For landlords looking to transfer personally owned property to a company, it’s essential to anticipate the tax advantages and tax traps alike.
In Part One, we explored the tax issues around incorporation relief (capital gains tax) and partnership relief (stamp duty land tax). Here we explain the danger posed by specialist property incorporation boutiques making unworkable claims.
Dan Neidle and Tax Policy Associates
Led by Dan Neidle, Tax Policy Associates (TPA) describe themselves as ‘a not-for-profit company, founded to improve tax and legal policy, and the public understanding of tax.’
Much of TPA’s activity is investigative, exposing what they regard as ‘dodgy’ tax schemes. There is no suggestion that a ‘plain vanilla’ incorporation is an unacceptable scheme, but TPA have looked at certain schemes around property incorporations, promoted by some property-focused tax boutiques.
While these boutique firms do implement plain vanilla incorporations in much the same way as a professional accountancy firm or law firm might do, in many cases they ‘turbocharge’ their incorporations by claiming tax benefits of dubious validity.
Director’s loan accounts
A commonly seen add-on is the ‘magic’ creation of a director’s loan account.
Say a landlord has £10m of properties with £4m of bank debt. The landlord borrows a further £2m from his wealthy uncle. He then has £2m sitting in the bank.
Incorporation relief requires all assets of the business to be transferred to the company except cash. So the landlord transfers to the company the £10m properties less £4m bank debt and less £2m uncle debt.
After incorporation, the individual lends the £2m cash to the company. The company uses this to repay the uncle. The individual then has a £2m loan to the company which the company can repay to extract cash tax-free from the company.
This doesn’t work! The £2m uncle debt where the cash is used in this way is not a proper liability of the business. It isn’t used to buy or enhance properties – it just sits in the bank. So while the bank debt can be validly transferred, the uncle debt can’t and its amount is subject to CGT currently at 24% which is £480k of tax.
Inheritance tax
Another claim made is that incorporating avoids inheritance tax (IHT).
Investment assets, including buy-to-lets, don’t qualify for business property relief whether those assets are held personally or in a company. There are various contrived structures that are used to argue that there is no IHT. The only thing these have in common is that they almost certainly don’t work and would definitely be challenged by HMRC if properly disclosed.
Substantial Incorporation Structure
Some promoters have arrangements whereby the landlord doesn’t have to transfer legal title to the properties to the company, only the beneficial interest in the properties. Many landlords like this as they are on good mortgage deals which they would lose if they were to tell the bank that the properties were transferred to a company.
This structure will be in breach of most mortgage agreements which require a borrower to say if there is any transfer, legal or beneficial, of the properties. There are also some tax technical issues with this too. It can lead to the bank debt being subject to CGT and interest paid to the bank not being tax deductible.
An enhanced version of the structure is to transfer beneficial interest in the properties up to the amount of the mortgage to the company. This results in most rent and interest being dealt with in the company. On sale the company receives cash to repay the mortgage, but the individual receives the balance of the proceeds, which is subject to CGT at 20% and the individual has the cash in their own hands. This is a complicated structure with numerous technical difficulties.
Hybrid partnerships
Another structure involves using a partnership. Income and interest are allocated to a company, while capital gains are allocated to the individuals who own the company, resulting in lower tax. HMRC believe this is caught by existing anti-avoidance legislation.
HMRC’s response
A bulletin from HMRC, Spotlight 63, addressed one of these boutique schemes. HMRC have also taken other enforcement action around how the DOTAS regime (Disclosure of Tax Avoidance Schemes) applies to these kinds of arrangements to identify participants for investigation.
We understand that HMRC are now looking closely at taxpayers who have used structures implemented by such tax boutiques focusing on property ownership. As HMRC cast a wide net, some taxpayers may have incorporated in a straightforward commercial manner with no additional tax resulting; however, the taxpayer faces expense and worry while HMRC investigate.
Beware boutiques bearing gifts
For landlords considering property incorporations – and indeed for all taxpayers – we recommend caution towards boutique firms’ schemes. Many of these firms do offer genuine advice which may work or at least is an arguable interpretation of the law. However, they tend to push the boundaries. It’s worth taking advice from an independent tax professional before proceeding.
Our property tax specialists can explain your options in plain English, guide you through HMRC’s rules and take the stress and uncertainty out of your decision-making. Contact us today for a chat about how we can help you.
