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Tuesday 27 September 2016
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Blue sky thinking: should your freehold surgery be an “investment”?

Legal & Finance

DEREK BELLEW

Consultant Solicitor and Chartered Arbitrator
Veale Wasbrough Lawyers

Derek has a particular interest in the primary healthcare sector, acting for over 250 GP and dental practices throughout the south and western regions of England and Wales over a period of 20 years

BEN WILLIS

Partner and Head of Healthcare
Veale Wasbrough Lawyers

Ben's main area of expertise is property management and development, with a particular interest in the healthcare sector. He has experience in the field of medical surgery development, having been involved in the acquisition and development of more than 60 new surgeries, both freehold and leasehold. He also deals with general property management matters for GPs, such as partner retirements, remortgages, acquisitions, disposals and leases

Historically, many surgery premises (apart from the inner-city health centres) were converted residential properties. Many GPs regarded their share in the ownership of the freehold as part of their pension arrangement or, generally, something of a "nest egg". As residential property prices increased, so did their "investment" in the surgery property.

These days, increasingly, surgery premises comprise new build, specialist medical centres. There is little or no immediate alternative use. Nevertheless, as notional rental values increase, many GPs have still been able to retire, sell their interest in the freehold surgery back to the continuing partners, and make a profit to help with their retirement provision. In that sense, it makes sense to treat the interest in the surgery property as a genuine "investment".

What has slightly upset the calculation is the introduction of entrepreneurs' relief from capital gains tax. This relief means that on disposal of business property (and the disposal of the property must take place at the same time as the business itself is disposed of) capital gains tax is payable at the rate of 10%, rather than 18% – a useful saving. The "fly in the ointment", however, is that this relief is not available in the case of "investments".

Every GP practice that owns its own surgery must be careful in how it organises its "structure" for the purposes of its freehold surgery property holding. While one may want the building to be regarded as an "investment" property for the purposes of seeing its value increase over time, one does not want it to be regarded as an "investment" for the purposes of assessing the applicable rate of capital gains tax.

In our view, it is also a question of the "cultural attitude" of the partnership. Take the following two scenarios:

  • A partnership of GPs develops a new surgery and treats it entirely as "partnership property", even though those participating hope that there is a profit for them at the end of the day.
  • A small number of GPs decide to deal with the development themselves, outside the practice accounts, with a view to owning the property in the longer term (even beyond retirement).

In the first case, the GPs should qualify for entrepreneurs' relief. In the second case, the GPs would be unlikely to qualify. So, what are the relevant considerations?

Accountancy treatment
If the freehold property is genuinely partnership property, deal with interests of the property-owning partners (and not all partners need to be property owners) in the capital accounts of the partnership, making adjustments, as shares change, through the capital accounts. The borrowing for the development will be a liability of the partnership, with internal accountability, as between the partners, in proportion to the shares in which they own the property.

Where it is genuinely an investment property, it is best to deal with matters completely outside the accounts of the partnership, ie, have a separate property-owning "vehicle".

Partnership agreement
If the asset is being treated as partnership property, deal with all arrangements as between the partners by the relevant provisions in the partnership agreement. Do not deal with interests of the owners in a separate deed. In the case of a genuine investment property, you will need to have a separate document evidencing the interests of the participants.

When do you have a lease?
You do not need a lease where the property is partnership property, even though not all partners are property owners. You can deal with the non-property owners perfectly well through a licence arrangement contained in the partnership agreement. In the case of an investment property arrangement, you will certainly need an arms-length lease granted between the property owners, as landlords, and the medical partners, as tenants.

Comings and goings
If the freehold property is partnership property, you will need to commit new partners to buy in at a specified time – after they have joined the partnership and have completed their probationary period. It is essential to get that commitment in writing before the partnership commences – do not leave it until later.

In the case of an investment property, you can leave the question as to whether a new partner buys in or not entirely as a matter for the property owners themselves to decide. They may prefer to keep the property for themselves, and not share that with incoming medical partners.

In the case of partnership property, it is essential to have the right to buy out a retiring partner. It is very important that there is a contract in place to do that at the time of the retirement, or entrepreneurs' relief may be refused.
In the case of death, it is better to have "two way" mutual options to buy/sell, in order to achieve the best outcome for the purposes of inheritance tax.

In the case of an investment property (where it is accepted that entrepreneurs' relief is not available), there is no need to provide, in advance, for the acquisition of the retiring partners' share, either in the case of normal retirement or upon death, as this can be something that can be negotiated and agreed at a later date.

Do surgery valuation methods differ?
It is an interesting question – and one for valuers to answer, not lawyers – as to whether "partnership property" should be valued differently from "investment property". Where one is looking at partnership property, the valuation will be of the immediate, and current, value, perhaps in relation to the current level of notional rent.

An incoming partner, from their perspective, is most interested in whether their share of the notional rent will be at least sufficient to cover the outgoing on their borrowing. An institutional investor, on the other hand, will be looking at the "yield" from a longer-term point of view, eg, until the expiry of the lease.

As far as yields are concerned, this depends on what is happening in the commercial property world. It may well be that a high valuation would more likely result from an instance where the freehold property is regarded as "investment property", rather than in the case of a buy/sell, as between medical partners.

A particular issue that may be relevant is whether one should take account of alternative-use value (like in the old days when the alternative use was that of a residential property). Our view is that it is probably better to ignore alternative-use value unless, say, planning permission for that alternative use has already been obtained and there is definitely going to be a realisation – for instance, if the practice is going into new purpose-built accommodation.

Where the position is more uncertain, it is better to deal with the possible "uplift" on realisation for alternative use at some stage in the future by a "claw back" arrangement, which enables a retiring partner to share in the uplift on a sliding scale, depending on how many years have elapsed since they retired.

Conclusion
Where a GP practice is contemplating a new surgery development, it is very important that they consider the nature of the "investment" they are entering into and take advice from specialist accountants and solicitors at an early stage.
The structure most appropriate to each scheme can then be put in place to facilitate the best outcome, from a tax point of view, as well as the most comfortable working relationship between the medical partners.