Land Pooling: Introduction
Land pooling has always been an interesting topic of discussion in the tax community. It became particularly relevant following the decision in Warrington v Brown 1989 STC 577.
As land development increases, questions over land pooling and the consequences of so doing will likely increase too. Whilst there are multiple options available for individuals to bring their land together (via joint venture, in a partnership, etc), land pooling via bare trusts is generally advertised as a straightforward solution with minimal tax consequences.
Now ultimately what will or will not be the most appropriate route to take will depend upon the ultimate goals of the individuals involved including, for example, whether they want to work in a partnership or if instead this is a one off sale and they just want to find a way to get in and get out quickly with the least amount of pain.
One solution which has been suggested to solve this problem has been “land pooling”. This is an option being floated all over the internet and it is suggested mainly that while there is some risk associated with it, it works from a legal perspective. This has led me to ask the obvious question – is that true? Does this work?
Unfortunately, I think that both HMRC and assorted tax advisers have been overselling this as a legitimate option. For this reason I think this is something worth looking into in more detail.
In this blog, I want to take a closer look at this analysis and establish whether or not the current thinking on the tax consequences of land pooling through a bare trust are correct.
What is land pooling?
Land pooling involves two individuals combining their two plots of land via a bare trust for the purposes of future sale. The reason the individuals would want to sell their land together would usually be because their ability to sell it at a higher price increases if the land is sold and marketed as one item.
Whilst this seems to be a pretty innocent act, the tax consequences which flow from combining the land in this way are far from straightforward. The question then becomes how can the two plots of land be combined for sale purposes with the least amount of pain from a UK taxation perspective.
The mechanics of land pooling
Land pooling usually works by two individuals who each own parcels of land next to each other transferring their respective shares to a bare trustee. The bare trustee will then hold the entire land on bare trust for the two transferors in shares equivalent to the value of the land they transferred in.
For example consider if A had land (Parcel A) worth 250,000 and B had land (Parcel B) worth 750,000. A and B transferred their shares to trustee C. Trustee C then holds the combined land (Parcel AB) on bare trust for A and B with A owning a 25% share of Parcel AB and B owning a 75% share in Parcel AB.
What is the tax analysis for land pooling?
In making this transfer there are two key taxes that need to be considered: capital gains tax and stamp duty land tax. It will also be necessary to consider income tax and potentially VAT in an overall tax analysis of anyone considering land pooling more generally. I am only considering these two tax consequences in this blog as they are the advertised tax consequences associated with land pooling.
In short, HMRC and some tax advisers take the view that the transfer to the bare trust does not create a capital gains tax charge or a stamp duty land tax charge. In my view, this claim does not appear to be correct in law and for this reason, anyone considering undertaking this sort of planning will want to take significant care.
Capital Gains Tax – Land Pooling
HMRC take the view that there will not be a disposal when property is transferred to the bare trust and as a result, there will not be any capital gains tax payable when a person’s interest in a parcel of land turns into an undivided share in the combination of two parcels of land. Specifically at CG34380, HMRC provides as follows:
“Asset pooling – land – Warrington v Brown {#}
In Warrington (or Jenkins) v Brown, 62TC226, members of a family had put into a trust various pieces of land. The purpose was to maintain the continuity of the family farming unit. The beneficial interests were expressed as a percentage of the value of the property as a whole, calculated by reference to the values of what were originally put in. The court had to decide on the position when a member withdrew the same piece of land as he had put in. Knox J held that there was no disposal because one had to look at the interests in the mass and not at the individual case. It was not a case of every member disposing of their interest in that piece of land. The reasoning of the judge suggests that there would have been no disposal if a different piece had been removed.
The documentation needs to be carefully considered before it is accepted that the decision in Warrington v Brown applies.
It follows from what the judge says that this is a situation in which TCGA92/S43 applies. The interest in the mass derives from the original asset put into the pool by the taxpayer, and the asset taken out is derived from the interest in the mass. Subject to rebasing, the cost to the taxpayer when he or she disposes of the asset taken out is the original cost of the first asset.
Where joint owners of land exchange their interests roll-over relief may be due in some circumstances, under the provisions of TCGA 1992/S248A – 248E in relation to disposals on or after 6th April 2010, see CG73002+, and under the terms of ESC/D26 in relation to disposals prior to 6th April 2010, see CG73015+.”
CG34380
HMRC have based their view on Warrington v Brown. In particular, it appears that they take the view that this passage is helpful:
Clearly Oliver LJ adopted the reasoning that Buckley LJ had used to dispose of the suggestion that there was a disposal of the beneficial interests of the persons who put property into the pool, but it is not insignificant that he himself described the result in the final sentence that I read, ‘Their interests in the mass precisely reflect the individual interests which they had before the deed was entered into’. That, too, in my judgment identifies the basis of the reasoning of the Court of Appeal in Booth v Ellard as being that one looks at the mass and not at the individual case in transactions such as the present, where property was put into a pool, and where that result is reached (that the interests in the mass precisely reflect the individual interests before the deed was entered into) there is for capital gains tax purposes no disposal. This seems to me inconsistent with the analysis that counsel for the Crown skilfully advocated of comparing the individual interests of the beneficiaries before and after. It is not for me to speculate whether the Court of Appeal might perhaps have reached a similar or even presumably a different result by any such approach; it simply is not the approach that was adopted by them.
Page 595 of Warrington v Brown [1989] STC 577
This result has some appeal in its simplicity, but ultimately, it fails to adequately address how it can be said that an undivided interest in a collection of parcels of land is equivalent to a 100% interest in one piece of land. Whilst the value of the interests reflect what had been put into the bare trust, the interests in the mass do not precisely reflect what had been put into the bare trust by the individuals.
Knox J failed to correctly apply the analysis of Oliver LJ in Booth v Ellard by disregarding the clear distinction between different types of property. There is a risk that a higher court if asked to consider this point will apply a different test.
What is the likely correct analysis?
Assuming that HMRC’s analysis is incorrect or at least there is a risk that it is incorrect, the correct analysis would be as follows.
Using the scenario from above, when transferring the interest to the bare trust, each of A and B will be giving up part of their parcels in land in return for a share in the other person’s parcel of land.
A will be giving up 75% of their share in Parcel A in return for a 25% share in Parcel B.
B will be giving up 25% of their share in Parcel B in return for a 75% share in Parcel B.
Each party will need to pay capital gains tax on any capital gain on their respective disposals. If there are significant gains, then this could result in a large capital gains tax charge immediately.
Stamp Duty Land Tax – Land Pooling
In line with the capital gains tax analysis, HMRC had previously taken the position that there would not be a stamp duty land tax charge in these circumstances. As the individual gets back what they put in, there has not been a disposal. HMRC has since withdrawn this guidance and have promised to update tax payers with their position though nothing on this has been forthcoming as yet. HMRC have claimed that they will continue to follow their old position until they release new guidance.
Whilst again, it is nice to see HMRC being so generous with their application of the law, their analysis is unlikely to accord with the law. As such, there is no reason for them to follow it going forward and it is unlikely that a judge would be inclined to side with the taxpayer were HMRC to change their mind in the future.
The argument, in short is basically that there is deemed to be no transfer of a land interest by the individuals to the trustees. The transfers to the trustees therefore fall to be ignored. A land transactions means the acquisition of a chargeable interest, but the only acquisition could be by the trustees or other beneficiaries acquiring a chargeable interest.
One difficulty is that whilst from a strictly economic perspective, in terms of values of land lost by either person, there is arguably not a transfer. But, in terms of the reality, a person will be transferring a portion of the land owned by them in return for a portion of the land owned by the other person. They will be collectively acquiring shares in the other person’s land. As such, whilst they may not have increased the value of what they own due to their giving up a certain amount of value in their land, they ultimately are acquiring a share in the other person’s land.
What is the likely analysis for land pooling and stamp duty land tax?
Stamp duty land tax is charged on “land transactions” (section 43 FA 2003). A land transaction is the acquisition of a chargeable interest. For our purposes, a chargeable interest is defined in section 48 FA 2003 as an estate, interest, right or power over land.
In the land pooling scenario, what you essentially have is a bare trustee acquiring two parcels of land which it will then hold on trust for the proportional benefits of the transferors. Following paragraph 3 of schedule 16 FA 2003, where a person acquires a chargeable interest as bare trustee, stamp duty land tax applies as if the interest were vested in the beneficial owners, and the acts of the trustee in relation to it were the acts of the person or persons for whom he is trustee.
This point has been considered in further detail by the court of appeal in Pollen Estate Trustee v HMRC [2013] EWCA Civ 753 at paragraphs 39ff. In particular, at paragraph 39, the Court of Appeal states that the interest acquired by bare trustees is deemed to be vested in the beneficiaries. In applying the deeming provision, it is necessary to focus on what the trustees have acquired. What follows as a consequences is that as a consequences of the deeming provision, for the purposes of SDLT, the beneficiaries act collectively.
Once the pooling exercise is complete, the trustees acquire collectively the equitable estate in the land (fee simple absolute). As a consequences of the deeming, this interest is deemed to be vested in the beneficiaries. The estate acquired in this case, therefore, is both a chargeable interest (as defined by section 48(1) FA 2003 and also a major interest as defined by section 117(2) FA 2003).
As a result, when identifying the subject-matter of the transaction for the purposes of section 43(6), one does so by reference to the equitable estate that has been collectively acquired. The chargeable consideration is the consideration given for that equitable estate and it is that consideration by reference to which SDLT is levied.
With this background in mind, it is now necessary to consider this in the context of the land pooling considered above.
In essence, what we have is a bare trustee acquiring the land, but to get to that position, we have the consideration as between the two parties being the various shares in their land. In the first instance, what appears to be happening is a land exchange. A is giving up part of his land for a share in B’s and B is doing the same.
Therefore, following sections 47 and paragraph 5 schedule 4 FA 2003, it appears that the exchange provisions should apply. So far as is relevant, these provide as follows:
5 Exchanges
Paragraph 5 Schedule 4 FA 2003
(1) This paragraph applies to determine the chargeable consideration where one or more land transactions are entered into by a person as purchaser (alone or jointly) wholly or partly in consideration of one or more other land transactions being entered into by him (alone or jointly) as vendor.
(2) In this paragraph—
(a) “relevant transaction” means any of those transactions, and
(b) “relevant acquisition” means a relevant transaction entered into as purchaser and “relevant disposal” means a relevant transaction entered into as vendor.
(3) The following rules apply if the subject-matter of any of the relevant transactions is a major interest in land—
(a) where a single relevant acquisition is made, the chargeable consideration for the acquisition is–
(i) the amount determined under sub-paragraph (3A) in respect of the acquisition, or
(ii) if greater, the amount which would be the chargeable consideration for the acquisition ignoring paragraph 5;
(b) where two or more relevant acquisitions are made, the chargeable consideration for each relevant acquisition is—
(i) the amount determined under sub-paragraph (3A) in respect of that acquisition, or
(ii) if greater, the amount which would be the chargeable consideration for that acquisition ignoring paragraph 5.
(3A) The amount mentioned in sub-paragraph (3)(a)(i) and (b)(i) is—
(a) the market value of the subject-matter of the acquisition, and
(b) if the acquisition is the grant of a lease at a rent, that rent.
(4) The following rules apply if the subject-matter of none of the relevant transactions is a major interest in land—
(a) where a single relevant acquisition is made in consideration of one or more relevant disposals, the chargeable consideration for the acquisition is the amount or value of any chargeable consideration other than the disposal or disposals that is given for the acquisition;
(b) where two or more relevant acquisitions are made in consideration of one or more relevant disposals, the chargeable consideration for each relevant acquisition is the appropriate proportion of the amount or value of any chargeable consideration other than the disposal or disposals that is given for the acquisitions.
[…]
The key provision is sub-paragraph (4)(a). This essentially states that if the subject-matter of the transaction is not a major interest in land, provided no money exchanges hands, then the land interests will be disregarded as consideration for the transaction.
In principle, one reads this and thinks “Happy days”. We are exchanging an undivided share in land for another undivided share in land (neither of these are major interests so we are all good!). If only it were that easy.
If we go back to the bare trust analysis above, we see that what is actually being purchased is likely to be considered a major interest given that the trustee is acquiring the full fee simple in the land and the full beneficial interest. As a result, arguably sub-paragraph 4 would not apply and instead we are looking at sub-paragraph 5 and so the relevant stamp duty would be levied on the market value of the interests transferred from one landowner to the other meaning the proportion which was kept.
So what can be done?
It is likely that the best solution will lie not in the land of trusts but rather in the land of contract, though ultimately the individual best decision will depend upon the parties involved and their ultimate goals.
Whilst there is unlikely to be a one size fits all solution, there will be a solution which can ensure certainty and minimization of tax payable.
Mary Ashley has advised on this point and would be happy to help you or your client further if you need help on this type of issue or any other tax issue. You can contact her here.