How overages on land sales are taxed
Further to our post on the tax implications of selling your garden we'll now cover how overages on land sales are taxed. These are often linked and can significantly impact the total consideration received by a landowner when selling their land. Especially where it has potential development value.
Overview
There has been a spate of residential property developments in the last few years. Because of the paucity of UK land available for development, overages have become increasingly popular. They are used as a method of enticing landowners to sell.
What is an overage?
An overage, is a contractual arrangement entitling the original landowner to receive an additional payment. Although only if and when certain conditions are fulfilled post-sale. These conditions are typically related to the enhancement of the land's value. What's more, this is usually contingent on obtaining planning permission or the actual development of the land itself.
The tax treatment
How overages on land sales are taxed, depends on how the agreement has been structured. For example, does the agreement allow for a one-off payment? Alternatively, is the overage payable as part of a series of transactions?
Additionally, the landowner's activities also need to be considered in the context of the land sale. For example, are they a property developer by trade, or was this a one-off transaction?
Equally important are the conditions relating to to the payment of the overage. For example, is the payment contingent upon a discernible event, like obtaining planning permission? Alternatively, is it more speculative in nature? For example, dependent on the development achieving a target sale price?
Capital gains tax treatment - ascertainable overage
Where HMRC's trading in land anti-avoidance rules don't apply, the future consideration is treated as a capital gain.
What's more, the exact capital gains treatment depends on whether the 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 is regarded as ascertainable where all the events which establish the amount have occurred.
An overage is ascertainable deferred consideration where all the events influencing the amount payable occur before the sale date.
Therefore, where the future consideration is ascertainable, the full overage is included in the total disposal proceeds. Therefore, there are no tax consequences when future amounts are received.
Capital gains tax treatment - unascertainable overage
Consideration is unascertainable if events establishing the amount don't occur until after the disposal date. 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.
So, where these rules apply any future consideration is taxed in the year of receipt instead of being included with the total proceeds on the land sale.
Overages taxed as income
If HMRC's anti-avoidance rules apply, and the transaction involving the land sale is regarded as trading, future consideration will be treated as income.
These rules are designed to catch profits that arise from land transactions, which, are akin to trading activities. The legislation is far reaching, capturing not only land sales but also overages. Especially 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.
If HMRC establish the landowner's intended to sell the land as part of a trade, or there is a pattern of similar transactions suggesting a trading activity, the overage payment is likely to be taxed as income. What's more, this is true even if the landowner is not a habitual property developer. Moreover, a single transaction can be treated as trading 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 development may find that an overage is taxed as income. Similarly, if a non-trading landowner enters into an overage agreement intending to profit from the land's future development value, this could also be perceived as a trading activity by HMRC.
Alternatively, where someone sells part of their garden to a developer with an overage clause entitling them to 10% of the value of the land if granted planning permission in 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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