A Case Study: Tax Implications on the Lease Extensions in the UK

We recently published an article examining the tax implications of lease extensions in the UK, focusing in particular on cases where leases are extended by more than 90 years using a surrender and regrant method. In this follow-up, we present a real-world case study demonstrating how such a transaction is structured and the various tax consequences that arise.

A surrender and regrant is a common method of lease extension in the UK. It involves the leaseholder surrendering their existing leasehold interest, after which the freeholder grants a new lease, typically with a 999-year term and updated provisions, over the same property. This process is often used when leases are running low on term, which can affect resale value and mortgage eligibility.

Background

Freeholder Property Ltd owns the freehold interest in a London block of four residential flats valued at around £3 million. Mr Smith, the company’s sole director and shareholder, personally holds the leasehold interests in Flats 1 to 4, each with about 85 years remaining.

To consolidate and future-proof his interests, Mr Smith decides to extend the leases to 999 years. The company regrants all four leases at a peppercorn rent and without a premium, and includes a new provision for parking rights.

The current market value of the leases, and the values upon the grant of 999-year long leases are as follows:

Tax Implications to the Leaseholder

Under Surrender and Re-grant, the leaseholder has two taxes to consider, namely, Capital Gains tax (CGT) on the surrender and Stamp Duty Land Tax (SDLT) when the freeholder regrants the lease on a new term with extended terms.

From a CGT perspective, the surrender of an existing lease and the grant of a new one is generally treated as a disposal of the old lease and an acquisition of a new lease. The “consideration” for the disposal is the market value of the new lease. The market value of the new lease is essentially the difference between the value of lease after the extension (which is expected to rise), and the value of lease under current lease terms (which is generally lower, given the lower lease terms remaining).

On certain surrender and regrant arrangements, Extra-Statutory Concession D39 (ESC D39) may apply, and thereby eliminate the Capital gains tax potential for the leaseholder. For that to apply, the following must be met:

1. The new lease is granted on terms that would be agreed between unconnected parties.
2. The lease extension is not part of a broader scheme or series of transactions.
3. The tenant does not receive a capital payment as part of the transaction.
4. The new lease covers the same extent of property as the original.
5. Other than duration and rent, the lease terms are substantially identical.

Where ESC D39 applies, the new lease is treated as acquired on the same date as the original lease, preserving the original acquisition date and deferring any CGT exposure. However, if the concession does not apply, a chargeable gain may arise based on the market value of the new lease relative to the cost of the original lease.

In the case of Mr Smith, the new lease is not being granted on the arms length terms, supported by peppercorn rent and no premium. Additionally, the lease terms are not substantially identical given the addition of parking space provision in the new lease. As such, capital gains will arise for Mr Smith as follows:

Capital Gains Tax at 24% (357,000 at 24%)                                 85,680

CGT is not the only tax to be considered for the leaseholder, Mr Smith. SDLT is another tax that may be chargeable to Mr Smith when the surrendered lease is re granted to him from the company.

However, Paragraph 16 of Schedule 17A of the Finance Act 2003 provides that where there is a surrender of an existing lease and a simultaneous grant of a new lease between the same parties, then:

• The grant of the new lease does not count as chargeable consideration for the surrender and
• The surrender does not count as chargeable consideration for the grant of the new lease.

This rule applies regardless of whether the parties are connected or not.

As such, where no monetary premium is paid and the rent under the new lease is a peppercorn, the chargeable consideration is nil, meaning that no SDLT liability arises on either transaction. Since the transaction between the company and Mr smith is at a peppercorn rent and no premium, no SDLT is payable.

Where a close company provides a loan or advances to a shareholder, director, or a connected person, a tax charge may arise under section 455 of the Corporation Tax Act 2010. This charge is equivalent to the corporation tax rate applicable to dividends—currently 33.75% for the 2025/26 tax year.

The section 455 charge does not apply solely to straightforward loans; it can also arise where:

• An individual owes a debt to the company, or
• The company takes on a third-party debt owed by that individual.

In this case, Freehold Property Ltd is granting a long lease to Mr Smith, a participator, without charging a premium. The uplift in value resulting from the new lease terms—£360,000—may be treated as a loan from the company to Mr Smith. If this amount is not repaid within nine months of the company’s year-end, a section 455 liability of £121,500 could arise.

Alternatively, under section 1020 of the Corporation Tax Act 2010, if a company provides an asset or benefit to a shareholder at less than market value, the difference is treated as a distribution. This would be taxed as dividend income in the hands of the recipient.

In this scenario, the grant of a lease at less than market value to Mr Smith could be treated as a distribution equal to the £360,000 uplift. Assuming Mr Smith is an additional rate taxpayer, the resulting dividend tax liability would be £141,660.

Only one of these two tax treatments—either a section 455 charge or a dividend tax—would apply, not both. The appropriate treatment will depend on whether the arrangement is classified as a loan or as a distribution for tax purposes.

Tax Implications to the Freeholder

Like the leaseholder, the company—as the freeholder—may be subject to both Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) in connection with the lease surrender and regrant. SDLT would normally arise on acquisition of the surrendered lease, and CGT on the grant of the new lease. However, under the sale and leaseback provisions explained above, SDLT is not chargeable to the company in this instance.

That said, the company will still incur a chargeable gain and be liable to Corporation Tax on that gain.

From the company's perspective, granting a new lease is treated as a part disposal of its freehold interest. As no consideration is received, market value is used to calculate the gain.

Where a lease is surrendered and then regranted to the same leaseholder, the company is treated as acquiring the surrendered lease at market value and disposing of it—via the regrant—also at market value.

In this case, the uplifted value across Flats 1–4 due to the lease extension is £1,860,000, and the company is treated as if it acquired the interests from Mr Smith at £1,500,000. After applying the part-disposal rules, the company realises a chargeable gain of £360,000. At the current Corporation Tax rate of 25%, this results in a tax liability of £90,000. This is calculated as follows:

Part-Disposal Formula

Allowable Costs: Initial costs * A / (A+B)

Where:

• A = the premium (consideration received),
• B = the market value of the reversionary interest (the remaining interest).

The reversionary interest is considered negligible due to the grant of 999-year leases. Therefore:

A / (A + B) ≈ A / A = 1

Therefore, 100% of the market value of the leasehold on existing terms, i.e. the deemed costs (£1,500,000) are allowable against the deemed sales proceeds.

Conclusion

This case study highlights the complex interplay of tax rules that apply to lease extensions via surrender and regrant in the UK, particularly when parties are connected and transactions are not conducted at arm’s length.

For leaseholders, the CGT position can be significant, especially when ESC D39 is unavailable. SDLT relief may be available where no premium or rent is paid. However, where lease extensions confer substantial value without payment, section 455 charges or dividend tax liabilities may arise.

For freeholder companies, the tax impact primarily arises through Corporation Tax on the gain, with SDLT generally relieved in surrender and regrant scenarios.