Bell & Scott

In this month's issue we comment on a recent Scottish case on the withholding of consent to sublease and look at the effect of VAT on the housing world.

Rachel Charitable Trust are landlords of premises at 3-5 High Street, Paisley. Burgerking are tenants, and trade from part of the premises. The restaurant was under performing, and was identified for disposal. The only interest shown was by Quids In (Scotland) Ltd who was prepared to take a sublease, but only on payment by Burgerking of a substantial reverse premium. The annual rent being paid by Burgerking relative to the occupied part of the premises was £112,000. By late 2004, however, the market rent for that part of the premises was around £75,000. Burgerking therefore sought consent to sublet the premises to Quids In (Scotland) Ltd for a rent equal to the passing rent, with Burgerking paying a reverse premium to Quids In of £25,000 per quarter.

The lease contained the usual prohibition on subletting except with prior written consent of the landlord, not to be unreasonably withheld in the case of a “substantial and respectable” subtenant who is “of sound financial standing” and, in the reasonable opinion of the landlord, is “demonstrably capable” of performing the tenant’s obligations under the lease and the proposed sublease obligations. There was a further provision requiring any sublease to be granted at “a full market rent”, without taking into account fines, premiums, grassums or other lump sum payments.

The application for consent was refused on two grounds: firstly that Quids In did not satisfy the test in the lease taking into account the annual rental liability and other liabilities under the lease, and secondly, that the “subsidy”, as it was described by the landlords, of £25,000 per quarter effectively meant the real annual rental being paid was £12,000, well below full market rent, and thus the proposed subletting failed to comply with the second provision in the lease. Burgerking thus sought an order declaring the refusal to be unreasonable.

Lord Drummond Young reiterated the principles which apply to considerations of whether a landlord has acted unreasonably, including that, where more than one reason for refusal is given, where some are found to be reasonable and others not, one valid reason will, as a general rule, be sufficient to justify the decision to refuse consent. So far as the first reason given for refusal is concerned, his Lordship found that use of the common test of three years’ profits requiring to equal or exceed three years’ rent was not unreasonable, provided it is not used to the exclusion of all other considerations. That was even more so when it was a sublease rather than an assignation which was being considered. Since the use of the test appeared to be the only reason for refusing consent on the first ground for refusal, and as that failed to properly take into account the full circumstances, the landlord had acted unreasonably.

On the second ground for refusal, he found that the payment being made by Burgerking was a genuine reverse premium but that the scale of it was well beyond that which was required to compensate for the difference in passing and market rent. As a result, he found that it would have a potential impact on future rent, and could thus affect the capital value of the premises. Whether it was treated as a reverse premium or a rental subsidy was not that important – the implications of the scale of the payment meant the landlord’s decision to refuse consent could not be said to be unreasonable.

As one of the two grounds for refusal had been found to be sufficient to justify the refusal, Burgerking were refused the order they sought.

Sheila Webster, Partner and Head of our Property Dispute Resolution Team comments:

Lord Drummond Young’s opinion is a very useful summary of the main considerations for decisions on granting or refusing consent to a sublease (or assignation). Those concerned that landlord/tenant law in Scotland and England have once again diverged, given the English case of NCR v Riverland in 2004 where a landlord’s refusal of consent was unreasonable in superficially similar circumstances, need not worry unduly. In the first place, there was no finding in NCR that the premium was large enough (even if a genuine reverse premium) to affect rent in the future, unlike here. Further, in England, it is for a landlord to prove the decision is reasonable; in Scotland, it is for the tenant to show it is not. Such emphasis can easily change the outcome of a case.

However, the decision is worth noting for other reasons. Until now, there has been only one unreported Scottish case suggesting that a landlord must give reasons for refusal of consent, and, as a lower court decision, it is not binding on higher courts where such arguments usually take place. However, Lord Drummond Young clearly and unambiguously states that a landlord is obliged to give reasons for refusal. Although he does not expressly say so, failure to do so might in future itself result in the landlord being found to have acted unreasonably.

Furthermore, the reasons given at the time of refusal are once again said to be those which will be tested. Although such reasons are not to be construed over strictly, a landlord considering refusal of consent should therefore take care to ensure that all grounds for refusal are made clear, to avoid being found unreasonable, despite having a good reason for refusal, at a later stage.

Case referred to: Burgerking Ltd v Rachael Charitable Trust.

The full text of the decision is available from the Scottish Courts Website here.

News

VAT and housing

What happens when the VAT world meets the housing world

James Aitken, Property Tax Associate comments:

In short, life becomes complicated. Almost nothing can be taken for granted. The VAT treatment depends on a number of factors such as what type of work you are doing, the type of property you are dealing with and whether you are a company and VAT registered or simply what is known as a "DIY property developer".

Construction Services

The supply of construction services can be either:

standard rated 17.5% (typically commercial buildings or repairs and maintenance work to any building)
lower rated (typically works in relation to conversion into or of domestic or other relevant residential buildings - see below)
zero rated (typically new construction of dwellings or certain residential and charitable buildings and works of approved alternations to protected buildings)

Treatment of "new homes" throughout the European Union

The current VAT treatment of housing in the European Union is described by the European Commission as "chaotic". In two countries (Germany and Portugal) housing is VAT exempt. The UK alone zero rates new homes. The other countries apply rates above, below and equal to the applicable standard rate. The 10 new members were allowed temporary reduced rates until the end of 2007. After that they will have to impose their full standard rate. The UK's right to have a zero rating was granted in 1977 and was meant to be in place for 4 years!. There is no likelihood at all of the UK's zero rating of new homes ending in the foreseeable future.

Repairs and renovations

It has been reported that the Government wants to reduce VAT on all property repairs and renovations as an incentive to ensure that more housing is repaired rather than demolished. At the moment a reduced rate of VAT, 5%, only applies in certain specific circumstances. In most other cases 17.5% has to be charged.

A number of EU countries (France and Italy) have been allowed to introduce temporary low rates for a limited number of labour intensive services such as housing repair and maintenance. This concession ended last year. It will be interesting to see if France and Italy continue with the reduced rates past 2005 and risk a confrontation with the EU.

VAT windfall for DIY property developers?

There has though been some good news for DIY property developers recently. A property developer named Jacobs who converted a former boarding school into a stately home worth £7 million pounds has won his case against HMRC regarding VAT recovery.

The Court of Appeal in England rejected an appeal by HMRC. The Court of Appeal ruled that that Mr Jacobs was entitled to recover VAT paid for building supplies and services in respect of parts of the premises that had formerly been used for non-residential purposes.

Mr Jacobs was relying on VAT that applied to residential conversions. The school had previously contained bedsits for the school staff, a flat for the headmaster and dormitories for boarding pupils. Mr Jacobs only sought to recover his VAT costs on the parts of the building that were not previously residential.

This case also highlights how difficult it is to take on HMRC. The case has taken 6 years and legal fees are estimated to be around £500,000. At least in this case it had a happy ending for Mr Jacobs. This case began before the following relief was introduced in 2002.

VAT reduction for certain residential conversions

You can qualify for a reduced VAT rate of 5% if you convert the following into a single residence:

properties that have never been lived in such as barns or warehouses
properties divided into flats
properties adapted from non-residential uses such as offices and dental surgeries
any dwelling empty for three years or more

Conversions into multiple residences that qualify for the lower VAT rate may include:

a single home
a building that has never been lived in

The 5% VAT rate also applies to:

any works of repair, maintenance and improvement to the fabric of the building including fully fitted elements such as bathrooms
Improving or introducing services such as water or electricity

The reduced rate does not apply to:

most granny/nanny annexes
non-fitted goods such as carpets and furniture
landscaping
costs of professional services such as architects or surveyors fees

Conclusion

The Chancellor in his latest pre-Budget Report announced a number of VAT consultations. It is hoped that the UK Government will also look closely at the VAT treatment for all housing works and in particular those relating to repairs and renovations with a view to ensuring that more properties are either repaired or renovated rather than demolished.

Planning Reforms unveiled

Planning etc (Scotland) Bill Released

In the July 2005 Edition of Property Update, Bruce Anderson commented on the Scottish Executive’s White Paper, “Modernising the Planning System”. The Planning etc (Scotland) Bill which implements the proposals contained in the White Paper has now been introduced and is making its way through the Scottish Parliament.

Following the White Paper consultation process, a raft of further proposals, some of which will be added during the passage of the Bill, are to be introduced by the Executive, including:

new obligations for the planning system to contribute to sustainable development
a formal role for the Parliament in drawing up the National Planning Framework
new measures to ensure greater transparency in the handling of local authority interest cases
further measures to encourage public participation in planning, including on major applications
additional proposals on enforcement of planning control.

As with the White Paper, the Bill does not include any proposals for the introduction of third party rights of appeal.

The Bill is presently before Communities Committee of the Scottish Parliament. The Communities Committee is considering the general principles of the Bill and has issued a general call for written evidence from all interested parties by 6th March 2006.

The Scottish Executive expect that the Bill with receive Royal Assent at the end of 2006 and that implementation will begin in 2007.

Details on submitting views to the Scottish Parliament can be found on their website here.

The Bill (as introduced) is available here.

Explanatory Notes to the Bill are available here.