Real Estate Focus – September 2020

Introduction

In this edition we take a look at an overhaul of the planning use class framework; a business interruption insurance test case; HMRC guidance on VAT and SDLT; and COVID-19-related restrictions on landlords.

COVID-19 STOP PRESS: restrictions extended

Over the past months numerous temporary restrictions have been imposed on commercial landlords seeking to take action against tenants for non-payment of rent. The next quarter day is looming: where are we now?

• Moratorium on forfeiture: Section 82 of the Coronavirus Act 2020 (the Act) came into force on March 20, 2020.  It created a moratorium on commercial landlords forfeiting a business lease for non-payment of rent (which is defined as including any sum the tenant is liable to pay under a business tenancy).
  
  The moratorium applies during the “relevant period”. This began on March 26, 2020 and initially lasted until June 30, 2020, but was extended to September 30, 2020. New regulations coming into force on September 29, 2020 further extend the moratorium in England to December 31, 2020. A similar extension will also take effect in Wales.
  
  Some industry bodies and commentators have severely criticised the move, describing it as “kicking the can down the road”. The Chief Executive of The British Property Federation has stated that it is imperative that the Government confirms that this will be the final extension.
  
  
• Commercial Rent Arrears Recovery (CRAR) is a statutory method of enforcement to recover rent arrears relating to commercial property. The Taking Control of Goods and Certification of Enforcement Agents (Amendment) (Coronavirus) Regulations 2020 came into force on April 25, 2020 and prevent landlords using CRAR unless they are owed a certain amount of rent. That was originally set at a minimum of 90 days’ unpaid rent but was subsequently increased to at least 189 days’ rent.
  
  The restriction is linked to the moratorium on forfeiture as it applies where notice of enforcement is given during the “relevant period” as defined in section 82 of the Act (see above).
  
  New regulations coming into force on September 29 further increase the minimum amount of rent that must be due before CRAR is used to 276 days’ rent where the notice of enforcement is served on or before December 24, 2020, and 366 days where the notice is served on or after December 25, 2020.
  
  
• Statutory demands and winding-up petitions. The Corporate Insolvency and Governance Act 2020 came into force on June 26, 2020 and (amongst other things) imposes temporary restrictions on creditors pursuing sums owed by corporate debtors, including landlords pursuing outstanding rent from tenants.

In broad terms:

• A statutory demand served by a creditor between March 1, 2020 and September 30, 2020 cannot form the basis of a winding-up petition against a company.
• A creditor who wishes to present a winding-up petition against a company on the grounds that the company is unable to pay its debts (including rent) can only do so on the condition that it has reasonable grounds for believing either that coronavirus has not had a financial effect on the company, or that the company would have been unable to pay its debts even if coronavirus had not had a financial effect on it.
  
  This applies to petitions presented between April 27, 2020 and September 30, 2020.
  
  
• There are also limitations on the court. If a creditor presents a petition between April 27, 2020 and September 30, 2020 for the winding up of a company on the grounds that it is unable to pay its debts, the court can only make a winding-up order if it is satisfied that the company would be unable to pay its debts even if coronavirus had not had a financial effect on the company.

The Government has stated that: “a decision is to be made shortly regarding the extension of these measures.”

As to the residential sector, section 81 of the Act imposes temporary restrictions on residential landlords’ ability to recover possession of residential premises. In the case of assured and assured shorthold tenancies in England, it does this by extending to three months the notice to be given to tenants before possession proceedings can be commenced. The extension originally applied to notices served on tenants on or before September 30, 2020.

New regulations in force in England on August 29, 2020 extend notice periods to six months in most circumstances (with exceptions for anti-social behaviour, six months’ plus worth of rent arrears and other serious grounds) for notices served on or before March 31, 2021. Similar (but not identical) extensions have been introduced in Wales.

What are use classes and why are they relevant?

One of the Government’s recent reforms to the planning system aimed at boosting the economy and housing supply is the enactment of the Town and Country Planning (Use Classes) (Amendment) (England) Regulations 2020 (the Regulations).  The Regulations introduce substantive amendments to the use class framework in England.

Use classes are essentially categories of common uses of land and buildings.  Within each overarching use class a number of sub-uses are considered, for planning purposes at least, to be broadly similar. For example, hotel and guest house uses fall within the same use class i.e. Use Class C1.  The relevant statutory instrument setting out the use classes currently in force is the Town and Country Planning (Use Classes) Order 1987 (as amended) (the UCO).

Use classes are relevant to landowners, tenants and developers as changes of use of land or buildings within the same specified use class are not caught by the statutory definition of “development” and therefore do not need to be authorised by deemed or express planning permission.

What has changed?

Subject to transitional and savings provisions, the Regulations came into force on September 1, 2020 and apply to England only. The most notable change to the UCO introduced by the Regulations is the replacement of previously separate use classes concerning shops, financial and professional services, restaurant and café and business with a new Class E. Class E now groups commercial, business and service uses together and encompasses the following types of use, principally to visiting members of the public:

(a) the display or retail sale of goods, other than hot food;

(b) the sale of food and drink where consumption is mostly undertaken on the premises;

(c) the provision of (i) financial services, (ii) professional services (other than health or medical services) or (iii) any other services that it is appropriate to provide in a commercial, business or service locality;

(d) indoor sport, recreation or fitness uses not involving motorised vehicles or firearms;

(e) the provision of medical or health services, provided the premises are not attached to the practitioner or consultant’s residence; and

(f) crèche, day nursery or day centre uses not including a residential use.

Class E also includes office, research and development or industrial process uses, provided these uses can be carried out in residential areas without detriment to amenity (for example, by reason of noise, smell, smoke and dust, etc.).

In addition to Class E, the Regulations introduce a new Class F.1 (Learning and Non-Residential Institutions) and a new Class F.2 (Local Community).  These classes include some of the uses previously listed within Class D1 (Non-Residential Institutions) and Class D2 (Assembly and Leisure) of the UCO.

The Regulations also amend the UCO to reclassify public house, wine bar, drinking establishment, hot food takeaway, live music venue, cinema, concert hall, bingo hall and dance hall uses as sui generis.  A sui generis use is a use of “its own kind” meaning it does not fall within a particular use class.  Changes of use concerning a sui generis use generally always require express planning permission.

Practical implications

The changes to the UCO present advantages for property stakeholders, since greater flexibility to change between uses without planning permission will assist in reacting to market demand and enhancing the value of portfolios.  Those wishing to take advantage, however, will still need to check that their proposals do not conflict with title covenants, on-going planning conditions or planning agreements that restrict the use of land or buildings.

There are also other considerations.  For example, changes of use within a broader use class may result in new uses, unconstrained by planning conditions, which have a negative effect on neighbouring amenity.  Some landlords may also wish to limit their tenants’ right to flit between a wider range of uses without planning permission. This will have implications when it comes to the drafting of permitted use and consent clauses in lease documents.  Similarly, the amendments to the UCO may affect the drafting of overage agreements and conditional contracts if planning permission is no longer required to authorise a particular change of use.

For further information please contact Head of Planning, Sarah Fitzpatrick and Senior Associate Carina Wentzel (carina.wentzel@nortonrosefulbright.com).

Property tax update

VAT and termination payments

Following a recent decision of the Court of Justice of the European Union, HM Revenue & Customs (HMRC) has revised its guidance and changed its position in relation to the VAT treatment of termination payments.

Previously it was HMRC’s view that the VAT liability in relation to payments made by a party terminating a contract, such as a break fee under a lease, depended on whether the termination fee had been drafted into the original contract or was negotiated separately. Fees that had been incorporated into the original document were treated as outside the scope of UK VAT, whereas a fee which was negotiated to terminate the contract would be consideration for the “service” of the counterparty releasing the payer from the contract early and therefore potentially subject to VAT.

The recent decision in Vodafone Portugal (Case C-43/19) means that this view is no longer sustainable. HMRC issued a Revenue and Customs Brief in early September to confirm that it would no longer draw a distinction between a fee that was prescribed in the contract and one which was negotiated separately.

In addition, HMRC amended its view on liquidated damages provisions, stating that such payments arise as a result of events envisaged under the contract and as such, they are part of the underlying agreement and are consideration for the goods or services provided under it. Again, this is a different approach to that taken, to date, which had been to treat amounts which are genuinely compensatory as being outside the scope of VAT (since they are not consideration for any supply).

This change of policy is relevant to a range of real estate transactions and it will be important to review carefully the nature of the payment in each case and to consider what would have happened if the contract had run its course; if taxable supplies would be made to the entity paying the break fee, it is likely that the break fee would be subject to VAT. For example, if a tenant pays a break fee to its landlord to terminate its lease this is likely to be subject to VAT, assuming that the landlord has exercised the option to tax. Dilapidations payments will also need close scrutiny, but may well be regarded as compensatory and therefore remain outside the scope of VAT.

It should be noted that the change in policy applies retrospectively and consideration should be given to past payments which may be affected by this change in policy.

VAT and SDLT: variations to existing leases

HMRC has published guidance to help businesses deal with the VAT and stamp duty land tax (SDLT) consequences of extending or varying leases. The new guidance is welcome, and has been published in response to the increasing frequency of lease variations as a result of the COVID-19 pandemic.

The guidance deals with the most common lease variations, being those which vary the amount of rent paid (for example, a short-term rent holiday), or where a lease extension is agreed (for example, a waiver of a tenant’s break right and/or a commitment to extend the term of the lease).

These arrangements can be complex from a tax perspective, particularly in terms of their VAT treatment. Where the arrangements involve a barter transaction, this would result in both the landlord and the tenant being treated as making supplies to each other, with the potential need to charge and account for VAT on the value of the supplies. While the complexity is not new, COVID-19 has resulted in a greater number of lease negotiations and thereby increased the numbers of taxpayers and/or their advisers seeking rulings from HMRC. HMRC has therefore engaged with this issue at policy level and has published Revenue & Customs Brief 11 (2020) in order to confirm their policy. It is expressly stated that there has been no change to its VAT or SDLT policy in this area.

VAT guidance

If a landlord and tenant vary a lease so as to reduce the rent payable, there will be no supply for VAT purposes if this is done by the tenant for no consideration. Conversely, if the tenant agrees to do something in exchange for the rent reduction, the rent reduction could be a payment for a supply. There had been uncertainty as to whether the tenant’s agreement to continue being a tenant, for example by agreeing not to exercise a break right or agreeing to a lease extension, could amount to consideration in these circumstances. HMRC’s guidance indicates that the tenant is not doing something in consideration of the rent reduction in this instance and thus there are no VAT consequences.

Similarly, if a tenant agrees to take on a new lease with new terms, they are not making a supply to the landlord just by so agreeing. However, if the landlord changes the terms of an existing lease and in exchange the tenant agrees to do more than just pay the rent during the lease (for example, agreeing to undertake works on behalf of the landlord), the landlord and the tenant would be treated as making a supply for VAT purposes.

SDLT guidance

Variations to existing leases can also have SDLT consequences. The guidance confirms that some changes, such as an agreement to reduce the rent, may not give rise to SDLT provided that nothing is given by the tenant in return for the reduction. A number of examples are given in the guidance as to when there could be an SDLT liability including:

• extending the term of a lease (“overlap relief” may be available in respect of any rent on which SDLT has already been paid);
• the grant of a reversionary lease;
• payment of a lump sum in return for changes made to a lease, or for a surrender.

Generally, the guidance is welcome and provides clarity around some issues which had caused delays in COVID-19 related commercial lease renegotiations; in particular, it is important to note that a barter arrangement does not need to be recognised for VAT purposes in many cases. Where taxpayers have accounted for VAT on the basis of a barter on historic transactions, these arrangements should be reviewed to determine whether any adjustments may be needed.

If you would like to discuss any of the above in more detail please contact Tax Counsel Julia Lloyd.

Business interruption insurance test case – the result

The Financial Conduct Authority v. Arch Insurance (UK) Limited and others [2020] EWHC 2448 (Comm) is a test case brought by the Financial Conduct Authority (FCA), the regulator of the eight defendant insurers. It sought a  determination on issues of principle relating to policy coverage in respect of claims by policyholders for business interruption losses arising in the context of the COVID-19 pandemic and the consequent advice of, and restrictions imposed by, the UK Government.

The High Court was asked to determine the correct construction of the terms of 21 representative policies. The FCA estimates that, in addition to the particular policies chosen for the test case, some 700 types of policy across over 60 different insurers and 370,000 policyholders could potentially be affected by the test case.

The relevant provisions of the representative policies essentially fell into three categories:

(i) “disease clauses”;

(ii) clauses covering prevention of access to premises and similar perils; and

(iii) “hybrid clauses” which refer both to restrictions imposed on premises and to the occurrence or manifestation of a notifiable disease.

The High Court handed down its judgment on September 15, 2020. It is complex and detailed, running as it does to over 150 pages, and contains an in-depth analysis of all the sample clauses. As such there is no overall “winner” or “loser”, but the court did find in favour of the arguments advanced by the FCA on behalf of policyholders on many of the key issues.

The FCA has commented that: “Although the judgment will bring welcome news for many policyholders, the judgment did not say that the eight defendant insurers are liable across all of the 21 different types of policy wording in the representative sample considered by the Court.  Each policy needs to be considered against the detailed judgment to work out what it means for that policy.”

It is likely that the judgment will be appealed and if it is, given its significance, it may “leapfrog” to the Supreme Court.  However the FCA has stated that any appeal would not preclude policyholders seeking to settle their claims with their insurer before the outcome of the appeal is known.