The stamp duty lottery for alternative property finance providers

Two types of alternative property finance reliefs exist for SDLT. Their conditions were framed around the two most common forms of Sharia-compliant mortgages. Their aim is to ensure that no more SDLT is payable on the purchase of property than would be payable if a conventional mortgage were used. Since their introduction, various start-ups have explored offering alternative property finance to individuals who cannot access, or do not wish to access, a conventional mortgage. One of the major hurdles is SDLT. This article contrasts the impact of the SDLT rules on two alternative property finance products in the market. One qualifies as a ‘home purchase plan’, the other does not. As we shall see, this makes a big difference.

In both cases, assume that:

• the purchased dwelling is worth £300,000.
• the individual is a UK resident first-time buyer.
• the individual contributes 10% to the price (£30,000 deposit).
• the finance provider is controlled by a non-resident (e.g., an overseas institution).
• the individual does not increase their share of the property during the term; and
• the individual refinances at the end of the specified term using a conventional mortgage, having increased their deposit by saving during the term, buying out the finance provider.

Part-own finance

• The dwelling is bought by the individual and the finance provider jointly via a partnership. The finance provider is entitled to 100% of the income profits and 90% of the capital profits. The individual is entitled to 10% of the capital profits.
• The partnership grants a tenancy to the individual for an initial term of five years at a specified rent. After five years the tenancy would turn into a periodic tenancy.
• The individual has the right but not the obligation to increase their partnership share (‘staircasing’) up to a maximum of 40%, which would reduce their monthly payment correspondingly.
• The individual is free to sell their partnership share at any time – either to the finance provider or another individual.
• The individual is also free to buy out the finance provider at a discount later.
• If the dwelling is sold, sale proceeds are distributed to the individual and the finance provider in proportion to their partnership shares.

SDLT charges on part-own finance

Notes:

1.  First-time buyer relief is not available. The tax is calculated at the residential ‘higher rates’ and increased rates for ‘non-resident transactions’. If the purchase price were over £500,000, the tax would be calculated at the ‘super rate’ and increased rates for ‘non-resident transactions’, and annual tax on enveloped dwellings (ATED) would be payable every year, because the individual would be a ‘non-qualifying individual’.
2. Assume that the net present value of the rent falls within the nil-rate band.
3.  SDLT would not be chargeable, as the individual would only increase their capital profit share.
4. Assume that the net present value of the rent falls within the nil-rate band.
5. Assume that the property is bought for £315,000 – a 5% increase over the term. The individual is no longer a first-time buyer and must pay SDLT on 100% of the market value of the dwelling at the relevant time, not the price paid, as the transaction would fall within special computational rules which apply to a transfer by a partnership to a partner and the individual has a 0% income profit share. If the individual were married or had entered into a civil partnership with someone who owns their own dwelling, the tax would be calculated at the residential ‘higher rates’, as the conditions for the exception to the ‘higher rates’ where the buyer has a prior interest in the purchased dwelling would not be met (see FA 2003 Sch 4ZA para 7A).

Rent-to-own finance

• The dwelling is bought by the finance provider. The individual contributes 2% of the price.
• The finance provider grants the individual a tenancy of the dwelling for a term of three years at a specified rent and an option to buy the home at a fixed price at the end of the term.
• The individual is entitled to extend the lease by 12 months or 24 months (up to a maximum term of 60 months). The strike price would increase proportionately.

SDLT charges on rent-to-own

Notes: 1 First-time buyer relief is available. The transaction is not a ‘non-resident transaction’. 2 Assume that the net present value of the rent falls within the nil-rate band. 3 Not applicable. 4 Assume that the net present value of the rent falls within the nil-rate band. 5 First-time buyer relief is available. The individual still qualifies as a first-time buyer. The reason for this difference in treatment is that only rent-to-own is a home purchase plan. This means that of the two types of finance provider only the rent-to-own finance provider counts as a ‘financial institution’ and consequently only rent-to-own falls within an SDLT alternative property finance provision and only rent-to-own finance providers can access the modifications made to various SDLT rules by the provision.

A ‘home purchase plan’ is an arrangement regulated by the FCA under which:

• a person (the ‘home purchase provider’) buys a qualifying interest in land or an undivided share of one.
• an individual (the ‘home purchaser’) has an obligation to buy the interest bought by the home purchase provider during the course of or at the end of a specified period; and
• the home purchaser is entitled under the arrangement to occupy at least 40% of the land during that period and intends to do so.

Such an arrangement falls within FA 2003 ss 71A and 73, the SDLT alternative property finance provisions, and is afforded the following benefits:

• The purchase of the dwelling by the home purchase provider, whether it buys it alone or jointly with the home purchaser, is eligible for first-time buyer relief (meaning that no SDLT is payable for purchases up to £425,000, reducing to £300,000 from 1 April 2025) if the home purchaser is a first-time buyer: see FA 2003 Sch 6ZA para 3(2).
• Where the home purchaser is not a first-time buyer, the transaction is ‘standard rated’ even though the home purchase provider is a company: see FA 2003 Sch 4ZA para 15(2) and Sch 4A para 6A(3).
• The increased rates for ‘non-resident transactions’ do not apply if the home purchaser meets the SDLT residence test at the completion date of the transaction even where the home purchase provider is non-resident in relation to the transaction: see FA 2003 Sch 9A para 16(4).
• ATED does not apply to the ownership of the dwelling by the home purchase provider: see FA 2013 s 157.

(Curiously, there is a mismatch in the conditions in s 71A. One of the conditions for arrangements to be a home purchase plan is that they must provide for the obligation of the individual to buy the dwelling bought by the finance provider. Under s 71A, the individual has the right but not the obligation to buy the dwelling in one transaction or in a series of transactions. This was not intended and presumably the FCA is content that arrangements within s 71A do count as home purchase plans.)

The application of the residential ‘super rate’, ATED, the residential ‘higher rates’ and increased rates for ‘non-resident transactions’ to part-own finance providers, and the restriction on claiming first-time buyer relief, were obviously unintended. Part-own did not launch until after the relevant legislation was passed.

To give part-own finance providers parity with a conventional mortgage and home purchase plans:

• The individual should be treated as the purchaser for the purposes of the relevant rules in the same way that ‘the person’ (rather than ‘the financial institution’) is treated as the purchaser for the purposes of the same rules in the case of home purchase plans.
• The individual’s purchase of the property from the partnership should be exempt from SDLT in the same way that ‘a further transaction’ within the meaning of FA 2003 s 71A(4) is exempt.
• The individual’s purchase of the lease should be exempt from SDLT in the same way that ‘the second transaction’ within the meaning of FA 2003 s 71A(1)(c) is exempt.

The easiest way to achieve this is to amend FA 2003 s 73BA (meaning of ‘financial institution’) by extending the meaning of ‘financial institution’ to include an entity offering these arrangements. This would mean defining such a person, as it is not possible to merely cross-refer to a regulated activity specified in Financial Services and Markets Act (Regulated Activities) Order 2001.

Conversely, alternative property finance providers, like rent-to-own finance providers, that offer arrangements that count as home purchase plans can access the benefits afforded by the SDLT alternative property finance provisions even though:

• the arrangements are not intended to be used for religious reasons.
• the finance term, and the term of the tenancy, is considerably less than would be offered in the case of an Islamic mortgage (e.g., five years rather than 25 years).
• the right to buy the property outright may be exercised at any time rather than at the end of the finance term.
• staircasing is optional rather than compulsory.
• the individual may walk away before the end of the finance term.

Moreover, the modifications made to the SDLT rules by falling within s 71A or s 73 (which are dependent on a home purchase plan) are not withdrawn if the arrangements end. The finance provider may claim first-time buyer relief on its purchase of the dwelling due to the individual qualifying for the relief, yet if the individual chooses not to extend the term or buy the property the finance provider would retain that saving.

It is tolerably clear that s 71A and s 73 apply to alternative property finance arrangements other than the Sharia-compliant mortgages on which they were based. This encourages the development of alternative property finance. However, there is an unequal playing field. Those who are lucky enough to have designed a product that falls within s 71A or s 73 (which implies that it qualifies as a home purchase plan) can access beneficial treatment. Those who are not, cannot, and, remarkably, can be unintended victims of punitive charges aimed at enveloping.

This article was originally published in the Tax Journal and is reproduced with kind permission.