Compulsory purchase (CP) and capital gains tax (CGT)
Whilst CPs can result in significant payments to landowners, they can also pose a potential tax liability through CGT, however the usual rates, reliefs and exemptions may apply.
The headline rate for CGT is currently 20%, albeit those in lower rate tax bands may pay some CGT at 10% (28% and 18% for residential property). The
first £11,300 (the annual exemption for 2017/18) of capital gains per individual is exempt from CGT.
In the right circumstances, such as a retirement, a cessation, a withdrawal from, or an incorporation of the business; entrepreneurs’ relief might also be available. Here, CGT is payable at a reduced rate of 10% on up to £10m of qualifying gains in an individual’s lifetime. It may also be possible to tax- efficiently access multiple CGT annual exemptions and lifetime allowances.
Mitigating CGT through reinvestment
While reducing the applicable tax rate, as above, may be beneficial, there are additional means to mitigate an immediate CGT liability, provided that the compensation is reinvested into qualifying replacement assets. This allows for the continuance or enhancement of a business without a reduction in resources through taxation forced by the CP.
Roll over relief, allowing deferral of the capital gain into new, replacement assets, is a useful mechanism for many preferring this route. For relief to be available on CP, the landowner must not have made known their willingness to dispose of the property to the relevant authority or any other party in the three years prior to the CP.
Amongst other stipulations, relief rules state that the ‘vendor’ must reinvest the proceeds within three years of the disposal. The earliest ‘reinvestment’ may take place for roll over relief purposes is one year before the disposal. However, HMRC has discretion, on request, to extend statutory roll over periods in circumstances such as CPs, where disposal timing can be unpredictable. The date of disposal for the compulsory purchased land is the date on which the amount of compensation is agreed or determined by a Tribunal (the disposal date remains the same even if this amount is varied on appeal).
If granted, this is particularly useful where suitable replacement qualifying property may be available now that may not be obtainable at the time of disposal.
However, landowners need to consider how to finance any purchase taking place prior to the CP and receipt of the proceeds. Debt financing the new asset for
the short term, with the intention to repay the capital from the CP proceeds, may well support the case for an extension to the roll over period where reinvestment is prior to the CP disposal. Of course the financing must be affordable and consideration must be given to a situation in which the CP does not proceed. An alternative might be an option agreement in respect of the purchase, although Stamp Duty Land Tax issues may arise.
By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article. This briefing does not constitute advice nor a recommendation relating to the acquisition or disposal of investments. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. Details correct at time of writing.