With the increase in stamp duty on property transactions, it has become much more common for properties to be held in special purpose vehicles (SPV's), and then traded by means of a sale of shares in the SPV itself. With a UK company, stamp duty on share sales is 0.5 percent - resulting in a saving of 3.5 percent of the purchase price. A full 4 percent saving may be possible if the SPV is not a UK company. How can you argue with savings of that magnitude?
The trouble is that selling a company is very different from selling a property, because the buyer will be acquiring only indirect ownership of the property, and in the process may acquire a range other assets and liabilities. This has an impact on the pricing of the transaction; on the way in which the buyer does its due diligence investigation; and on the contractual protection which the buyer needs. In addition, there are a number of specific problems which the buyer may encounter, particularly in relation to tax. It is wise to be aware of these before embarking on an SPV deal, and subsequently regretting it.
Pricing Issues
The price for an SPV will always be derived from the agreed valuation of the property. However, a number of adjustments typically need to be made, besides arguing over who should benefit from the stamp duty saving. A simple example is that rent collected by the SPV belongs to the SPV, not to the seller. If the rent has not been distributed by way of dividend, then the buyer will be getting the benefit of it (even if it relates to the pre-completion period), and this needs to be reflected in the price. Conversely however, the SPV may have liabilities – for example an unpaid bill for tax in respect of a pre-completion period. Again the price needs adjusting to reflect this.
All this means that it may be worth preparing completion accounts for the SPV – this is the only way in which proper comfort can be obtained regarding the true assets and liabilities of the SPV (and accordingly the appropriate price). It is then very important that both buyer and seller ensure that the accounting policies to be used for these accounts reflect the terms of the transaction - for example, in relation to the value ascribed to the property, and the appropriate provision for tax.
Due Diligence
The principal due diligence issue is to investigate title to the property – to be sure this is vested in the SPV – and to review all associated documentation, namely planning consents, occupational leases, etc. In some cases the existence of the SPV may be helpful, because the SPV itself will have the benefit of existing reports and contracts. This may avoid the need to use up a permitted assignment of contractors' warranties. However, the buyer will not itself have the benefit of those reports, and so any claim will be assessed only in the light of the original circumstances – this may result in a need to have the reports re-addressed to the buyer in the context of the transaction itself.
Depending upon the circumstances, the buyer is likely to need to do additional due diligence, to gain reassurance about the extent of the other assets, and liabilities, which it will inherit with the company. This may involve some form of accountants investigation, to review financial records. It will also involve some legal due diligence to check that the SPV has been properly administered, and to review other relevant legal issues such as litigation and contracts associated with the property.
Warranties and Indemnities
However "clean" the SPV appears to be, the buyer cannot rule out the subsequent discovery of some unknown liability of the SPV. This risk is typically covered by warranties and indemnities in the purchase contract. It is unusual in a normal company sale for the buyer to receive an indemnity against all liabilities of the target company, because this places too great a burden on the seller. However, this may be appropriate where the SPV has a short history and has done nothing besides hold the property.
Warranties are always subject to qualification through the disclosure of information to the buyer. Once the buyer becomes aware of a problem, it must cover itself in the contract, either through a price adjustment or a specific indemnity.
Warranties and indemnities are of course only as good as the covenant of the person giving them. This problem is often less acute on a normal property sale. If this is a concern, the buyer may need to make a retention for a suitable period to provide a fund to meet warranty and indemnity claims.
Tax Issues
There are three particular tax issues worth highlighting, although there are always a whole range of these to consider.
The first arises if the SPV is non-resident for UK tax purpose – eg it is resident in Jersey – the buyer needs to be satisfied that this is indeed the case. Is it true that the PV has been managed and controlled outside the UK? Non-resident status is liable to challenge by the Inland Revenue, and even if the buyer has a tax indemnity, fighting such a challenge is at best an unwelcome distraction.
The second arises where the ownership of the property by the SPV results from an internal group reorganisation by the seller's group. For example, the property may have been transferred to the SPV by the seller itself. In such a case, the sale of the SPV is likely to crystallise a tax charge within the SPV, and this needs to be covered either by a price adjustment and/or a tax indemnity.
The third arises in any case, and results from the "inherent" tax liability on the part of the SPV. In other words, how much tax would the SPV have to pay if it sold the property at its current market value? This is usually not automatically provided for in the SPV's accounts, but it is a legitimate concern for the buyer – one which would not arise on a normal purchase of the property. Depending upon the circumstances, this may also need to be covered through a price reduction and/or tax indemnity.
Financial Assistance
On final point to note is that, if the SPV is a UK company, it will be subject to rules which prohibit "financial assistance" being given by the SPV itself in the context of the sale. This can have a result which seems objectionable from any rational assessment, but breach of the rules is a criminal offence. Examples of transactions which may be prohibited include getting the SPV to pay arrears of rent to the seller as and when received; transferring an unwanted property in the SPV from the SPV to another company in the seller's group at less than market value; and getting the SPV to create a mortgage over the property to secure borrowings incurred by the buyer to make the acquisition. These issues can be overcome in most cases, but it all adds to the complexity of this kind of deal.
Conclusion
So in conclusion there is no question that the stamp duty savings through an SPV sale can be large. But as this article illustrates, these savings come at their own price, which is at best a more complicated (and expensive) process of negotiating and documenting the transaction. In some other cases, the difficulties can make it better to revert to a more familiar path, which has the advantages of speed and certainty.
For further information, please contact Barney Hearnden at barney.hearnden@cms-cmck.com or on +44 (0)20 7367 2878.
This article first appeared in Property Week on 2 February 2001.
