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HMRC internal manual

Capital Gains Manual

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Leases: commutation of rent where landlord is a freeholder

The following example illustrates the situation where 

  • the capital sum is received by a landlord who is a freeholder or a leaseholder under a long lease,
  • the payment is made in commutation of the rent due under the lease, and
  • the terms of the lease provide for the possibility of commutation of the rent.

The calculations would have been the same if the tenant had paid the capital sum for the waiver of certain of the terms of the lease rather than in commutation of the rent.

On 30 June 1985, Mr B bought the freehold of a property for £50,000. On 31 October 1989, he granted a 21 year lease of the property in return for a premium of £20,000. The rent payable under the lease was £5,000 a year. One of the terms of the lease was that the tenant could commute the rent for any period on the payment of a lump sum.

On 31 October 1991, the tenant exercised the right to commute the rent and paid £35,000 to Mr B. As a result, no further rent was payable for the remaining 19 years of the lease.

The Valuation Office Agency reported the following values:

  • the right to receive rent for the period 31 October 1989 to 31 October 1991 (the period during which rent was actually paid): £7,500;
  • the value of the reversion at the end of the lease: £17,500.

The gain arising to Mr B on the grant of the lease, recomputed following the payment for commutation of the rent, is calculated as follows.

1) Amount chargeable under Schedule A, see CG70900.

The total premiums received are £20,000 + £35,000 = £55,000. However, separate calculations of the amounts chargeable under Schedule A are needed. The actual premium of £20,000 was paid for the grant of a 21 year lease; the deemed premium of £35,000 is treated as having been paid for a 19 year lease (the period of the actual lease to which the commutation relates).

Amount chargeable Sch A:

(i) £20,000 - (£20,000 x 21 – 1) = £12,000

                                                       50     )

(ii) £35,000 - (£35,000 x 19 – 1) = £22,400

                                                       50     )

                                                                       £34,400

2) Computation of gain

                          Premiums received                                                                                      £55,000

Less                   Chargeable Sch A                                                                                        (£34,400)

                                                                                                                                                                         £20,600

                          Allowable expenditure

                         £50,000 x                      £20,600                                 £12,875

                                                 £55,000 + £7,500 + £17,500

                         Indexation     £12,875 x 0.232                                   £2,987                     (£15,862)

                        Chargeable gain                                                                                                       £4,738

NOTE. If a taxpayer is within the charge to Capital Gains Tax, neither indexation allowance nor taper relief apply to disposals of assets on or after 6 April 2008. Previously indexation allowance had been frozen at April 1998. Companies and other concerns within the charge to Corporation Tax are not affected by these changes. For indexation allowance see CG17207+ and for taper relief see CG17895+.