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Commercial tenants in Scotland are about to experience a shake-up in their tax returns. Revenue Scotland have published new guidance over the past week to help explain how leasehold interests are affected.

Background

On 1 April 2015, Stamp Duty Land Tax (SDLT) was replaced in Scotland with a new Land and Buildings Transaction Tax (LBTT). By and large, LBTT followed the same lease rules as SDLT and there was no major change for new tenants of commercial properties. However, as from 1 April 2018 there are new obligations on those tenants.

Under the old SDLT scheme, tax was paid at the start of the lease and, in most cases, there was no further communication with HM Revenue & Customs unless there was an abnormally large increase in rent at review.

However, tax calculations were often based on estimated rental payments. A commercial lease may provide for the rent to be reviewed every 3 or 5 years since the future market rent is not known when the lease is signed.

Other leases, such as certain retail units or renewable energy projects, provide for an element of the rental to be calculated according to turnover – the rent paid to the landlord is directly related to the performance of the tenant’s business or energy generation project.

In both of these cases, the tax calculation is made at the start of the lease based on a reasonable estimate of future rents.

What’s changed?

Under LBTT, the new rules provide that the tax paid over the life of a lease should accurately reflect the rental payments actually made.

All tenants must now submit an LBTT return to Revenue Scotland every three years confirming the rent actually paid. As the first LBTT returns were submitted on 1 April 2015, the first three-yearly reviews will shortly be due.

If more rent has been paid than was estimated at the start of the lease, additional tax may be due to Revenue Scotland on those extra payments.

Even if the tax calculation made at the start of the lease was correct and no further payments are due, a nil return will still require to be made to Revenue Scotland every three years.

Burden or benefit?

Rent review provisions in commercial leases invariably provide that the rent review will be “upwards only” – the rent can be increased but never decreased. It is therefore likely that a three-yearly review will result in more tax becoming payable following a rent review.

However, the three-yearly period is not the only time when tenants need to review their tax returns. When a tenant leaves a property for whatever reason (assignation, lease expiry, early termination) they need to inform Revenue Scotland and, once again, confirm the rent actually paid. If the tenant has agreed an early surrender of the lease, or exercised a break option, that may reduce the value of rent paid over the life of the lease and a partial tax rebate may due.

Example: If a Tenant entered into a five year lease with a break option at year three, the initial tax will have been calculated based on five years’ rent. However, if the tenant breaks the lease at year three, only three years rent are actually paid. This would result in a lower tax calculation, and the tenant may be entitled to a partial rebate when the final review return is submitted.

Exceptions

  • If a lease was entered into prior to 1 April 2015, it is subject to the old SDLT rules and does not require to be reviewed every three years
  • If a lease was not notifiable when it was granted (i.e. the value of the lease was under the tax threshold, and duration was shorter than 7 years), there is no need to submit a three-yearly review
  • If the grant of the original lease was subject to 100% relief from LBTT, then no three-yearly review is required for so long as the relief is available.

What do tenants need to do?

Revenue Scotland will shortly be writing to all tenants who they believe require to submit a three-yearly return from 1 April 2018 onwards. In order to submit a review return, you will need details of the original tax calculation made when the lease was granted. If a solicitor or accountant submitted the return on your behalf, you may wish to request that information now.

In the next part of our real estate blog, we will look at how to submit a three-yearly review return and how you will know whether any further tax needs to be paid.

Revenue Scotland’s updated guidance on lease transactions can be found here: https://www.revenue.scot/land-buildings-transaction-tax/leases.

However if you require any advice or assistance in the meantime, please do not hesitate to contact a member of the Gilson Gray real estate team.

The information and opinions contained in this blog are for information only. They are not intended to constitute advice and should not be relied upon or considered as a replacement for advice. Before acting on any of the information contained in this blog, please seek specific advice from Gilson Gray.

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