Imagine a farmer. Let’s call him David. He owns 50 acres of farm land with development potential. So does his neighbour, Jim. The two of them have learned that they can each earn more, selling the two pieces of land as a single 100-acre parcel. ‘Great! Let’s get cracking!’ they declare.
Just hold on – David, Jim. Not so fast. There’s a potential huge tax trap ahead…
… and it goes like this:
David and Jim's collaboration agreement
The two neighbours will enter into a Collaboration agreement. This splits the sales proceeds in proportion to the size of each parcel of land – in this case 50:50. Now – there’s a clause in the agreement that splits the money, regardless of whose land sells first. So, let’s say, for cashflow reasons, a developer negotiates to buy the land in two parts, David and Jim will share the proceeds from each payment. But what are the tax implications? Read on and find out about this heavyweight double tax whammy.
TAX WHAMMY number one
Let’s say David’s land sells first. He passes 50% of the proceeds to Jim. So far, fine. But, next comes the catch. Even though he’s only keeping half of the money, David is liable for Capital Gains Tax (CGT), based on 100% of the proceeds. This is because, when working out the taxable gain, the payment of Jim’s share is not a deductible expense.
‘But surely, as only 50% of the proceeds are David’s, he won’t have to pay all that tax?’ Sorry. That’s not the way it works. You see, he beneficially owns 100% of the land and so must pay tax on 100% of the proceeds.
TAX WHAMMY number two
It’s not just David who gets hit. Jim also must pay tax on his 50% share of the sale. So – HMRC gets two bites of the same financially juicy cherry.
Your Tax Expert knows best
Here’s how the situation works using real numbers:
Years ago, David bought his share of the land for £100,000. He sells it for £1,100,000 and transfers £550,000 to Jim. David has to pay Capital Gains Tax on the gain of £1,000,000. Jim is due to pay CGT on the full £550,000. So, even though the sale proceeds are only £1,100,000, the amount subject to CGT will be £1.55 million.
To conclude – be very careful. The temptations of a Collaboration Agreement are strong. But, will the certain double-tax hit, compensate sufficiently for the potential higher sale price?
As ever, our advice is – check with an expert tax specialist.
This legal information is not the same as legal advice and you may not rely on our post as a recommendation of any particular legal understanding. Pease, consult an attorney if you’d like to get an advice on your interpretation of this article.