‘Sale and leaseback’ agreements are coming back into fashion in the corporate world. There are financial implications for both seller and buyer in such deals, whose number has increased despite a high level of press interest and public controversy in recent months (most notably surrounding HM Revenue and Customs’ agreement with property company Mapeley). By Marios Gregori of PKF.
That was only one of a number of high profile transactions, including the £1.09 billion deal between HSBC and Spanish property company Metrovacesa for the HSBC Tower in Canary Wharf. The hotel sector has also seen a high level of activity, including the £128 million sale and leaseback by Travelodge of 17 of its hotels in April 2007. Accor Hotels did a £439 million deal with Land Securities Trillium in February, while McDonald Hotels’ arrangement in January with the Moorfield Real Estate Fund was worth £400m.
In the past, sale and leaseback transactions were undertaken by property-rich organisations, but were not as popular as they are in the current buoyant marketplace. Many companies considered properties to be their most essential assets in the running of their businesses and were sceptical of sale and leaseback transactions. These were only undertaken as a last resort when, perhaps, the realisation of cash became necessary.
However, the significant rise in property values in recent years has led many property-owning companies to cash in. Companies have taken the view that owning land and buildings can be a drain on resources and a distraction from core business activity; so they have undertaken sale and leaseback transactions to enable them to concentrate on their operational activities. By the same token, these companies have been able to realise significant value from their property interests, which they have used to repay borrowings, carry out share buy-backs or recycle cash back to the operational business as working capital.
For instance, there has been much press coverage about the pressure placed on J.Sainsbury’s by its own shareholders, who wanted the supermarket chain to follow competitor Tesco’s example and enter into sale and leaseback arrangements for its property portfolio. The latter is valued at somewhere between £5.5 and £9.0 billion.
The introduction in the UK of Real Estate Investment Trusts (REITs) in January 2007 has further increased the appetite for sale and leaseback transactions for property-owning companies. The introduction has enabled tax-exempt REIT vehicles to make acquisitions at higher values than would otherwise be the case, because they do not have to take into account any latent capital gains or tax on the rental stream in their pricing calculations. The sale and leaseback transaction can also be used as a mechanism for creating a REIT - this was the model used by Vector Hospitality’s recently created REIT.
Sale and leaseback agreements can generate a number of tax benefits for sellers, including the offset of the lease costs as operating expenditure. Other tax issues that can arise out of an agreement which need to be considered include:
• Chargeable gains for the vendor on the sale
• Stamp Duty for the purchaser on the acquisition
• Potential Stamp Duty Land Tax (SDLT) on the lease for the lessee
• Capital allowance balancing adjustments for the vendor
• Industrial Buildings Allowance issues
On the sale of a property, the vendor would be liable to tax on chargeable gains on the difference between the purchase price and the sale proceeds, subject to indexation allowance. If, in advance of a sale, the operational activities are transferred into another company in the vendor’s group, the shares in the property owning company could be sold instead of the asset. The chargeable gain would then be calculated on the tax base cost of the shares.
The leaseback of the property would not give rise to a capital gain on the original owner; however, the position of the purchaser would depend on the length of the lease and whether a premium was paid for the lease.
Stamp Duty Land Tax
SDLT would be payable by the purchaser at a rate of up to 4% on an asset acquisition. For a share acquisition no SDLT would be due; however, stamp duty reserve tax (SDRT) would be payable by the purchaser at a rate of 0.5%. The leaseback of the property would potentially give rise to a SDLT charge on the lessee; however, there are provisions that exempt the ‘leaseback’ from SDLT, provided that certain qualifying conditions are met. The main qualifying conditions are as follows. Whether these conditions can be met would depend on the commercial requirements of both parties…
• the sale transaction is entered into wholly or partly in consideration of the leaseback transaction being entered into, and…
• the only other possible consideration for the sale is the payment of money or the assumption, satisfaction or release of a debt, or both, and…
• the vendor and purchaser are not members of the same group.
On disposal of an asset, a balancing adjustment will arise on the vendor company; however, this could be managed with commercial negotiation and entry into a joint election with the purchaser (s198 CAA 2001). If the company is sold, however, the capital allowance history stays with the company and no balancing adjustment arises.
Industrial Buildings Allowances (IBAs)
The Budget in March 2007 proposed changes to the tax legislation for IBA allowances. This could have a negative impact on many sectors, such as the hotel industry. The changes proposed are that IBA assets, such as hotels, will from 2008/09 be entitled to a lower rate of allowances and will be gradually phased out, with complete withdrawal in 2010/11. In addition, no balancing event will take place on a disposal. Therefore, if the IBA asset is disposed of, there is no balancing impact on the allowances previously claimed by the vendor, although any future allowances available to the purchaser will be scaled down. If the company shares are disposed of, the IBA history stays with the company.
It is unfortunate that the Chancellor chose to phase out IBAs over the next few years, as this has made investments in hotels in particular less attractive than they would have been for property investors under the old rules. However, under current market conditions, and with the stimulus created by the introduction of REITs, there is a great opportunity for property-rich companies to realise significant value from their property portfolios and, if required, to continue their operational activities through leaseback arrangements.
PKF has had numerous discussions recently with large hotel groups and family companies looking to undertake such transactions. Rising interest rates and attempts to dampen property prices are unlikely to diminish the trend.
Despite the negative publicity and the accusations of government departments selling off their most valuable property assets, well thought-through sale and leaseback deals continue to deliver benefits for companies. Of course, you can only sell property once, but sale and leaseback can provide not only a valuable injection of cash, but the longer-term opportunity to focus on core business activity without the need to manage property assets.
Marios Gregori is Real Estate Tax Director at PKF.
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