In our response to the Government’s Fixing our broken housing market consultation, we compared the UK tax consequences of the traditional model for the sale of land for residential development in the UK with various routes to land pooling. Our conclusion is that there needs to be a level playing field in tax terms.
The Government has talked of a consensus that the UK needs from 225,000 to 275,000 homes per year to keep up with population growth and to tackle years of under-supply. The Department for Communities and Local Government (DCLG) said the problem is threefold: not enough local authorities planning for the homes they need; house building that is simply too slow; and a construction industry that is too reliant on a small number of big players.
The Government has looked at how land is used in other countries to help address the housing problems it sees in the UK. The consultation used the case study of Bonn city council, which has made extensive use of land pooling and typically has several pooling processes running concurrently. While we have not discussed the German model of land pooling in our formal submission to DCLG, people may be interested in how it works. The Bonn approach involved the council assembling all land ownerships, then preparing a masterplan, obtaining outline planning permission and using local contractors to create serviced plots ready for housing development. Each landowner then received one or more of the 186 building plots according to their share of either the original land value or land area, minus public administration and infrastructure costs.
Under the traditional model of housing development in the UK, landowners effectively compete to ensure that their land is used for the most profitable part of the development (usually high end private housing) rather than for, say, parkland or affordable homes. In contrast, land pooling involves landowners pooling their land interests (either by agreement or via a pooling vehicle) and sharing the profits of development according to the proportion of land they have provided for the development with the aim of improving the marketability of the land and ultimately to achieve a higher profit than they could by acting individually.
Part of the value of land pooling is seen as promoting sustainable development by equalising values through a pooling process in recognition that all the land is integral to the development whether used for high value prime residential or for community infrastructure or green space. It is also seen as more effective in terms of a patient capital approach rather than the need to maximise short term returns by early disposal.
The consultation asked how land pooling could make a more effective contribution to assembling land and wanted views on any barriers inhibiting greater take up, and how those might be addressed.
To help our comparative tax analysis, we looked at the traditional approach in the UK, which is that a landowner grants a developer (who will finance the development) an option to acquire land that will form part of the housing development, the developer then obtains planning permission and the landowner sells to the developer. The traditional model tends to maximise sale prices at the start of the development process and militates against longer term high-quality development.
The CIOT’s response (which was on this aspect only) was that the tax consequences provide a strong incentive to a landowner to adopt the traditional route rather than pooling arrangements. The traditional model, as compared with land pooling offers a generally lower effective tax rate, more generally avoids tax charges crystallising ahead of receiving cash (so-called ‘dry’ tax charges) and more generally preserves entitlement to reliefs frequently available to landowners based on their or their property’s tax status prior to the development. The current tax framework tends to act as a strong incentive to a landowner to adopt the traditional route in preference to land pooling.
Ensuring a comparable tax outcome for landowners whether they adopt the traditional model or pooling route would remove this perverse incentive. When we say comparable, we mean broadly the same outcome so that the tax consequences of pooling does not distort the economic or social decision to pool the land because the tax cost of doing so is higher when compared to the tax consequences of adopting the traditional route. Comparable tax treatments would allow each route to be judged on its merits and in accordance with (or at least not in opposition to) underlying housing policy if that policy is to promote pooling.
Achieving comparable tax treatment is not without difficulties. In part because it involves the application of a number of different taxes.
Broadly speaking, comparable tax treatment for land pooling would mean some or all of the following tax characteristics:
- The landowner’s pro-rata final entitlement is taxed as a capital disposal at Capital Gains Tax rates (CGT), with the potential to secure CGT reliefs including Entrepreneurs’ Relief, rather than as a trading transaction taxed at the top rate of income tax of 45 per cent.
- Dry tax charges are avoided at the time the land is pooled (or de-pooled), in so far as the tax liability arises at the point of final disposal.
- While land is pooled, the landowner is taxed as if the land is in direct ownership so for income tax purposes, rents are taxed in the hands of the landowner.
One way to achieve this level tax playing field would be with a land pooling vehicle that effectively freezes the status of land pre-pooling. Similar to the traditional model, tax would be charged at the point a tranche of land is sold and a pro-rata share of the proceeds are paid out. If the development does not go ahead, the land would revert to the landowner without triggering a tax charge. While freezing the tax position for CGT and IHT is a likely focus for landowners, other taxes will need to be considered (such as SDLT, corporation tax, income tax and VAT).
An alternative route may be a wider permissive legal power to grant particular tax treatment to landowners participating in a development that satisfies the defined requirements of a sustainable development with the costs of exercising the power met, at least in part, out of the development.
The tax system should in principle not operate to promote one approach to land development while artificially penalising another.
Blog by Kate Willis, technical officer for CIOT's Property Taxes Sub-committeeMore Articles by Chartered Institute of Taxation (CIOT) ...