for SSE purposes. If so, a share sale may prove significantly more tax efficient than a direct sale of the property. The issue is highly fact-sensitive and should be considered carefully before any transaction proceeds. However, developers and their advisers should not automatically dismiss the possibility that SSE may be available simply because construction work has yet to begin.