How overages on land sales are taxed
Following on from our post on the tax implications of selling your garden we're now going to discuss how overages on land sales are taxed. These are often linked can significantly impact the total consideration received by a landowner upon the sale of their land where it has potential development value.
Overview
There has been a spate of residential property developments in the last few years. Given the paucity of UK land available for development the concept of overages or 'slice of the action deals' have become increasingly popular as a method of enticing landowners to sell.
What is an overage?
An overage, is essentially a contractual arrangement that entitles the original landowner to receive an additional payment, if and when certain conditions are fulfilled post-sale. These conditions are typically related to the enhancement of the land's value, usually as a result of obtaining planning permission or the actual development of the land itself.
The tax treatment
How an overages on land sales are taxed, are contingent on how the overage agreement itself has been structured. For example does the agreement allow for a one-off payment?, or is the overage payable as part of a series of transactions?
You also need to consider the landowner's activities in the context of the land sale. For example are they a property developer by trade, or was this a one-off transaction?
The conditions under which the overage becomes payable are equally important. Is the payment contingent upon a discernible event, like obtaining planning permission, or is it more speculative in nature?
The conditions for payment of the overage becomes are equally important. The payment may be contingent upon a discernible event, like obtaining planning permission, or more speculative in nature - for example dependent on the development achieving a target sale price.
Capital gains tax treatment - ascertainable overage
If HMRC's anti-avoidance rules do not apply, and the transaction involving the land sale does not form part of, or amount to, a trade, any future consideration will be treated as a capital gain.
The exact capital gains treatment will then depend on whether the amount of overage is ‘ascertainable’ or ‘unascertainable’ at the date of disposal.
An overage will be ascertainable if on the date of the sale it is known or established by calculations. Additionally it can be regarded as ascertainable where all the events which establish the amount that have occurred.
An overage is considered ascertainable deferred consideration where all the events that influence the amount of consideration have occurred before the date of the land sale.
Where the amount of future consideration is ascertainable, then the full amount of the overage is included in the total disposal proceeds of the land itself. There are no tax consequences when future amounts are received.
Capital gains tax treatment - unascertainable overage
Consideration is unascertainable if events that establish the amount do not occur until after the date of the disposal. For example an initial payment of £200,000 on a land sale is made, plus three further payments equal to the excess of profits over £300,000 in the following three years.
The presence of a maximum amount to be paid does not imply that the consideration is ascertainable in the maximum.
The capital gains tax treatment of unascertainable future consideration was established in two important tax cases which are covered in HMRC's guidance here.
Put very simply, where these rules apply then any future consideration is axed in the year of receipt as opposed to being included as part of the total sale proceeds when the land is sold.
Overages taxed as income
If HMRC's anti-avoidance rules apply, and the transaction involving the land sale forms part of, or amount to, a trade, any future consideration will be treated as income.
These rules are designed to catch profits that arise from land transactions, which, by definition, are akin to trading activities. The legislation is far reaching, capturing not only outright land sales but also overages where the consideration is contingent and unascertainable at the time of the initial sale.
The tax treatment of an overage as income will be contingent on the landowner's intentions at the time of the original land sale and their history of similar transactions. I
If HMRC can establish that the landowner's intention was to sell the land as part of a trade, or that there is a pattern of similar transactions suggesting a trading activity, the overage payment is likely to be taxed as income. This is true even if the landowner is not a habitual property developer. In fact a single transaction can be treated as trading if it is undertaken in a manner resembling a trade.
For example a landowner historically engaged in buying and selling land with the intention of realizing a profit from its development may find that an overage payment is taxed as income. Similarly, if a non-trading landowner enters into an overage agreement with the clear intention of profiting from the future development value of the land, this too could be perceived as a trading activity by HMRC.
Conversely where someone sells part of their garden to a developer with an overage clause that entitles him to 10% of the value of the land if planning permission is granted within the next five years that overage may be treated as a capital gain. This is especially where they have no track record of property development, and the overage is clearly linked to the disposal of their garden.
Summary
Ultimately how overages on land sales are taxed will depend largely on the landowners intentions and how the sale agreement is structured.
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