Introduction
Land development for renewables projects generates a relatively secure long-term revenue stream for the landowner in the form of rental payments and generally increases the value of the development site. More than ever, landowners are actively exploring tax efficient ways of participating in these projects. Over the last year or so, a structure specifically designed to mitigate the landowner’s liability to inheritance tax (IHT) has emerged.
This structure involves the formation of a limited liability partnership (LLP) as a trading vehicle to hold the project assets and undertake the development. With prime development land increasingly difficult to secure, developers are recognising the need to accommodate the landowner’s tax objectives, particularly if they want a competitive advantage over other developers.
This article looks at some of the key issues surrounding the IHT-driven LLP structure.
The landowner’s objective
Under a conventional lease structure, on the death of the landowner, an IHT charge of 40% on both (i) the underlying development site value and (ii) capitalisation of the projected rental income under the lease may arise. One implication of participating through a conventional lease structure may therefore be the need to sell land or other assets on the death of the landowner in order to fund a significant IHT liability. This consideration may outweigh the revenue stream benefits for the landowner, thereby deterring the landowner from participating in land development for a renewables project.
The key aim of the LLP structure is to allow the landowner’s estate to make a claim for business property relief (BPR) and thereby potentially mitigate or avoid the liability to IHT that would otherwise arise through participating under a conventional lease structure. Although HMRC’s treatment of such LLP structures is as yet uncertain, to permit a claim for BPR, the LLP must be a trading business and the landowner’s executors should also be able to demonstrate to HMRC that the landowner was actively involved in the LLP’s business. The LLP, therefore, needs to be set up in a way that evidences the landowner’s active participation.
Setting up the LLP
The LLP is set up with both the landowner and the developer holding membership interests. The developer then transfers to the LLP all its assets, reports and contracts which relate exclusively to the project. In turn, the landowner grants a lease of the development site to the LLP on normal commercial terms (other than in relation to the payment of rent, where a peppercorn rent is paid, and any landowner controls which will be covered by the landowner’s business interest in the LLP).
As mentioned above, to support any future claim for BPR, it is critical that the terms of the LLP Agreement help demonstrate that the landowner is actively involved in the LLP’s trading business. The key planks of any argument in support of active participation will be the landowner’s right to:
- share in the LLP’s profits
- receive information relating to the project on an ongoing basis
- appoint a representative to the LLP board
- attend LLP board and members meetings
- participate in the decision making process
The profit sharing is structured such that the landowner, in his capacity as member of the LLP, is entitled to receive a “priority profit” payment calculated on an equivalent basis as the rent would have been determined under a conventional lease arrangement. Unlike a limited liability company, the LLP can pay the "priority profit" payment even if the LLP has no distributable profits.
The priority "profit payment" is the landowner’s only economic interest in the LLP; the developer is entitled to all other profits generated by the LLP, as well as to any capital generated on the sale of the LLP.
Key factors to be considered by developers
Fundability: Unless and until this structure becomes more widely used, it is difficult to state with absolute certainty how funders will approach matters in the context of project financing. This is particularly the case at a time of economic uncertainty where credit approval teams at banks may be reluctant to entertain novel and unfamiliar structures. Provided funders:
- recognise that the "priority profit" payment is in effect ‘rent’ (rather than a “leakage” from the LLP which should be subordinated to the debt funding);
- can still take a full security package over the project assets (including the developer’s interest in the LLP); and
- have step-in rights (including an ability to step into the developer’s shoes as a member of the LLP and, as a result, ensure ongoing payment of the “priority profit”),
then they ought in principle to be willing to fund a project set up using this structure.
At least one major UK bank has indicated to us that it supports this approach to the funding of a project using this structure.
Exit/sale: The novel nature of the structure could also present a potential hurdle for a developer looking to sell the project. Until the structure is tried and tested, cautious purchasers/investors may shy away from projects set up on this basis. However, if the structure becomes more common place, this should be a short term concern (since the sale of membership interests in an LLP is akin to selling shares in a company).
Control: One of the most challenging facets of the structure is the inherent tension between, on the one hand, the landowner’s need to be able to demonstrate he is carrying on a trade and, on the other, a reluctance of the developer to forego more economic rights or relinquish greater operational freedom than it would under a conventional option and lease structure. As the structure has not been tested by HMRC, it is impossible to state with certainty the minimum amount which must be given to the landowner in order to qualify for BPR.
Transfer of membership interests: Whilst a developer may be comfortable with the current landowner having a greater level of involvement in the LLP, it may be less happy with other family members, or a subsequent owner of the development site, having the same level of input to the LLP.
Tax: Before an LLP structure is adopted it is critical that the LLP obtains specialist tax advice due to the risk of anti-avoidance rules applying. It is worth flagging a couple of tax related issues:
- Stamp Duty Land Tax (SDLT): Under an LLP structure, SDLT will normally be calculated under special rules applying to partnership transactions. As these rules are based on the market value of the lease interest, the LLP may wish to instruct a formal valuation to protect its position in case of an HMRC enquiry. If the value falls below certain thresholds, no SDLT may be payable at all.
- Other taxes: Developers are naturally keen to ensure they are not exposed to a greater level of tax if the LLP structure does not satisfy its primary objective. If, on the landowner’s death, HMRC successfully challenge the availability of BPR, then the landowner’s estate will be liable to IHT without the benefit of such relief, but no additional tax will be assessed on the LLP or the developer.
Administrative burden: Setting up an LLP does carry with it additional administrative requirements in comparison to a typical lease arrangement. Like a limited liability company, the LLP will need to prepare accounts and make an annual submission to Companies House, and board meetings will need to be properly notified and convened to ensure the landowner’s participation in the LLP is not simply words on a piece of paper.
Costs: The formation of the LLP will almost certainly give rise to fairly detailed negotiations, particularly in relation to the terms of the LLP Agreement. It is also worth bearing in mind that despite the structure being driven by the landowner’s tax planning, the landowner may still expect the developer to meet all of his costs and not simply those in relation to the lease. Given the landowner is the primary beneficiary of the structure, we expect developers will push hard to resist meeting the additional costs incurred by the landowner in connection with the LLP structure.