beta This part of GOV.UK is being rebuilt – find out what beta means

HMRC internal manual

Capital Gains Manual

Compensation: displaced tenants: business tenancies

1. Introduction

The guidance below considers the legislation applying to business tenancies in:

  • England & Wales
  • Northern Ireland and
  • Scotland

 

This guidance then considers the Landlord & Tenant Act 1954 and the protection it affords.

In particular, the guidance considers:

  • Security of tenure
  • Grounds for refusal to grant a new tenancy
  • Right to compensation

 

Finally the issue as to whether compensation received is chargeable to Capital Gains is considered, including:-

  • Entitlement to compensation following a court application
  • Entitlement to compensation where no court application is made
  • Drummond v Brown; a case which considered statutory compensation.

 

 

2. Legislation applying to business tenancies

England & Wales

Most business tenancies in England and Wales now operate under the protection of the Landlord & Tenant Act 1954 (L&TA 1954). There are certain exceptions, the most important being:

  • Tenancies of licensed premises (prior to 11 July 1992), see CG72450
  • Agricultural tenancies, see CG72380
  • Tenancies for fixed terms of 6 months or less.

 

Northern Ireland

In Northern Ireland similar legislation is to be found in the Business Tenancies Act (NI) 1964 (BTA 1964). The instructions below apply to tenancies falling within the Business Tenancies Act (Northern Ireland) 1964, but the following points should be noted:

  • Any reference to `the Court’ is, in Northern Ireland, a reference to the Lands Tribunal.
  • Section 4 BTA 1964 is equivalent to Section 25 L&TA 1954.
  • Section 5 BTA 1964 is equivalent to Section 26 L&TA 1954.
  • Section 19 BTA 1964 is equivalent to Section 37 L&TA 1954.
  • Section 10 BTA 1964 is equivalent to Section 37 L&TA 1954.
  • Section 20 BTA 1964 is equivalent to Section 38 L&TA 1954.

 

Scotland

In Scotland, there is no similar legislation regulating business tenancies. Hence, the decision in Drummond v Brown has no application in Scotland.

 

 

3. L&TA 1954

Deciding whether compensation received for the loss of a business tenancy is chargeable to Capital Gains Tax can be difficult. A basic understanding of the relevant parts of the L&TA 1954 is needed. A brief description of the main provisions of that Act follows.

 

Security of tenure

Probably the most important consequence of a tenancy falling under the protection of the L&TA 1954 is the security of tenure which this provides to the tenant. Even though the tenancy will have been granted for a particular term, for example 10 years, the tenant will normally be entitled to continue to occupy and use the property following the expiry of that term. The manner in which this is achieved is as follows:

 

a) Statutory tenancy

If the landlord and tenant do nothing, a statutory tenancy comes into being. This statutory tenancy will have the same terms, for example the same rent will be payable, as the original tenancy. The statutory tenancy will continue until either the landlord or the tenant brings it to an end by one of the actions referred to below.

 

b) Right to new tenancy

When a tenancy is coming towards the end of its term, the tenant is entitled to ask the landlord to grant a new tenancy, Section 26 L&TA 1954. The landlord is only entitled to refuse to grant a new tenancy in certain limited circumstances, see below. If the landlord is not willing to grant a new tenancy, he must specify the grounds on which he opposes the new tenancy. The tenant can then apply to the Court for the grant of a new tenancy if he considers that the grounds specified by the landlord are invalid.

 

c) Notice to quit

When a tenancy is coming towards the end of its term, the landlord can issue a notice to quit, Section 25 L&TA 1954. This notice informs the tenant whether the landlord will oppose the grant of a new tenancy. If the landlord does oppose the grant of a new tenancy, the grounds of that opposition must be specified. Again there are only certain grounds on which the landlord can validly oppose the grant of a new tenancy and the tenant can apply to the Court if he considers that the grounds specified in the notice to quit are invalid.

 

Grounds for refusal to grant new tenancy

A landlord can only refuse to grant a new tenancy on one, or more, of the following grounds:

  1. If the tenant has been in serious breach of one of the terms of the tenancy, for example by failing to pay the rent on time.
  2. If the landlord is prepared to offer a tenancy of suitable alternative accommodation.
  3. If the tenancy is under a sub-lease of part only of a building and the landlord wants to let or sell the building as a whole.
  4. If the landlord wants to demolish or reconstruct the property.
  5. If the landlord wants to occupy the property.

 

Right to compensation

If the landlord refuses to grant a new tenancy on any of the grounds set out at 3, 4 or 5 above (respectively Section 30(1)(e), (f) and (g) of the L&TA 1954), the tenant is entitled to compensation under Section 37 L&TA 1954. If the landlord refuses to grant a new tenancy on other grounds, compensation under the L&TA 1954 will not be due.

The amount of compensation due is normally either the rateable value of the property or twice the rateable value. The larger amount is due if the property has been in use for the purposes of a business carried on by the occupier for at least 14 years.

 

4. Is compensation chargeable to capital gains?

To the extent that the compensation is payable under Section 37 L&TA 1954, it is exempt from Capital Gains.

This is so whether or not the landlord makes an additional payment, because for example the tenant, having received a notice to quit agrees to surrender his tenancy early rather than serve out the full period of his notice. Any additional sum paid relates to the surrender of the tenancy and remains chargeable to Capital Gains.

It is important that you are satisfied that any compensation which is claimed to be exempt as statutory compensation is in fact payable under Section 37 L&TA 1954, particularly in cases where there is a surrender of the tenancy before it comes to an end. In all cases it will be necessary to obtain copies of the relevant documents and correspondence, for example the notice to quit and any subsequent agreement for early surrender, before any decision can be taken on whether the compensation is exempt or chargeable.

 

Drummond v Brown (58 TC 67)

The authority for exempting statutory compensation payable under Section 37 L&TA 1954 is the case of Drummond v Brown, 58TC67. In that case, the taxpayer was served with a notice to quit as the landlord wished to occupy the property. At the end of the notice period, the taxpayer left the property and received compensation calculated in accordance with the L&TA 1954.

The Court decided that the compensation did not arise from the disposal of an asset. The tenancy had already come to a natural end and the compensation was payable simply because the statute said that it should be. This situation was contrasted with that in which a tenant surrendered the fag end of his tenancy to the landlord without receiving a notice to quit; in such circumstances the compensation would be chargeable to tax. The two types of cases can be distinguished by reference to the instructions below.

 

Entitlement to compensation

The tenant is entitled to compensation under Section 37 L&TA 1954 in certain circumstances if he is unable to obtain a new tenancy. His entitlement to compensation will depend on whether or not he has applied to the court for a new tenancy, and on the grounds put forward by the landlord in opposing the grant of a new tenancy.

 

a) Court application

If the tenant applies to the court for a new tenancy he is entitled to compensation on quitting the tenancy if the court is precluded from granting a new tenancy because any of the grounds specified in Section 30(1)(e), (f) or (g) L&TA 1954 applies, see 3, 4 and 5 above.

 

b) No application made to court

If the tenant does not apply to the court for a new tenancy, or if he withdraws his application, he may still be entitled to compensation, but only:

  • if the landlord opposes the grant of a new tenancy by the issue of a notice to quit under Section 25, or by the issue of a notice opposing the tenants request for a new tenancy under Section 26, and
  • the landlord’s notice specifies one or more of the grounds in Section 30(1)(e), (f) or (g) L&TA 1954, see 3, 4 and 5 above, and it does not specify any other grounds.

 

Exempt consideration

If the tenant is entitled to compensation, either in accordance with a) or b) above, that compensation is not chargeable to Capital Gains to the extent that it is within the limits provided by the L&TA 1954, as set out above.

 

Compensation within the scope of Capital Gains

The compensation will however be within the scope of Capital Gains Tax in the following circumstances:

  • If the notice to quit, or the notice opposing a request for a new tenancy, specifies grounds other than those contained in Section 30(1)(e), (f) or (g) L&TA 1954, as above, the tenant will not be entitled to compensation under the L&TA unless he applies to the Court for a new tenancy and fails because the Court upholds one of the grounds in Section 30(1)(e), (f) or (g) L&TA 1954. Any compensation paid in such cases will not derive from the statute and must therefore derive from the disposal of the tenancy.
  • If the tenancy agreement itself contains a provision for the payment of compensation on termination of the tenancy.

 

Termination by agreement

The landlord and tenant may together apply to the Court under Section 38(4) L&TA 1954 to terminate the tenancy in a manner which is not provided for by the statute. This route will often be taken if the landlord needs an early surrender of the tenancy in order to sell the property to a developer, or to redevelop it himself. In such circumstances, the landlord will often be prepared to pay more to the tenant for a surrender of the remainder of the tenancy than the tenant would receive if the tenancy was terminated in accordance with the L&TA 1954.

The tenant may still be entitled to statutory compensation if the conditions in either a) or b) above are met, and if so that part of any surrender payment made by the landlord is not chargeable to Capital Gains. The balance of the surrender payment relates to the surrender of the fag end of the tenancy, which is a disposal, and is therefore within the scope of Capital Gains Tax.

If the tenant is not entitled to statutory compensation the whole of any surrender payment by the landlord is chargeable.