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Forward Funding and Prudential contracts: managing risk in new-build commercial property

Commissioning new-build commercial property is commonly done by way of dual contracts: for the purchase of land (subject to SDLT) and for the vendor to build out the property. How can buyers manage the risk of the builder letting them down?

Often instead of agreeing to buy a completed building in a new build situation, the purchaser acquires the development site from the vendor and at the same time enters into a separate development agreement with the landowner or a connected person for the construction of a building.

For stamp duty land tax (SDLT) purposes, the expectation will be that the price paid for the land will be subject to SDLT, while the price paid for build will not. This approach was agreed for old stamp duty in the 1992 case of Prudential Assurance Co Ltd v Inland Revenue. HMRC accept that it continues to apply for SDLT. This type of forward funding has become known as “Prudential arrangements”.

There are however some potential commercial difficulties with Prudential arrangements, when compared to a contract for the purchase of a completed building.

Financing the land purchase

Whether the purchaser intends to own the building as an investment, to be let out, or for its own occupation, it may be unwilling or unable to hand over capital for a non-income producing asset during the expected duration of the build works.

Where the purchaser is considered ‘good for the money’ such as a large pension fund or real estate investment trust, the landowner may be prepared to agree deferred payment terms, nearer to the expected completion date.

Ensuring the build is completed to spec and on time

Where Prudential arrangements are used, the separation of contracts for land and building mean that the purchaser is potentially at risk where the developer fails to deliver on the terms of the building contract. The land has already been acquired.

Accordingly it is important to ensure that the building contract is made with a developer of substance and good reputation, and contains adequate commercial protections.

If this risk is unacceptable to the purchaser, it could opt to enter into a single contract to purchase a completed building, at additional SDLT cost.

A note on SDLT and pricing

The price for the land and for the build, in Prudential arrangements, must be apportioned on a just and reasonable basis between the two contracts. HMRC accept that it is reasonable to apportion to the land interest an amount equal to its market value at the effective date of the land transaction. The purchaser is subject to SDLT on that market value

A purchaser using Prudential arrangements should have or obtain valuation evidence to support his SDLT return in respect of the land transaction.

This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.

Samuel Dooley

Associate

I advise and train on tax issues, specialising in real estate and M&A transactions.