Real Estate Focus – February 2022

Ground rents on the way out

The Leasehold Reform (Ground Rent) Bill announced in the Queen’s Speech in May 2021 received Royal Assent on February 8, 2022 to become the Leasehold Reform (Ground Rent) Act 2022 (the Act). 

The Act follows a great deal of adverse publicity about escalating ground rents in long residential leases and its stated purpose is to “end the practice of ground rents for new leasehold properties”. 

The Act applies to “regulated leases”, meaning long leases of a single dwelling for a term exceeding 21 years and granted for a premium on or after the Act comes into force. Leases granted pursuant to a contract entered into before then are excluded, although “contract” does not include an option or right of pre-emption.

Landlords of regulated leases must not require the tenant to pay a “prohibited rent”, being any rent that exceeds an annual rent of one peppercorn. “Rent” is defined as “anything in the nature of rent, whatever it is called”.

Certain leases where, according to the government, ground rents “fulfil a justifiable purpose”, are excepted. These include: 

• leases that expressly permit the premises to be used for business purposes, provided the landlord and tenant give each other written notice in advance that they intend the premises to be used as such;
• statutory lease extensions;
• “community housing leases”; and
• “home finance plan” leases including those granted as “rent to buy arrangements”.

Despite early indications to the contrary, retirement homes are not excepted but the Act provides that it will not apply to them until April 1, 2023 at the earliest.

Enforcement is through local weights and measures authorities and district councils may also enforce. Financial penalties are determined by the enforcement authority, subject to a minimum of £500 and a maximum of £30,000. Unlawfully charged rents can also be recovered, with interest. 

At the time of writing we do not know when the Act will come fully into force but the indications are that this is likely to be within six months after Royal Assent. Given that the Act is not retrospective, it will be interesting to monitor its impact on the market in the run-up to commencement.

The residential PRS in Wales – radical revamp ahead

While the Leasehold Reform (Ground Rent) Act 2022 will apply to new long residential leases in Wales as well as in England, residential tenancies are a different matter.

Landlords and prospective landlords in the residential private rented sector (PRS) in Wales can no longer delay getting to grips with the Renting Homes (Wales) Act 2016. It has been announced that the Act and supporting regulations will come fully into force on July 15, 2022.

The aim of the legislation is to create a simpler and more transparent system for renting homes which also strengthens the position of tenants – to be known as “contract-holders”. However, given the extent of the overhaul it may take some time to achieve the desired simplicity and transparency. 

The Act establishes a new legal framework for renting homes. Tenancies granting to individuals the right to occupy a dwelling as a home must be one of two kinds of “occupation contract”: a “secure contract” generally for use by public sector and “community” landlords; or a “standard contract” for use by private landlords.  

Both types of occupation contract must clearly set out the respective rights and obligations of each party in a prescribed form of “written statement of occupation contract” which includes “fundamental terms” that are also prescribed and cannot be changed. 

Broadly speaking the Act is retrospective, so that existing residential tenancies and occupational licences will automatically be converted into an occupation contract. 

While existing residential PRS landlords in Wales are likely to have had the new regime on their radar for some time given that the legislation was enacted in 2016, investors in portfolios of let residential properties located across the border may well be caught off-guard.

“Government to protect leaseholders with new laws to make industry pay for building safety”

In our January Real Estate Focus we mentioned a press release published on January 10, 2022 by the Department for Levelling Up, Housing and Communities (DLUHC) announcing that leaseholders of “medium-rise flats” will not face costs in relation to dangerous cladding. Instead, the industry was given two months to agree to a financial contributions scheme to fund such costs, failing which “if necessary, the government will impose a solution in law”.

DLUHC went further on February 14, 2022 with another press release accompanied by extensive - and controversial – amendments to the Building Safety Bill, several of which have hit the headlines.

Key measures that have been proposed include:

• Broad powers to prevent developers and product manufacturers participating in the housing market if they do not help fix cladding problems, for example the power for government to block planning permission and building control sign-off on developments: “We cannot allow those who do not take building safety seriously to build homes in the future…”.
• Extending the reach of the new building safety levy contained in the Bill “with scope for higher rates for those who do not participate in finding a workable solution”.
• New powers to allow cladding companies to be sued and subject to fines for defective products. 
• New powers to allow developers to be sued where they have used shell companies to manage specific developments so as to “avoid taking responsibility for their actions”.
• Extensive provisions to protect leaseholders of buildings over 11 metres in height from the remedial costs not only of defective cladding but also of other "relevant defects" that cause a "building safety risk". 

The director of policy at the British Property Federation has stated that the broad powers proposed for government, in particular the ability to block planning permissions, “ring alarm bells”. We will report further as the Bill progresses.

VAT lease termination payments and dilapidations

Readers may recall that in September 2020, HMRC published a Revenue and Customs Brief setting out its updated view on whether payments made to terminate a contract, such as a lease, were within the scope of UK VAT. The VAT position in respect of dilapidations was also thrown into doubt. Unsurprisingly, this led to extensive dialogue between HMRC and representative bodies from industry, including the real estate sector.

Wind forward to February 7, 2022 and HMRC has now published Revenue and Customs Brief 2 (2022), which will take effect from April 1, 2022. This addresses the questions of whether payments made to terminate a lease and dilapidation payments attract VAT.

Following the recent ECJ decisions in MEO (C-295/17) and Vodafone Portugal (C-43/19), the Brief states that HMRC will “treat payments arising out of early contract termination as further consideration for the contracted supply where the payments are linked to that supply”. It now explicitly provides that termination payments will only attract VAT if the underlying goods or services are liable for VAT, meaning that termination payments in relation to a lease will only be within the scope of UK VAT if the landlord has exercised the option to tax. This VAT analysis applies both where the original contract provided for a termination payment and when a separate agreement is made between the parties at the time of surrender.

In relation to dilapidation payments, HMRC’s view is that, in most cases, such payments will represent compensation paid to a landlord for damage to the property rather than further consideration for the supply of a lease and are therefore outside the scope of VAT. However, the nature of the payment should be confirmed on a case by case basis.

HMRC has also published updated guidance in its VAT Supply and Consideration Manual to reflect its revised position.

For further information please contact partner Julia Lloyd or another member of the Property Tax Team.