TENANT DEPOSIT SCHEME

From 6 April 2007, all landlords and letting agents taking deposits for assured short hold tenancies (ASTs) in England and Wales must safeguard them with a Government-authorised tenant deposit protection scheme. The legislation aims to ensure that tenants who have paid a deposit to a landlord or letting agent and are entitled to receive all or part of it back at the end of that tenancy, actually do so.

There are three schemes which are required to be open to both private landlords and letting agents to join and make use of if they wish.

1. The Tenancy Deposit Scheme (TDS) is an Insurance-based scheme run by an organisation called The Dispute Service and was established back in 2003 to provide independent dispute resolution and complaints handling for the lettings industry. It has been running a voluntary tenancy deposit scheme for use by regulated agents since that time and is backed by the three professional bodies for letting agents in the residential property sector, ARLA, NAEA and RICS. For more information visit the website www.tds.gb.com  or call 0845 226 7837.
    

2. Tenancy Deposit Solutions Ltd (TDSL) is an Insurance-based scheme; it is a new company set up as a partnership between the National Landlords Association and Hamilton Fraser insurance brokers. For more information visit the website www.mydeposits.co.uk/
    

3. The Deposit Protection Service (DPS) is the sole Custodial scheme - the running costs of this scheme are funded entirely from the interest earned on all the deposits held by the scheme. The Custodial scheme is run by Computershare who have administered similar schemes for some years in other parts of the world, particularly Australia and New Zealand. For more information visit the website www.depositprotection.com

Commencement:
The new Stamp Duty Land Tax (SDLT) system comes into force 1 December 2003.

Introduction:
In his Budget Statement on 9 April 2003 the Chancellor of the Exchequer announced that a modernised system of stamp duty, renamed 'Stamp Duty Land Tax', would apply to most land transactions on or after 1 December 2003. This change will have important repercussions for private landlords and letting agents, all of whom were required to have tenancy agreements stamped where the rental value of the tenancy exceeded £5,000 (either per annum, or over the term of the agreement). In summary, the new system introduces a replacement tax for stamp duty called SDLT which, for residential tenancies, will only need to be paid where the lease value exceeds £60,000, or, strictly speaking, £60,000 at net present value (NPV - explained further below). Below this threshold, for the vast majority of private tenancies, no tax will be payable and so this change will be a welcome simplification for landlords.

New System:
The new SDLT system will replace the current archaic system of impressing a physical stamp on documents with a regime in line with that for other taxes. People acquiring interests in land will be required to submit a 'Land Transaction Return' to the Inland Revenue along with payment of the duty. Stamp Duty Land Tax applies (subject to some transitional provisions) to all 'land transactions' completed on or after 1 December 2003. 'Land transaction' includes the conveyance or transfer of a freehold (in Scotland, transfer of ownership), the assignment or assignation of an existing tenancy and the grant of a new tenancy. It replaces stamp duty, which is abolished except for instruments relating to stock and marketable securities, and for instruments relating to some partnership transactions. We are likely to see further minor changes to the SDLT rules in the future as the system is 'fine-tuned', and further anti-avoidance measures are incorporated.

This new system for stamp duty will help to achieve the Government's aim of a modern, efficient, system of taxing land transactions which promotes fairness between taxpayers, reduces distortions and prevents avoidance.

Execution Date:
The new rules will apply to all land transactions executed after 1 December 2003. In the context of shorthold residential tenancies, this means that the new system will apply to all new tenancies granted or with commencement dates after this date. Transition rules will apply to existing tenancies where the tenancy is extended after 1 December 2003.

Net Present Value:
The Finance Act charges Stamp Duty Land Tax on the 'Net Present Value' ('NPV') of rent payable under a lease or tenancy. NPV simply applies a discount to allow for inflation. For short tenancies (i.e. 1 to 2 years), the difference between the total rental value and the NPV rental value will be small enough that, in most cases, the total rental value will be a close approximation for deciding whether SDLT will be payable (see examples below). A temporal or discount rate of 3.5% currently applies to the NPV calculation.

Tax liability and SDLT Thresholds: .
The Finance Act sets a threshold of £150,000 for commercial leases, £60,000 for residential leases. If the NPV rental does not exceed the threshold, no Stamp Duty Land Tax is charged on the rental element.

If the lease or tenancy appears to be above the threshold, then it will be necessary to make a calculation of the SDLT payable, based on the total rental value of the lease adjusted for net present value. The SDLT is then levied at a rate of 1% on the amount of NPV-adjusted rent in excess of the threshold. The example 2 below demonstrates how this calculation works.

Example 1:

Ben rents a house for twelve months. The rent is £1000 per month; therefore the rental value over the year’s duration of the lease will be £12,000. The net present value of the rental over this rental period is £11,594. Because the NPV rental value is less than £60,000, no SDLT is payable. Calculation:

NPV (year 1) = 12,000 / 1.035 = £11,594.20

Example 2:

Albert rents a house for his family for three years. Under the tenancy, the rent is £2000 per month for the first year rising to £2200 per month for the second and third years. The NPV calculation is based on the total rent due each year over the term of the tenancy, and so for tenancies granted over several years, it will be necessary to split the rental up into yearly amounts before applying the NPV calculation. The NPV-adjusted rents in each year period are then added together to give the total NPV-adjusted rental value.

The NPV of the rental for this example is calculated as follows:

Year 1: 24,000 / (1 + 0.035) £23,188

Year 2: 26,400 / (1 + 0.035) x (1 + 0.035) £24,645

Year 3: 26,400 / (1 + 0.035) x (1 + 0.035) x (1 + 0.035) £23,811

The net present value (NPV) of the rents under the lease is £71,644, (the sum of the calculated annual values). Because this is more than £60,000, the rate of tax is 1%, and the excess over the threshold is £11,644. SDLT tax payable on this transaction will be £11,644 x 1% = £116.44.

Partial Periods:
If the tenancy is not for an exact number of years (e.g. 18 months), then a reduced level of rent will be receivable in the final part year. The NPV discount is applied to the actual rent receivable in this part year in a similar way. There should be no attempt to annualise or average the rents.

Tenancy Extensions:
Where a tenancy is extended during the currency of its term, perhaps by invoking an ‘option to renew’ clause in the tenancy agreement, then this extension is treated as the grant of a new tenancy for the period by which the term of the tenancy is extended. The NPV’s of the individual transactions should be calculated, and further SDLT tax may be payable on this second transaction.

However, because this extension will be treated as a transaction linked with the original tenancy (a ‘linked transaction’), a SDLT liability may arise even if the original tenancy transaction was below the SDLT threshold. In this case, the NPV’s of the series of exempt transactions should be added together, and if over the threshold, SDLT will be payable on the amount of NPV-adjusted rent that exceeds the threshold.

Periodic Tenancies and Rollover:
If the original fixed term tenancy comes to the end of its term but the landlord does not require possession of the property, this extension is treated, in England and Wales, as a periodic tenancy which extends the term of the tenancy. In Scotland, there is a similar treatment called tacit relocation. For the purposes of SDLT, the continuation of an existing tenancy will be deemed to be the grant of a new tenancy for a further period of 12 months, and so on as the tenancy extends for each 12 month period. The effect of this implied extension to the tenancy is the same as for Tenancy Extensions’ (see above), and a further SDLT liability may arise on each extension.

Where a tenancy is granted for an indefinite term, for example as a contractual periodic tenancy from the outset, the tenancy will be deemed to be for an initial period of 12 months, for SDLT purposes. As above, should the tenancy continue after this period, the continuation will be deemed as the grant of another tenancy for 12 months and so on with each deemed grant being treated as a ‘linked transaction’ – linked with those previously.

Extension and Break Clauses:
Any break clauses incorporated into the tenancy agreement should be disregarded for the purposes of calculating the total NPV rental value, and do not entitle a refund if the tenancy is ended early.

Equally, a clause allowing the option for the tenant to renew is disregarded in the initial NPV calculation (although SDLT liability may occur at the point an agreement is made to extend the tenancy - see ‘Tenancy Extensions’, above). The initial rental calculation should be based purely on the stated term of the lease.

Rent Review Clauses:
If the lease contains a rent review clause, then this may affect the SDLT calculation. If the rent increase is certain, then the annual amounts of rent used in the SDLT calculation should be adjusted to allow for the rent increase (see example 2 above). If, on the other hand, the future rent is not fixed because it is linked to the retail price index (E.g. RPI plus 5% ) then the review amount will be based on the known amount (i.e. 5%) and the unknown RPI element of the increase may be disregarded.

Who Pays the SDLT ?:
For tenancies, it is the lessee or the person to whom the lease is granted (i.e. the tenant) who is liable for payment of the SDLT (where applicable), and when there are joint tenants, they become jointly liable for the SDLT charge. As for house sales, it is the buyer of the freehold or lease who is liable for paying the SDLT.

Premium Leases:
When a new lease is granted, which includes the tenant paying a premium or an up-front payment, this is called a premium lease. The value of the premium should be combined with the NPV-discounted value of the rental payments when deciding whether the lease will attract SDLT, but the premium should not be discounted using the NPV method as the premium is received at the beginning of the lease.

The same residential threshold will apply (£60,000) in deciding whether SDLT is payable on the premium lease, and the amount of payable will be the same provided that the total lease value, including premium and rental, does not exceed £250,000. Higher SDLT tax rates will apply for higher lease values.

Transitional Provisions:
The draft SDLT guidance is not clear regarding the tax position with regard to the extension of tenancies already in existence. The suggestion is that SDLT would be payable if the NPV-discounted value of any rental payment for the term of the extension (if taking place after the SDLT commencement date) exceeds the published thresholds (£60,000). If this situation applies, you are advised to contact the Inland Revenue Stamp Office for further guidance.

Temporal Discount Rate:
The annual discount rate used for the NPV calculations is called the temporal discount rate and it discounts future values (mainly to allow for inflation). The current discount rate is prescribed in the regulations as 3.5% but is likely to vary if the inflation rate rises or falls significantly.

Enforcement:
We currently have little information on how the new rules are likely to be enforced on tenants (if indeed they will be for residential tenancies).

Other Issues:
Under SDLT, it will make no difference whether the property is unfurnished or furnished.
Provided that the lease is for a residential tenancy, the different types of residential tenancy (company letting, assured tenancies etc.) will all be liable for SDLT in the same way. Equally, the type of tenant (individual, company etc.) will not normally make any difference.
There will no longer be any relevant distinction between the original or counterpart copies of the tenancy agreement for tax purposes. Because SDLT is no longer a duty on paper documents, it is the transaction itself that incurs the tax liability.
The old system of granting tenancies for "one year less one day" for stamp duty avoidance will no longer apply. The NPV calculation is based on the total rent due each year over the term of the tenancy and it is simply the total rent payable that is important.
Duty of Agent: .
Where SDLT applies or is likely to apply to a tenancy, a letting agent should alert the tenant to his liability to notify the Inland Revenue of the transaction, and the extent of his liability for SDLT.

NPV Calculator:
The Inland Revenue plans to include a calculator on their website (web address given below) so that lessees can enter the details of their lease, and it will calculate their SDLT liability. In the meantime, most popular spreadsheets (E.g. Excel) include a NPV function which can work out the values for you automatically.

The Paperwork:
Where SDLT is payable, there is a requirement that the relevant declaration forms (SDLT1 and SDLT4) must be completed and submitted to the Inland Revenue. It appears from the guidance, that neither a landlord nor his agent are responsible for submitting the declaration forms, although there may be an implied duty of care to inform tenants, as the responsible parties, of their liability for SDLT.

The regulations include a requirement to notify the Inland Revenue Stamp Office of relevant transactions. This is done by completing a Land Transaction Return (LTR) within 30 days of the effective date of the transaction. In response, the Stamp Office will issue an SDLT certificate (replacing the current need to get documents stamped).

What Happens if you sent in your return late ?: .
Finance Act 2003 introduces a penalty for late notification and payment. The fixed penalty is £100 where the return is delivered within 3 months of the filing date, or £200 in all other cases. There is also provision for tax geared penalties to be charged where the return is more than 12 months late.

Sources for Further Information:
Stamp Office SDLT Handbook – available soon on the Inland Revenue website (below)

Inland Revenue Stamp Office Website: www.inlandrevenue.gov.uk/so