Overage payments in property; pitfall or windfall?

Property specialist, Graham Goldspink, and tax expert Sharron Carle, look at how overage payments can be secured and tax liabilities on them minimised.

A contingent payment, generally known as "overage", is a payment which is promised to be paid to one party upon the happening of a future trigger event. It is usually intended that the event will occur after completion of the current transaction. This trigger may be positive, as in the case of the grant of planning permission, or negative such as a payment linked to the removal of a restrictive covenant.

According to Keystone property specialist, Graham Goldspink, the most common example of overage is when a seller sells their property at market value, but the purchaser agrees to pay a sum linked to any uplift in value following a trigger event. This usually works on the basis that the trigger event makes the sale land more valuable than previously, for example the grant of a planning permission to build a development where previously the land was bare. Examples of common trigger events include:

• the grant of planning permission for development or change of use
• the implementation of a planning permission
• practical completion of a development
• subsequent sale of the completed development at a higher price within a fixed time period
• sale of the property with the benefit of planning permission.

The total of an overage payment can be calculated in numerous ways. This can be a simple agreed sum based on a percentage of the increase in value or can be more complicated and linked to future sale profits after deducting all relevant and agreed costs.

It is easy to understand why a seller would like to receive an overage payment, but as with most deals it is down to factors such as the bargaining strength of the parties or the availability of suitable land that will influence whether or not overage can be negotiated. It should be noted that overage is not always appropriate, it can lower the initial purchase price and may affect the amount that the buyer is willing to pay up front for the land.

Overage provisions are notoriously complex arrangements and great care must be taken in drafting the provisions. There is a wealth of case law that centres around imprecise drafting and differing interpretation of the same provisions. The devil is in the detail and parties must seek to consider all reasonably foreseeable circumstances to ensure that the overage provisions reflect the agreement of the parties.

Particular attention should be paid in negotiation stage to the duration of the overage, what will trigger payment, how much the payment will be, how payment is to be calculated and consideration of whether or not payment will release the overage obligation. Given the difficulty in predicting the future, it is extremely important to narrow down the way in which the overage payment will be calculated and to tightly define what constitutes a trigger event. It is in the interest of both parties to have certainty over the precise terms being agreed. Using worked examples in documents to illustrate when overage applies and how much is payable in those circumstances adds to this certainty.

It is for the beneficiary of the overage i.e. usually the seller, to ensure that the obligation to make the future payment is adequately protected by some form of security. This security may be against not only the current party to the deal but also potentially successors in title to the land originally sold.

There are many methods of securing overage, with each having their respective advantages and disadvantages. It is not uncommon for more than one method of security to be used or a combination of types. The most common methods used include:

• personal contractual obligation
• restrictive covenant
• positive covenant and associated restriction
• mortgage or charge
• guarantee or bond.

Tax considerations

Keystone tax specialist, Sharron Carle, points out that the receipt of future overage payments could also give rise to unexpected tax liabilities for a seller who has held the property as an investment asset and is expecting to be taxed under the capital gains tax rules. The types of sellers most likely to be vulnerable are individuals, trusts and charities.

Unfortunately where overage becomes payable, a danger exists that the monies received will be treated as trading profits and taxable at income rates currently up to 50% rather than the lower capital gains rates.

The main problem arises when land is sold to a developer and the sale contract includes a provision for further payments to be made to the seller linked to the success of any future development. HMRC call these "slice of the action contracts" and very firmly take the view that any money received under them is taxable as trading income in the hands of the seller.

The sorts of arrangements which would fall clearly into this category include trigger events based upon:

• Additional units built or sold by the developer
• Gross sales values exceeding an expected level; or
• The developer selling the land, or any undeveloped part of it, at a profit.

HMRC do accept that overage linked to the simple grant of planning permission would not necessarily fall within the charge to income tax, but the wider implications of FTE overage provisions should be very carefully considered as the way they are drafted can dramatically alter the seller’s tax position.

Fortunately, there is an exclusion from income tax treatment for sellers who would be eligible for principle private residence relief on the sale and there are methods acceptable to HMRC which can allow a seller to circumvent the provisions.

Taking into account the complexities than can be caused by the prospect of future payments in relation to land sales both from a commercial and a tax perspective, it is clearly prudent to take early advice on how best to structure these transactions.