Lease extensions and the 3% surcharge

Following on from our recent series spotlighting SDLT issues, today we're considering the 3% SDLT surcharge in the context of lease extensions.

The issue

The 3% SDLT surcharge has been with us for eight years now and the basic rules are as follows:

• Trusts and companies pay an extra 3% SDLT (over and above normal SDLT rates) on acquisitions of interests in dwellings of £40,000 or more.
• Individuals pay the 3% surcharge on acquisitions of interests in dwellings for £40,000 or more when they already own (either individually or along with spouse or civil partner) an interest in another dwelling worth £40,000 or more.
• There is a ‘replacement of main residence exemption’ for individuals which broadly exempts them from the surcharge if the new dwelling replaces an old dwelling as a main residence (although this exemption does not apply to the first purchase of a main residence).

One of the more obscure rules (which will be relevant below) is that a reversionary interest in a dwelling which is subject to a lease with at least 21 years to run will not be subject to the surcharge.

These basic rules are not always easily applicable to more complicated transactions. For example, does the 3% surcharge apply to the purchase of a lease extension?

Example

Rishi owns a leasehold property in Kensington with 40 years left to run and he also owns his main residence and various other rental properties. He pays £600,000 to extend the lease from 40 years to 120 years.

As this extension is an interest in a dwelling with chargeable consideration of £40,000 or more (actually it is treated as a surrender of the old lease and a grant of a new lease), he needs to pay SDLT on this transaction along with the 3% surcharge. His SDLT bill here will be £35,500 (£250,000 @ 3% plus £350,000 @ 8%).

The transaction in the above example could have been structured slightly differently to remove the 3% surcharge (and therefore reduce the SDLT bill by £18,000). This would have involved Rishi taking the new 120-year lease as an overriding lease, subject to and with the benefit of the existing lease. Although this gets to the same commercial result, this works because Rishi would be buying a reversionary interest and, more specifically, a lease subject to an existing lease with at least 21 years to run.

As mentioned above, such a reversionary interest is specifically exempted from the 3% surcharge and so structuring things in this way will reduce Rishi’s SDLT liability from £35,500 to £17,500.

Hamilton Rose's view

This is a good example of how a clear understanding of the rules can lead to SDLT savings.

Although some commentators have suggested that this kind of planning could be subject to anti-avoidance rules, we tend to disagree. The legislation clearly intends leasehold reversions not to be subject to the 3% surcharge and perhaps we could justifiably argue that the real flaw in the legislation is not providing a blanket exemption from the surcharge for leasehold extensions.

Clearly this kind of planning would only be relevant for extensions which cost at least £40,000. Anything below this amount would be exempt under general rules.