Examining the draft RPDT legislation
The draft legislation for the new residential property developer tax (RPDT) has been released following an earlier consultation on key design elements for the tax, which took place over the summer (see bit.ly/3uELP7A).
There were a few hot topics identified by stakeholders in discussions with officials, such as how profits falling within the scope of the tax should be computed and the treatment of build to rent activities.
Ostensibly the tax is being implemented to pay for government contributions to defective cladding, but given the limited involvement of many affected taxpayers (and the commitment of others to remedying defects), it appears to be more of a cash grab. There will no doubt be taxpayers who are disappointed with certain policy decisions, while others will be waiting on 27 October to see the outcome of further engagement on the rules.
How much is charged?
One of the continuing frustrations for taxpayers affected by the measure is that the rate has yet to be announced, and this is not clarified in the draft legislation. This makes it harder to anticipate the impact of the tax and plan for the coming financial period. It seems likely that the rate will depend on how broad the base is, as the government intends the tax only to apply for ten years and the stated aim is to raise £2bn (total; £200m per year) in that timeframe. With important questions relating to the tax base still open – most notably, the application of the rules to build to rent activities – it seems likely that the rate can only be announced once the breadth of the taxpaying base is finally known.
The original consultation proposed that only profits in excess of £25m (on the basis of a 12 month accounting period) would fall within the scope of the tax. This concept of a tax-free de minimis for all taxpayers is retained in the legislation but the quantum of the allowance has been left blank. It is not clear if the £25m previously stated is now under review and if so whether it will be revised upwards or downwards. If the allowance is not fully utilised in an accounting period then there is no provision for carry forward of the excess.
Who is in scope?
The legislation applies only to companies that are ‘RP developers’, meaning companies that are within the charge to corporation tax and undertake RPD activities as defined in the legislation.
There is a slight circularity in the drafting of the definition of RPD activities, as it applies to any activities carried out by an RP developer on or in connection with land in the UK in which the RP developer has or had an interest and for the purposes of or in connection with the ‘development of residential property’.
The use of the phrase ‘development of residential property’ is somewhat misleading: here, that phrase is non-exhaustively defined to include (among other things) dealing in residential property, designing it, marketing it, managing it, seeking planning permission and ancillary activities. Therefore, a company does not need to carry out any construction at all in order to count as an RP developer for the purposes of the tax. The broad nature of this test may cause concern in relation to some operations by groups that would not normally be considered to comprise property development but may have a loose connection with it. It remains to be seen whether this will be addressed with tighter drafting or (less satisfactorily) merely by way of guidance.
It was not clear from the original consultation whether a company could be within the scope of the tax if it did not own the land in question (for example, sub-contractors). The definition of interest in land for this purpose is borrowed from the SDLT legislation, but the interest must have formed part of the trading stock of the RP developer or a related company.
The requirement for an RP developer to have or previously have had an interest in land is a useful qualifier, but including land that has been disposed of is still wider than is perhaps appropriate. On the one hand, if a developer disposes of a stake in a joint venture project and continues to project manage the site and provide construction works then it does not seem unreasonable for those activities to be within scope.
On the other hand, the lack of any time limit at all and the fact that ownership by ‘related companies’ is also counted means that companies will need to be extremely careful to ensure that they do not inadvertently neglect to include profits relating to activities that are connected to land that was owned by them or by a group company many years previously. The definition of ‘related company’ for this purpose is any member of the same group and any ‘relevant joint venture companies’. The treatment of joint venture entities is an area of particular complexity (discussed further below) and it is not entirely clear how the requirement to hold an interest in land interacts with the rules relating to the attribution of profits of joint venture companies.
What kind of land is in scope?
The definition of residential property is borrowed heavily from existing legislation such as the SDLT definition under FA 2003 s 116, which broadly covers dwelling buildings, the garden or grounds of such buildings and interests and rights which subsist for the benefit of either. There are however some important distinctions. Most notably, there is a fourth limb added to the usual definition which captures land in respect of which planning permission is being sought or has been granted so that it will fall within any of the main paragraphs.
There are a couple of curious points here. First, at what point is planning permission ‘being sought’ for this purpose? Does an application need to have been made, or will some earlier stage in the process count? Hopefully HMRC will draw a sensible line in interpreting this phrase and make their view clear in guidance. Second, is it really fair to include land that may never in fact achieve planning permission within the definition of residential property?
The carve-outs from the definition are similar to those under TCGA 1992 Sch 1B. Student accommodation is excluded if it is designed, adapted or in the process of being constructed for use by persons who will occupy it wholly or mainly to undertake education and if it is reasonable to expect that the building will be occupied by such persons on at least 165 days each year. This appears to draw a sensible line in excluding properties that are not really equivalent to the broader residential sector while avoiding the difficulties associated with a more stringent definition (such as the definition in a VAT context). By contrast, the exclusion for care homes is really quite narrow, which will be a disappointment to those operating in the retirement living sector.
Computing the profits
One of the biggest open points in the original consultation was the method for computing profits. A number of models were put forward, and stakeholders in the roundtable sessions almost universally plumped for the one that was most familiar (as it was based on corporation tax profits): model 2a. This is the model which has been carried forward into the legislation.
RPD profits or losses are therefore computed largely by reference to corporation tax profits and losses, which will be a huge relief to taxpayers and advisers with only a short window to get on top of the detail of the new rules. There are of course some adjustments required, such as leaving out of account the profits, losses and capital allowances relating to non-RPD activities.
Profits of a charitable trade within the meaning of CTA 2010 s 479 are also left out of account, so that primary purpose trading by charities will not be chargeable to RPDT. However, there is no ability for a company to make qualifying charitable donations to reduce its liability to RPDT. This will be of huge concern to charitable groups involved in residential development, such as not-for-profit affordable housing providers that often enter into joint ventures with housebuilders. Many such joint ventures are already at the fringes of viability and tend to be in areas sorely in need of regeneration.
Another disappointment for taxpayers (though not a surprising one) is that loan relationships credits and debits are to be left out of account entirely, meaning that highly leveraged groups will pay RPDT on a much higher profit than their true economic profit.
The RPDT effectively sits on top of other taxes. It will not be deductible in computing profits for corporation tax purposes and by the same token corporation tax payments will not be deductible in computing RPDT profits. This fact, combined with the importation of most corporation tax rules, means that the RPDT really behaves more like a corporation tax surcharge than an entirely new tax. However, it sits entirely outside the main framework of the corporation tax legislation.
Chargeable accounting periods for RPDT will follow a company’s accounting period for corporation tax purposes, with apportionment of profits or losses for periods straddling the 1 April 2022 commencement date.
Giving effect to losses carried forward
Another big question posed by the original consultation was the extent to which losses should be capable of being utilised. The government was clear from the beginning that the carry forward of pre-RPDT losses was not on the table but was also wary of allowing post-RPDT losses to be carried forward to future chargeable accounting periods, on the basis that this could make the legislation unworkably complex.
Happily, the policy decision appears to be that loss carry forward will be available for post-RPDT losses. Losses will only be capable of carry forward if the RP developer continues to be an RP developer in the period in which the loss is utilised. There is a cap on the amount of carried forward losses and group relief which can be surrendered in any one chargeable accounting period, which is given by a formula in the legislation. In substance, it allows relief for only 50% of losses over the £25m allowance, as an approximation of the effect of the corporate loss restriction.
Profits and losses of joint ventures
Joint venture companies are within the scope of RPDT in the same way as other companies, but are more likely to benefit from the de minimis profit allowance in full given they cannot form part of a group.
Profits of a joint venture company that fall below the de minimis profit allowance (and so are not taxed) are attributed to the joint venture partners. The intention is that groups only ever get one bite of the cherry in respect of the profit allowance and cannot split their projects across joint ventures to minimise RPDT liabilities.
Joint venture companies are taken into account for this purpose if they are not a 75% subsidiary of another company and there are five or fewer persons who between them hold at least 75% of the ordinary share capital (or economics) of the company. Profits are attributable to a developer only if it holds at least 10% of the ordinary share capital of the joint venture company (unless the joint venture company does not have ordinary share capital), while the amount to be attributed is tested only by reference to the developer’s percentage entitlement to amounts available for distribution to equity holders.
Losses are attributed by the same mechanism but only if the developer and joint venture company elect by notice to HMRC. Developers should ensure that existing and new shareholder agreements enable them to require the joint venture company to make such an election. Meanwhile, there is no ability for groups to surrender losses to the joint venture company (as there would be under the consortium relief rules in most cases).
Sharing the tax-free allowance
The legislation contains two different definitions of a group: one to allocate the de minimis profit allowance and one to allow surrender of losses across groups. For the purpose of determining entitlement to the de minimis allowance, ‘group’ is defined as a company and all of the companies of which it is the ‘ultimate parent’, which very broadly looks at 75% ownership of ordinary share capital and economics (drawing on definitions from CTA 2010 Part 5 Chapter 6).
The de minimis allowance is shared across the group, pro rata unless the group specifies otherwise. A group can nominate a member of the group to be the ‘allocating member’, which is responsible for allocating the allowance across the ‘receiving members’ of the group. A company that is a member of a group can be a receiving member in any chargeable accounting period if that period ends at the same time as or during an accounting period of the allocating member and it is a member of the same group as the allocating member at the end of the accounting period of the allocating member.
A relief group exists where one is the 75% subsidiary of the other or both are 75% subsidiaries of a third company. The availability of group relief in overlapping accounting periods is fairly straightforward and relief is given in much the same way as for corporation tax. There are some errors in the drafting that slightly obscure the meaning, but the intention appears to be that the same loss can be available to surrender as group relief both for corporation tax and for RPDT purposes (Sch 1 para 9(4)). Unsurprisingly, the same limitations apply to RPDT group relief as apply to corporation tax in respect of arrangements for the transfer of companies that would otherwise form part of the group, as do the restrictions under CTA 2010 Part 14 relating to changes in company ownership.
The administration of the tax again draws heavily on corporation tax principles, which will be music to the ears of beleaguered finance directors in the sector, who are still contending with a number of other recent tax changes (including in relation to the construction industry scheme, IR35 and a proposal for wholesale VAT reform).
The intention appears to be that RPDT will be paid as if it were an amount of corporation tax. The legislation imposes an obligation on an RP developer to notify HMRC on or before the payment of the tax of how much of the total paid represents RPDT. It is not clear whether this will be included within the CT600 or whether a separate written notification will be required. Given how easy it would be to overlook a separate notification, the former would make the process far more straightforward.
The QIPS regime will apply to RPDT and given the proposed level of the de minimis profit allowance, RPDT payers will presumably all be ‘very large’ companies for this purpose. There is an obvious issue here for any taxpayer with an accounting period straddling the commencement date of 1 April 2022: an instalment payment including a liability to RPDT may fall due prior to 1 April 2022.
The legislation deals with that issue by allowing RPDT to be ignored in computing instalment payments falling due before 1 April 2022 and the additional amount then to be added to the instalment payment first falling due on or after 1 April 2022. This may still leave some taxpayers with very little time to get their compliance up to speed, and it would have been preferable to give taxpayers another year before commencement, but there is clearly a lot of political momentum behind the measure.
Group payment arrangements will apply in respect of RPDT and the responsible company for CT purposes will automatically become the responsible company for RPDT too.
As is to be expected, the draft legislation contains a broad anti-forestalling provision, which applies to profits arising in an accounting period ending before 1 April 2022 as a result of arrangements entered into on or after 29 April 2021 (when the original consultation paper was published). As is usual, the rule bites where a main purpose of the arrangements is to secure a tax advantage. If the rule applies, the profits are treated as if they arose to the developer in its first chargeable accounting period ending on or after 1 April 2022. As there is no provision for a just and reasonable apportionment of the profits attributable to the implementation of the arrangements, it seems possible that a taxpayer could make its position worse by putting planning in place.
All of the usual rules applying to the computation of corporation tax profits, including transfer pricing, will already have been applied to RPD profits. However, the government has also pre-empted an obvious method by which RPD profits could be manipulated.
The transfer pricing rules are specifically applied to provisions made between an RP developer’s RPD activities and its other activities by deeming the activities to be carried on by two different persons under the same control. This concept behaves similarly to the separate enterprise principle that adjusts the tax effect of provisions made between companies and permanent establishments. This could lead to significantly increased complexity for taxpayers within the scope of the tax that have non-RPD activities (particularly mixed use developments, where costs are very likely to be attributable to both types of activity), but from HMRC’s perspective this is clearly a necessary evil.
Despite the huge amount of work that has been done in the time available, there are still details to be ironed out in advance of 27 October. The elephant in the room is the dry tax charge being faced by taxpayers with build to rent activities, with the original consultation paper concluding that profits from build to rent should be within scope. There has been strong opposition from many stakeholders to that idea for a variety of reasons, not least that it would involve a dry tax charge, which could distort the market by making build to rent extremely unattractive or even unviable.
It would also likely be far more onerous for such taxpayers to comply with the rules; presumably they would be required to compute their profits on the basis of a deemed trading activity. The current legislation would require quite a lot of additional provisions to deal with this satisfactorily. In addition, build to rent projects tend to be highly leveraged and so these taxpayers would also be hit hard by the non-deductibility of debt finance costs.
The government did in the original consultation explain its concerns that excluding such developments altogether would lead to problems of its own; chief among them was the potential for distortion in taxpayer behaviour in the other direction (i.e. encouraging build to rent activity).
If build to rent is included, the least distortive approach would seem to be having the profit computed by reference to a deemed market disposal and re-acquisition at practical completion of a development (on the assumption that the property is held as trading stock), with the resulting tax payable by instalments over a period (for example, ten years). It is an unenviable policy decision to have to make and it will be interesting to see how the government squares the circle on this.
A version of this article was originally published in the Tax Journal. Please contact Helen Coward or your usual Charles Russell Speechlys contact.