Owning agricultural or other land with development potential can be a financial lifeline. Even if it is not currently zoned for development, the prospect of the land being zoned in the relatively short-to-medium term can be the source of much needed capital, in the form of an option payment, without impacting unduly on clients' farming or other operations. If a developer knocks on your clients' door offering riches substantially in excess of the agricultural value of the land and beyond any return they could hope to generate from the land itself, it can be hard for the client to resist biting off the developer's hand. The developer may be offering a not insignificant payment now for what amounts to a right to buy the land at a later date once planning permission for development has been granted. Before committing to any deal, however, clients should be advised to give careful consideration to what is on offer. An upfront payment is usually made by the developer for the option, but the serious money only arrives once planning permission has been granted, which could be a number of years hence, or indeed never if the planning permission is not obtained.

To avoid the client being left totally at the developers' whim on the issue of timing, the developer should be required to try to obtain planning permission as soon as possible and, in doing so, to maximise the value of the site, while consulting your client and keeping them, as the owner of the site, informed throughout the process. The type of planning permission to be obtained, ie outline or detailed, should be made clear at the outset, as should whether the planning permission is to be for a residential, commercial or mixed usage.

The price eventually paid for the site is usually at a discount of between 10% and 30% of the market value, with the benefit of the particular planning permission, once this had been obtained. The discount is generally viewed as recompense to the developer for the time, costs and risks involved in obtaining planning permission. Usually the upfront payment for the option is deducted from the total price.

The more speculative and longer-term the development, the greater the discount from market value is likely to be, in order to reflect the perceived risks to the developer of pursuing an application for planning permission. This will also be reflected in the level of upfront payment.

If planning permission is likely to be granted for the development of the site in the short term, or with minimal effort, the client might be best advised not to pursue the option route, but to consider proceeding on a traditional sale basis suspensively conditional on planning being obtained. Indeed until the last five or ten years this is how such a situation would have been handled. It is only within that timeframe that the use of option agreements has become more widespread.

The option agreement documenting the deal has to contain detailed provisions dealing with how to ascertain the price to be paid for the site. These will require careful consideration, particularly of the items of expenditure that the developer may incur. These items can be deducted from market value before the price is fixed and may, for example, include acquisition of additional land or servitudes for services, children's play areas, flood prevention measures and planning gain. The developer should be required to minimise this expenditure and verify properly what it claims to be entitled to deduct. Given that the developer will almost certainly be able to recover the VAT, the deductions from the market value calculation should be on a net basis. Of course the landowner wishes to sell the land for as high a price as possible (and therefore with the fewest deductions), whereas the developer wants to maximise its profit by purchasing it as cheaply as it can.

The developer will probably be looking to limit the area to be acquired at 70% to 90% of market value to developable areas, and to pay a much lower (or no) price for non-developable areas such as amenity ground. If so, a ceiling figure, or percentage of the site that will be deemed to be non-developable for the price calculation, should be agreed at the outset. This figure will obviously vary from site to site but a ceiling of 20% of land being non-developable (and therefore 80% being developable) would suffice. In mixed developments, given the potential disparity in market values for different uses, it would also seem prudent to specify a deemed maximum area for the lower-value use.

It would also be prudent in every case, given the uncertainties as to the total amount that might ultimately fall to be deducted from the price, to agree at the outset a ‘floor' figure below which the money actually received by your client will not fall. This can to some extent be inflation-proofed by being linked to the Retail Prices Index or (preferably) to a property value-related index, for example any one of the various new house price indexes in the case of a prospective residential development, although such an index may not keep pace with increases in land values in the particular neighbour-hood. In mixed-use developments different minimum prices could be specified for each use.

The planning authority may require various infrastructure improvements and common facilities in exchange for the grant of planning permission. The planning gain provisions of any agreement can often have a major impact on the amount of the price. The developer will normally expect the landowner to bear most of these planning gain costs by deducting them from the market value of the site. It then suits the developer to agree these with the local authority without too much argument as first it gets planning permission and secondly the cost involved reduces the market value. From the landowner's point of view, this makes the inclusion of a floor price at the outset all the more important.

If the parties cannot agree the figures a professional valuer is usually brought in to determine the issue. The site will not have been exposed for sale on the open market, so, as a result, the market value under the deal could easily be below the price that might be achieved if the site was marketed.

While the client will be able to continue to farm the land or use it for other purposes that do not interfere with the developer's proposals up until the option is exercised, they will not be able to sell or transfer the land, grant security over it or do anything that might prejudice the future planning application without first getting the developer's consent. If, at the time the client is considering granting the option, there is any likelihood of them wishing to sell or transfer part of the land, they should exclude that part from the option. The alternative would be to build in some limited ability to transfer, up until the option is actually exercised, subject to the acquiring party being bound to enter into an option agreement with the developer in equivalent terms. This could be especially important in longer-term options so as to permit inter-family transactions for tax-planning purposes. Other possibilities include a limited ability to sell or transfer to bodies with compulsory purchase powers. This could enable minor infrastructure works unconnected with the proposed development to proceed unhindered or delayed simply by the options existence.

CGT is chargeable on the initial upfront payment made by the developer. No taper relief will be available as the asset disposed of (the right to buy land at a later date) has no acquisition cost. Any CGT paid is, however, taken into account when calculating the tax payable on the eventual sale price (augmented by the initial payment) following exercise of the option.

The impact of CGT on the upfront payment can significantly erode the benefit to the client by as much as 40%. In appropriate circumstances its impact could be reduced by staggering the upfront payment over a number of years, and using several years' CGT allowance, or in appropriate circum-stances by transferring shares in the site to additional family members before entering into the option and making use of a number of individuals CGT allowances. A careful consideration of the client's personal tax and family situation at an early stage can highlight the opportunity to mitigate the tax impact on the upfront payment.

While at the outset the developer may identify a large area to be subject to the option, it might not be successful in obtaining planning permission for the whole area. If it only manages to obtain planning permission for part of the site, or decides that it only wants to develop part of the site, is it to be permitted to exercise the option for that area? Is it to be permitted to exercise the option in stages? In either of these cases, and also where the identified area is not the entirety of the client's landholding, care should be taken in drafting the contract to preserve all rights that the client might need to continue with their operations on the land not ultimately acquired by the developer. Rights for access, water supply, drainage and other services should be carefully considered. The developer should be required not to interfere with any water supply arising or passing through the opted areas and not to obstruct access.

There is a concern with option agreements that, while landowners want the best price, developers want to drive down the price and therefore the structure involves an inherent conflict of interest that can lead to potentially disadvantageous consequences from the landowner's viewpoint. An alternative structure that is aimed at addressing this potential imbalance is the promotion agreement, where the landowner enters an agreement, not with the developer, but with a specialist promoter. While a limited upfront payment may be made to the landowner, the promoter in theory accepts the risks and the cost of the planning process. In exchange the promoter receives an agreed percentage of the actual selling price of the site rather than the market value.

When planning permission is obtained the site is sold on the open market to the highest bidder. The theory is that as both promoter and landowner benefit from obtaining the maximum sale price as soon as possible, and as they therefore have the same objectives, both will strive to get the best possible planning consent in the shortest timeframe.

Furthermore, when it comes to planning gain they will both give as little to the planning authority as possible to secure planning consent. Promotion agreements are generally only currently available for larger sites where there is a real prospect of planning permission being available in the short term and are therefore very attractive to a promoter. They usually require the landowner to be more proactive in promoting the site, and in the planning process, and consequently are not for everyone. From a landowner's point of view if planning permission is likely to be forthcoming in the short term there does not seem to be much attraction in a promotion agreement: why not either obtain outline permission themselves and market the site with the benefit of that permission or simply market it ‘with development potential' and pay the marketing agents' commission? Alternatively in such circumstances why not sell the site with the contract being suspensively conditional on planning permission being obtained subject to a suitable longstop date after which either party can walk away from the deal, and, in doing so, avoid the issue of deductions from the market value, CGT on the upfront payment etc?

The possible future introduction of planning gain supplement (PGS) should be borne in mind when considering the financial aspects of either an option agreement or promotion agreement. If such a tax is introduced, which although much heralded is as yet far from certain, the landowner could, in addition to meeting planning gain costs, find the return to them reduced by a PGS imposed to fund non-site-specific infra-structure improvements. PGS, if introduced, is likely to be calculated on the basis of the increase in value of the land once planning permission is granted. There would seem at the very least to be an argument that the landowner will be paying twice for planning gain, so, once PGS is introduced, there should certainly be a case for simplifying the price calculation by removing all provisions relating to payment by the landowner for planning gain from the option agreement. In the interim the landowner should not accept provisions which potentially allow both PGS and planning gain deductions to be made from the price.