Update: commercial property

Carbon reduction commitment

For the past year, property lawyers have been getting to grips with the carbon reduction commitment (CRC) energy efficiency scheme, with little sign of any standard practice yet emerging on CRC drafting for leases and the raising of enquiries, against the backdrop of a complicated and ever-evolving scheme.

CRC is a mandatory emissions trading scheme for the UK, which aims to reduce carbon dioxide emissions through energy efficiency. Organisations that met the qualification criteria '“ which are based on whether they were supplied with electricity by a 'half hourly meter' and how much electricity they were supplied with '“were obliged to register with the Environment Agency by the end of September 2010.

Participating organisations monitor their energy use and, with effect from 2012, purchase allowances from the government for each tonne of carbon dioxide they emit. The more carbon dioxide an organisation emits, the more allowances it has to purchase, so the obligation to purchase allowances is supposed to provide an incentive for organisations to reduce their carbon emissions.

The coalition government inherited CRC from the previous administration. In the face of property industry concerns regarding the complexity of CRC, it was anticipated that the coalition would make changes to it. The first change, introduced in the autumn 2010 spending review, was not widely predicted and announced that revenues from allowance sales totalling £1bn a year by 2014-15 will be used to support the public finances, including spending on the environment, rather than recycled to participants.

The decision not to recycle the revenue raised from the sale of allowances, but to direct the money into the government's coffers, transformed the way in which the CRC scheme will operate and significantly increases the cost of participation in CRC.

The scheme is now effectively an additional tax on participating organisations '“ including affected landlords and occupiers, who will each be keen to pass on liability for such costs so far as possible. This may lead to the wider adoption of CRC drafting in leases.

How should practitioners be dealing with the changes to CRC? In the current absence of any industry standard drafting, individual firms and practitioners are left having to develop their own preferred clauses.

From a landlord's point of view, a typical CRC clause could include a definition of 'CRC costs' (to include not only the cost of allowances but the administrative cost of participating in the scheme) incurred by the landlord under the 'CRC scheme' (defined by reference to the 2010 order) and would impose on the tenant an obligation to pay to the landlord a fair proportion of such CRC costs attributable to the property.

From a tenant's solicitor's point of view, it is suggested '“ particularly if the bargaining position of the tenant allows '“ that a standard tenant's amendment should be sought, stating that a tenant will not be liable under the lease for any CRC costs incurred by the landlord pursuant to the CRC scheme.

Practitioners should already be considering CRC when undertaking due diligence on the purchase and letting of affected property. A set of consultation CPSE.6 enquiries is available online. Enquiries include requests for details of the types of meter (particularly half hourly meters) which are present on the property; details of the seller's energy consumption for the preceding two years; details of CRC cost recovery from occupational tenants; and, where relevant, whether or not the seller is willing to sell any CRC allowances to the buyer.

Further refining in 2011

The amendment to CRC announced by the Treasury in its October 2010 spending review is unlikely to be the final amendment to the scheme. A DECC consultation inviting comments from CRC stakeholders as to how the scheme could be improved or simplified closed on 11 March 2011.

Lobbying groups such as the UK Green Building Council urged their members to participate in the consultation. A further more formal consultation may follow later in the year, with even the scrapping of the scheme not ruled out.

In the meantime CRC remains mandatory for participants and DECC is reminding participants that they should continue to fully comply with the scheme and 'use the introductory phase to gain experience on reporting, complying and surrendering allowances in CRC'.

With the further changes to CRC promised by the coalition in 2011, lawyers might be tempted to adopt a 'wait and see' approach to CRC. However, with the scrapping of recycling payments already announced, the sums at stake for landlords and tenants are now higher and the burden of paying for allowances will be something that most landlords are keen to pass on so far as possible. Some of the steps practitioners are advised to continue to take are:

• Ensuring that participating clients continue to comply with the scheme in its present form.
• Following the progress of government and industry consultations on CRC, participating where appropriate.
• Dealing with responsibility for CRC compliance and costs when granting or taking leases.
• Raising CRC enquiries as part of the due diligence process when buying or letting property.

Sub-sale relief

HMRC has stated its intention to make the use of sub-sale schemes to avoid stamp duty land tax a thing of the past. The revenue has made it clear that they will 'relentlessly pursue' deliberate SDLT avoidance.

SDLT is levied on the consideration paid for every property transaction at the point of 'substantial performance'. This occurs where a party either enters occupation of a property or pays over a substantial amount of the consideration. Normally, SDLT is paid on each transaction that is 'substantially performed'.

Sub-sale relief is designed to ensure that, where one property transaction happens in several stages, SDLT is paid only once on the full value of the final transaction. No SDLT charge arises where no 'substantial performance' occurs and the second transfer happens at the 'same time' as the first transfer (i.e. within hours of it).

For example, if A sells Alphabet House to B, who does not 'substantially perform' the contract but instead sells it on to his neighbour C on the same day, then only C would have to pay any SDLT on the transaction. This structure depends upon B paying A the consideration after he has transferred the property on to C. This ensures that no SDLT charge arises, as 'substantial performance' of the contract with A does not occur while the property is in B's hands. Substantial performance of the contract between A and B at the same time as and in connection with the contract between B and C is ignored.

Sub-sale relief schemes can utilise this exemption to dramatically reduce the overall SDLT charge payable. The key is to ensure that 'substantial performance' of the contract between A and B is simultaneous with or delayed until after the final transaction to C has taken place. SDLT is only due on the transfer to C, which is arranged in the most tax-efficient manner possible.

For example, the final transfer to C can be arranged as a gift, or as a payment of a dividend in specie where B is a company and C is its sole shareholder. Neither of these transfers involve a chargeable consideration and so no SDLT will be payable. SDLT advisers have also heavily promoted schemes involving a sub-sale and either the alternative finance regime or the complex SDLT partnership calculations.

HMRC claims that any such financial alchemy will be neutralised by section 75a of the Finance Act 2003. This section will affect transactions which took place on or after 6 December 2006. It does so by stating that where a land transfer is linked to other transactions (e.g. the two SDLT-free transfers to C above) it is replaced for SDLT purposes by a notional land transaction. The consideration for this notional transaction is the overall price received by the vendor from the whole chain of transactions. It will thus include the price paid by B to A.

Whether or not these provisions have the intended effect, it is clear that HMRC is currently on the warpath. HMRC has stated that it will investigate existing schemes by comparing the reported transactions at the Land Registry with the SDLT returns that they receive. HMRC is likely to order a 'discovery assessment' where it finds that the title has been transferred more than once within a short space of time. This will involve further paperwork for the purchaser and may result in a further SDLT bill.

HMRC has also stated that discovery assessments will still be possible after the usual nine-month enquiry window has passed if an SDLT return appears suspect. Practitioners should treat any existing or proposed scheme as providing a cash-flow benefit, rather than definitely reducing the overall SDLT liability. Any potential scheme users may only wish to engage their advisers on a tight contingency basis.

In our experience, HMRC's tactics will also affect the attitudes of the banks, who will want to have the SDLT money sitting in an escrow account for security purposes. This will put an extra burden on the purchaser which will require funding.

HMRC is not necessarily correct to assert that sub-sale schemes are now ineffective. There are still SDLT planning ideas in existence, which are kept highly confidential. However, it is clear that any scheme users can expect rigorous scrutiny. Advisers should provide robust advice, and deal carefully with HMRC's enquiries.