PROPERtyb r i e f i n g

Spring 2014

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LETTER from the editor

it ALL ADDS UP

Welcome to our latest newsletter which looks at a range of issues relevant to the property sector. With the transition date already passed for those companies that have

December year ends and who will be adopting FRS 102, we review some of the key issues that will be relevant to property companies. We also examine the tax issues that companies adopting FRS 102 will need to consider as part of their transition. Although economic conditions are improving, tenants can still fail and Caroline Turner from Gordon Dadds discusses the options available to the landlord if this happens. At the

IntROductIOnAt first glance Barack Obama, the 1980s rock band Marillion, and a tV property show presenter, Kevin Mccloud, seem to have little in common. However, all three have harnessed the power of the internet to find investors for projects via different forms of crowdfunding.

It’s not just celebrities, public interest or community projects and political parties who are raising investment online – ordinary companies, including those in the property sector, are increasingly harnessing the power of the web as they seek alternatives to scarce bank funding.

there are various different types of crowdfunding and an increasing number of online platforms which offer to organise the investment rounds. However, at its simplest, crowdfunding is the use of the internet to raise investment from the public (the “crowd”).

• EquityfinanceAn equity crowdfunding approach is used to raise investmentcapital with contributors receiving equity in the company.contributors may act as investors and receive shares directly, or the crowdfunding service may hold the shares on behalf of the investors by acting in an agency capacity.

One website that focuses on raising equity funding for UKbusinesses from the crowd is crowdcube (www.crowdcube.com). to date, crowdcube has raised over £20 million for more than 100 companies, with the Kevin Mccloud company, HAB Housing Limited, having raised nearly £2 million through the site. HAB Housing is believed to be the current holder for the most raised in a single round of crowdfunding.

the website allows investors to review “pitches” made by the entities searching for investment which include amongst other information, financial projections, business plans, market data, information on the backgrounds of the principals and, perhaps most crucially of all, exit plans. crowdcube applies due diligence

to the applications it receives and says that only 25% of the applications it receives reach its website.

For investors, reviewing the pitches on the site can be fun and not unlike an online version of the television show dragons den. Businesses get the advantage to reach out to thousands of new investorsinaquickandconvenientprocess.

• Debtfinancedebt based crowdfunding uses the internet to match investors wanting to lend to businesses seeking loan finance. One such example of this concept is the Funding circle website (www.fundingcircle.com) which describes itself as an online marketplace and has helped raised loans of over £250 million.

Investors potentially benefit from, amongst other things, stronger returns than available from conventional investments (the Funding circle site is currently reporting a 6.1% average return after fees and bad debts) and the ability to manage risk by diversifying loans across a number of recipients.

Businesses benefit from a source of finance independent from the banks and the ability to borrow up to £1 million.

PROPERtyIf web-based marketing and fundraising and the traditions of the property market seem unlikely bedfellows it may be time to think again. As mentioned above, it is the Kevin Mccloud established HAB Housing Limited that has broken records for equity crowdfunding, having raised nearly £2 million fromover 600 investors with each person investing between £100 and £150,000. the company seeks to build beautiful and environmentally friendly housing at affordable prices. current projects include sites of 40 to 100 homes in Stroud, Oxford, Swindon and chippenham.

Perhaps reflecting the uK public’s passion for property investment, property specific crowdfunding websites are now appearing with examples such as the House crowd (www.thehousecrowd.com),

beginning of April we saw changes to the way in which capital allowances on commercial property transactions will be treated for tax purposes. Clive Curd from veritasadvisory looks at these changes and explains why ignoring them could cause you a financial loss. I would like to take this opportunity to thank Caroline and Clive for their contributions to this newsletter.

Finally we look at an up and coming form of alternative finance, crowdfunding, and the recent developments in VAT for those engaged in constructing accommodation to be used by institutional establishments.

I hope you find these articles useful and if you would like to discuss the issues that they raise please feel free to contact me or your usual haysmacintyre contact.

Ian Daniels head of propertyE idaniels@haysmacintyre.com

crowdahouse (www.crowdahouse.com) and Property Moose (www.propertymoose.co.uk). While the details vary from site to site, these sites allow investors to become shareholders in SPVs investing in properties for income and capital growth. While still in their infancy, these models offer private investors a route into property investment and those in the industry a potential new source of finance.

BEnEFItS & dRAWBAcKSCrowdfunding is allowing organisations to seek equity financefrom outside their immediate groups of shareholders, and for those looking for debt finance to search and identify alternatives to bank debt.

For investors, crowdfunding offers a choice of investments, with potentially higher rates of return (and risk!), and the chance to be an angel investor. For the investor there may also be generous tax benefits such as Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS), although these tax reliefs are not available for companies which invest solely in property.

It is an old adage that risk and return are inversely related and, whilst the potential returns from crowdfunding may look high and attractive, those considering entering the market need to consider the attendant risks. References above to sites are for reference purposes only and should not be considered an endorsement, or otherwise, of any particular website – other websites are available! – which takes us onto regulation.

REguLAtIOnOn 1 April 2014, consumer credit market regulation transferred from the Office of Fair trading to the Financial conduct Authority (FcA) and, at the same time, crowdfunding platforms offering loan and equity investment funding became regulated bythe FcA. Whilst many of the new regulations ensure that the industry applies the FcA provisions, thereby being regulated in a comparable way to other financial services firms, FcA regulation

impactsdebtandequityschemesindifferentwayswiththeriskier,equitybasedfundingsubjecttostricterrules.

Rules applying to crowd funding platforms include those relating toFCAconductofbusiness,minimumcapitalrequirements,clientmoney and dispute resolution. However, the stricter rules affecting equity based schemes have drawn some criticism, with fearsthat they could significantly reduce the size of the “crowd”. the regulationsincludearequirementthatcrowdfundingplatformsonlypromote equity based investments to certain types of investors,which include: professional clients, retail clients who are advised, retail clients certified as sophisticated or high net worth, or, retail clients who confirm that they will not invest more than 10% of their net investible assets in these products.

these rules are to be reviewed by the FcA over the coming year and the crowdfunding market will be subject to a “post implementation review” in 2016 to identify whether further changesarerequired.

While the longer term impacts of regulation are not clear, the rules have already had the effect of highlighting the risks of investment to the “crowd”. the following abbreviated risk warning appears on the crowdcube site:

“Investing in start-ups and early stage businesses involves risks, including illiquidity, lack of dividends, loss of investment anddilution, and it should be done only as part of a diversified portfolio. crowdcube is targeted exclusively at investors who are sufficiently sophisticated to understand these risks and make their own investment decisions. you will only be able to invest via crowdcube once you are registered as sufficiently sophisticated.”

Of course these risks are already well known to the professional or “sophisticated” investor but prospective ‘dragons’ may not appreciate the full risks of a start up investment.

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a) Poolingrequirement:expendituremustbepooledwithintheir accounts (pooling does not mean making a claim, but identifying the value to be elected over in the accounts); and

b) disposal value statement: written statement of the disposal value of fixtures that at an earlier point had to be brought into account; and

c) Fixedvaluerequirement:anagreementbetweenthetwoparties, formally agreed within two years of the transaction, of the value to be transferred between them (typically via a S198 election).

Many owners and investors of property do not have the knowledge and experience of the issue of capital allowances at the point of a transaction. A specialist capital allowances advisor can provide this essential advice and should be appointed for every transaction. the seller, providing the wrong or missing information could have ramifications at a later stage. A purchaser, not understanding what detailtoaskforandrequestingpoolingbeforesalewillrisklosingtax relief.

Every property has a different capital allowances history and it is

ChAngE iS hERE From 1 April the capital allowances (cAs) compliance legislation changed and will affect how buyers and sellers deal with commercial property transactions; failure to do so, will result in potential financial losses.

this legislation, introduced in the Finance Act 2012, and referred to as S187A, is intended to stop what HMRc believe are erroneous claims being made by some tax payers. the legislation is drafted to force the issue to be dealt with at the point of sale. no longer can capital allowances be viewed as an afterthought, because of the risk to both the buyer and seller of losing out on the benefit.

the key change for clients is that, should capital allowances not be pooled and elected over at the point of sale, then the purchaser, and all future purchasers will be prevented from claiming any capitalallowancesontheassetsacquired!

On a transaction, where an item of plant and machinery is within S187A, the past owner (current owner) is treated as owning the fixture and for a future claim to be made, the following criteria must be satisfied, where the owner is within the charge to tax:

the neW CAPitAL ALLoWAnCe RULES FOR TRAnACTiOnS

ThE PROBLEM OF inSoLVent tenAntS IntROductIOnOne of the problems for a landlord is what should he do if the tenant becomes insolvent and there are unpaid rent arrears? can he forfeit the lease, agree a surrender of the lease for a premium or sue the tenant for the rent arrears in the same way that he may if the tenant were not insolvent? Once a tenant becomes insolvent and starts an insolvency process, the landlord’s rights to act are severely curtailed.

VOLuntARy LIquIdAtIOnIfthetenantgoesintoVoluntaryLiquidationthenthelandlord’sright to commence proceedings are not affected. However, the liquidatorcouldapplytorestraintheproceedingsiftheyarecommencedagainstacompanyinliquidation.

Ifthetenantcompanywentintovoluntaryliquidationthenitislikely that the company would not wish to retain its premises since itislikelytohaveceasedtrading.Theliquidatorandthelandlordcouldreachanagreementtohandovertotheliquidatoranygoods that the company owns, that are still at the premises, and arrange for the orderly clearance of the premises. the head lease could then be forfeited or surrendered.

cOMPuLSORy LIquIdAtIOnIf the landlord wants to start proceedings against the tenant for unpaid rent or forfeiture of the lease, he would need to obtain leave to do so from the court if the tenant is a company in compulsoryliquidation.

However, in the case of Ezekiel v Orakpo [1977] the court held that peaceable re-entry of the premises by the landlord is not “an action or legal proceedings”. So if the tenant is in compulsory liquidation,anexpedientcourseofactionforthelandlordwouldbe to change the locks, when the tenant is not present at the premises, and simply take the premises back.

AdMInIStRAtIOnIf a company goes into administration, the landlord, who may

be owed rent arrears, is prevented from exercising any rights of action without leave of the court or consent of the administrator. If the landlord applies to court to bring proceedings, the court will balance the interests of the landlord against the interests of all the creditors, and take all the circumstances of the case into account. If the administrator has moved into the tenant’s premises, then he will become liable to the landlord for payment of the rent and rates when they fall due, as part of the costs of the administration.

the recent court of Appeal case about the administration of the GameStoresGroupLimitedhasclarifiedthequestionofwhetherthe administrator is liable for rent payments of the premises, or whether the rent payment was a debt of the company in administration. Previous cases had held that if the rent for a quarterfellduebeforetheadministrationcommenced,itwouldjustbe a debt, not a cost and expense of the administration.

When the games Store group went into administration it did so thedayafterthequarterlyrentbecamedueforitspremises.Therent was not paid by the games Stores and shortly afterwards the administrators sold the business and assets to a new buyer. the new buyer benefited from the fact that the rent fell as a debt of the games Store group, and they were going to have almost an entirequarterrentfree.

ThelandlordsappealedtotheCourtofAppeal,onthequestionofwho should be liable for the rent. the court of Appeal held that ordinary justice should not be defeated by the “happenstance that a rent day occurred immediately before the date of administration” and decided that the administrator should pay rent for the period he retained possession of the property. therefore, following this case, it appears that rent can be apportioned following the insolvency and the administrator will be liable to pay for the period he has the benefit of the property.

Caroline Turner is an Associate at gordon dadds LLP and can be contacted at carolineturner@gordondadds.com

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Property cAs cash SavedOffice £300,000 £63,000Industrial £150,000 £31,500Retail shop £70,000 £14,700Hotel £320,000 £67,200care home £260,000 £54,600Student £150,000 £31,500

the cash savings above will be lost if the criteria above are not met; it is certainly worth paying attention to such savings before concluding a property transaction.

Clive Curd is a founder director at veritasadvisory and can be contacted at clive.curd@veritasadvisory.co.uk

critical to allow sufficient time within the transaction, to:a) establish the entitlement to claim; andb) toretrievethenecessaryinformationtoquantifythelevelof

capital allowances to be elected over within the purchase contract.

the cash saving that might be achieved will vary but the table below sets out claims (and the cash saving possible) that we would anticipate in an average claim for different types of property:

tyPIcAL cAPItAL ALLOWAncES On AcquISItIOnAssuming no prior restriction and full entitlement, say the following acquiredoncurrentrulesfor£2million,acorporationtaxrateof21% and full use of AIA and assuming an average claim.

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Business combinationsFRS102requiresintangibleassets(suchasbrands)toberecognised on business combinations when their fair value can be measured reliably, which is less restrictive than current uK gAAP. It is therefore expected that more intangibles will be recognised on consolidation under FRS 102 than under existing uK gAAP. Furthermore,FRS102hasintroducedarequirementthat,whereanentity cannot reliably estimate the useful life of an intangible asset, the amortisation period should not exceed five years.

WHAt ABOut tHE FRSSE?the Financial Reporting Standard for Smaller Entities (“FRSSE”) framework may be an alternative to adopt for those entities that are small and do not want to adopt FRS 102. However, despite initial consultation indicating that the FRSSE would remain unchanged, the tentative view is now that the current FRSSE will be withdrawn and replaced by FRS 102 “light”. An Exposure draft is expected in June 2014 which will not leave much time for preparing for any changes if a 1 January 2015 start date is intended.

In cOncLuSIOnthe message for property companies is clear: a decision on the choice of future accounting framework will need to be made in the near future. For some, there will be significant change, both in presentationandintheinformationrequiredtocompilefinancialstatements. An early assessment and resulting action plan is stronglyrecommendedtoavoidanyunexpectedconsequencesofsuch changes.

1 January 2014 saw the transition date pass for entities that will be adopting FRS 102 and who have december year ends. Entities will need to be able to restate their balance sheet as at their transition date under FRS 102, but what does this mean for the property sector?

WHEn dOES It APPLy?FRS 102 becomes mandatory for accounting periods commencing on or after 1 January 2015; for a 31 december 2015 year end this will mean preparing an opening balance sheet as at the date of transition which will be 1 January 2014. Early adoption of FRS 102 is permitted.

WHAt IS tHE IMPAct?Revaluation of assetsFRS102allowsProperty,PlantandEquipmenttobeheldundereither the cost or revaluation model, as permitted by FRS 15. On transition, there is the opportunity to revalue an asset once and hold it at that value going forwards i.e. its “deemed cost”. If arevaluationmodelisadopted,FRS102requiresrevaluationswith “sufficient regularity” to ensure the carrying amount of the asset does not differ materially from its fair value at the end of the accounting period. Adopting a revalued amount for an asset as its deemed cost at transition will give a potential benefit to the balance sheet value of the entity, albeit at an increase in future depreciation charge but without the commitment to arranging future valuations.

Investment propertiesunder FRS 102, investment properties will be carried at fair value, provided such value can be reliably measured, which will normally be the case. unlike under existing uK gAAP, investment properties leased to other members of the same group will be classified as investment properties. Annual revaluation gains and losses on such properties will be recognised through the profit and loss account rather than through the statement of recognised gains and losses.

deferred taxdeferred tax will be recognised on timing differences which will mean deferred tax liabilities will be recognised on the revaluation of properties and other revalued assets.

Financial instrumentsFRS 102 makes a distinction between “basic” and “other” financial instruments. Basic financial instruments (such as trade debtors and creditors and straightforward bank loans) will mostly be carried at amortised cost.

For“other”financialinstruments,entitieswillusuallyberequiredto show such instruments at fair value on the balance sheet. this will mean that, under FRS 102, entities will be recognising assets and liabilities, such as interest rate swaps and forward exchange contracts, at fair value on the balance sheet which were not previously recognised. the movements on such derivatives will be charged to the profit and loss account, unless the entity chooses to hedge account.

this is an area of potential complexity for entities adopting FRS 102.

FRS 102 WhAt it meAnS for ProPertY ComPAnieS

tAX imPiCAtionS of FRS 102As explained earlier, from 2015 many uK companies will be adopting FRS 102. As the corporation tax treatment generally follows the accounting treatment, the changes will have a significant impact on the tax position of many companies in the property sector.

Theaccountingchangesmayevenrequiresome companies to make elections before the start of the accounting period, where the new standards are adopted for the first time, to minimise the tax implications. Accordingly, it is important that consideration is given to the impact of the changes now, to ensure that there is sufficient time to plan and make any appropriate elections.

the tax legislation already covers many of the issues arising on transition following changes made on the introduction of IFRS. the effect of these changes is, in many cases, to provide tax treatment broadly equivalent to that applying under currentuK gAAP. However, HMRc recently published two papers providing an overview of the key tax considerations arising from the transition to FRS 102.

Below is a summary of the key corporation and deferred taxation implications arising from the introduction of FRS 102.

InVEStMEnt PROPERtIESunder current uK gAAP, the tax that would arise on the disposal of investment properties at their open market value was disclosed in a note to the accounts, unless there was a binding agreement to sell the property at the balance sheet date, in which case deferred tax was recognised.

under FRS 102, any movement in value will be recognised in the profit and loss account but will remain non-taxable. Furthermore, the deferred tax arising on the revaluation of investment properties must be provided for under FRS 102. the deferred tax provisions will reduce the net asset value of many property investment companies and is a significant change. unrealised profits from the revaluation of properties will, however, continue to be unavailable when determining distributable profits.

LEASE IncEntIVESthe effect of a lease incentive is recognised over the term of the whole lease under FRS 102. this differs from current gAAP where it recognises the effect to the first break clause or rent review under the contract. As the tax treatment follows the accounting treatment, the timing of tax deductions under FRS 102 may change for tenants with leases with rent free periods. However, first time adopters of FRS 102 are not required to adjust for leases thatcommenced before the entity’s transition date.

FInAncIAL InStRuMEntSFRS 102 requires derivatives (such asinterest rate swaps, options and forward contracts) and non plain vanilla debt (loans where the repayment amount can vary or with non standard interest rates) to be measured at fair value on a company’s balance sheet, with the movements recognised through the profit and loss account.

As the corporation tax treatment for loans and derivatives generally follows the accounting treatment, the fair value movements on such financial instruments will need to be recognised for tax, other than where certain specified exceptions apply.

the tax rules for loans and derivatives also requireamounts taken straight to reservesto be brought into account for corporation tax purposes. the differences arising from a company restating its opening figures to recognise the fair value of a financial instrument on the transition to FRS 102 will, therefore, need to be recognised for corporation tax purposes although, in many cases, the effect may be spread over 10 years following reliefs previously introduced for IFRS.

HEdgIngHedge accounting, which matches the movement on the hedging instrument with the hedged item, is allowed under FRS 102 if certain conditions are met.

As hedging may not be effective for tax purposes where financial instruments are measured at fair value, HMRc introduced special rules to allow a company to disregard the effect of hedges and effectively restore the current uK gAAP position (where FRS 26 has not been previously adopted) – the, so-called, disregard provisions. A company must, in most cases, make an irrevocable election for the disregard provisions to apply before the start of the relevant accounting period where the new accounting policy applies. the time limit for making such an election is therefore approaching rapidly for the companies adopting FRS 102 next year, although HMRc are considering relaxing this time frame.

cOncLuSIOnIt is vital for companies to understand and plan for the tax implications arising from adopting FRS 102. the implications for financial instruments are complex and need to be considered as soon as possible, especially by the many property companies who have hedged against interest rates (or exchange rates) on loans.

Although entities may feel that the introduction of FRS 102 is something that can be left for now, failure to consider the tax position soon may result in missing the opportunity to make appropriate elections. For instance, if you have a december year end, the choice over electing on the disregard provisions may need to be made this year.

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WhAT iS A “RELEVAnT RESiDEnTiAL BUiLDing for VAt PUrPoSeS Recent Briefs from HMRc have potentially changed the VAt status for construction companies building certain types of accommodation for institutional organisations and means that a re-evaluation of the appropriate VAt rate from the familiar zero rating may be necessary.

BAcKgROundthe relevant tax legislation, which permits such zero rating, refers to the supply of services in the course of construction of a building intended “solely” for “relevant residential purposes”. It then sets out the following types of building intended for use for such a purpose:• Children’shomes;• Carehomes;• Hospices;• Residentialaccommodationforstudentsorschoolpupils,e.g.

boarding houses or halls of residence;• Residentialaccommodationformembersofthearmedforces,

e.g. barracks;• Monasteries,nunneriesandsimilarestablishments;and• Institutionswhichare the sole ormain residenceof at least

90% of its residents.

Since only the user, or owner, of the building can certify what useabuildingwillbeusedfor,constructioncompaniesfrequentlyobtain a certificate from their customer confirming the building’s use and that they can zero-rate their supplies. Although the legislation refers to the building being “solely” used, HMRc interpret this as meaning 95% or more.

However, two developments this year, concerning student accommodation, may limit the circumstances when zero-rating is applicable.

WHAt IS A StudEnt?the first development was Revenue & customs Brief 03/14 issued on 31 January 2014. this stated that whilst the term “school pupil” was reasonably clear and uncontroversial, the term “student” was lesssoandrequiredclarification.

the Brief went on to say that the definition also covered any person receiving education or vocational training from a university or other higher, or further, education institution with a view to: obtaining a generally recognised academic or professional qualification;maintainingan existingprofessional qualification;or undertaking a course of study which, whilst not leading to a recognisedqualification,hasahighlevelofacademiccontentandis intended to improve the knowledge and understanding of the student in an area of academic interest.

All of this is unsurprising, but the Brief went on to say that people who attend classes, often badged as “summer schools” but where the subject of which falls into the category of hobbies or leisure interests (for example pottery workshops or literature appreciation courses)willnotqualifyas“students”.

It also said that, whilst people training to become a minister of faithwillqualifyas students, thoseattending religious retreatsorseminaries which are intended “primarily to foster or reinforce faith” will not be considered as students.

the relevance of this is that many schools and universities let out their boarding houses or halls of residence during vacations to people running such summer schools. the result of such lettings could mean that HMRC’s 95% or more qualifying use test isno longer met, such that the zero-rate should not apply to the construction services.

HMRc’s view has been that if a construction company relied on a certificate in good faith and had no reason to doubt that the certificate was not correct, then they would not pursue the builder for VAt that should have been charged. there is no suggestion in the Brief that this policy will change. However, if you are constructing a new hall of residence or boarding house, your position with HMRc would be strengthened if you had, in writing, evidence that you had asked your customer to confirm that they had considered the impact of this Brief and that the accommodationwillpassthe95%qualifyingusetest.

WItHdRAWAL OF cOncESSIOnSthe second development was Revenue & customs Brief 14/14 issued on 7 April 2014. this concerns the construction of student accommodation for Higher Education Institutes (“HEI”) and of new dining rooms and kitchens constructed at the same time as new residential accommodation for students and school pupils.

the Brief announced the withdrawal of two concessions with effect from 1 April 2015. the first of these allowed HEIs to ignore vacation use when determining whether the use of the building was 95% or more for student accommodation. the second allowed dining rooms and kitchens to also be zero-rated if they were used predominantly by the living-in students. transitional rules will allow the concession to continue to apply where the first supply is made prior to 1 April 2015, provided it is a meaningful start to the construction of the building and the work is expected to progress to completion without interruption.

Again the responsibility for issuing a certificate claiming zero-rating lies with your customer, but if you are engaged in constructing new accommodation for an HEI or new kitchens or dining rooms, then it would be sensible to have evidence that your customer has taken account of this Brief. If you have that evidence then it is your customer who is at fault, not you!

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disclaimer: this datasheet has been produced by the partners of haysmacintyre and is for private circulation only. Whilst every care has been taken in preparation of this document, it may contain errors for which we cannot be held responsible. In the case of a specific problem, it is recommended that professional advice be sought. the material contained in this datasheet may not be reproduced in whole or in part by any means, without prior permission from haysmacintyre.

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