If you’re a landlord who’s looking to transfer personally owned property to a company, it’s essential to have an up-to-date understanding of the tax advantages and tax traps alike.
Here we explore the pros, cons and latest tax issues, based on our experience of advising landlords and our knowledge of the UK tax landscape.
Tax deductions for landlords: a brief history
In 2015, the UK Government introduced new rules relating to tax deduction for interest for buy-to-let (BTL) landlords. Deduction for interest is now restricted to 20%, even for higher rate taxpayers who are paying tax at 40% or 45% on their rental income.
This leads to very high effective tax rates which can leave a landlord with negative post-tax cashflow even where the pre-tax cashflow is healthily positive. This sparked a lot of interest in the idea of “incorporating” BTL property portfolios because companies are not subject to the same interest deduction rules.
Even before these rules, there had been significant interest in property incorporations as the corporation tax rate, then at 20% (now 25%), was lower than income tax rates which go up to 45%.
In 2022, the “Mini Budget” triggered an increase in interest rates. This renewed interest in incorporating property portfolios.
We are therefore revisiting the tax issues on incorporating. Much has already been written on this topic, including our previous article here. This article focuses on what has changed. But we start with a brief resume.
Should I incorporate my property portfolio?
A lot of landlords approach us with a strong desire to incorporate. While we’re glad that property owners are considering their tax position while in the pub or on the golf course, we’re also glad that they’re seeking professional advice!
Doing the numbers can reveal that property incorporation isn’t always the right solution. Often the savings are smaller than expected. There can also be disadvantages on sale of property or on passing it down to one’s children.
Incorporation works best where the landlord has high borrowings or where they can afford to leave net rental income in the company (as taking it out gives rise to income tax). Although incorporating can have disadvantages for estate planning, some of the bona fide tax efficient planning techniques used for investment assets work better with companies than personally owned properties.
Tax implications of incorporating
Many landlords think that transferring properties to their company is like transferring it to themselves so no tax arises! This isn’t the case.
The transfer of property to your company is treated as if it were a sale at market value. So there is capital gains tax (CGT) for the landlord and stamp duty land tax (SDLT) for the company.
Happily reliefs may be available, albeit with potential pitfalls.
Incorporation relief and CGT
Incorporation relief defers the capital gains that would arise on incorporation until the company is sold or liquidated.
To qualify for relief, the property portfolio must be a “business”. HMRC’s published guidance to its Inspectors on the transfer of a business to a company states that:
“You should accept that incorporation relief will be available where an individual spends 20 hours or more a week personally undertaking the sort of activities that are indicative of a business. Other cases should be considered carefully.”
The basis for HMRC’s threshold of ‘20 hours or more’ is the Upper Tribunal in the case of Ramsay v HMRC (2013), which we’ve written about in detail here. While HMRC seem to accept that if the taxpayer works more than 20 hours a week on the properties, this doesn’t mean that where an individual works less than 20 hours it is automatically not a business.
Among the further conditions for incorporation relief, the properties must be transferred in exchange for shares. This means not just creating a loan on transfer that can be repaid as a means of extracting cash from the company. We’ve encountered cases where, in the absence of appropriate advice, landlords have transferred properties for a loan thinking that incorporation relief would apply, only to come unstuck when HMRC assess the CGT.
With HMRC’s detailed conditions for incorporation relief in mind, we recommend that taxpayers seek professional advice before making any decisions.
Partnerships and SDLT
When an individual transfers a property to a company, there is an SDLT charge based on the market value. However, when a partnership transfers property to a company owned by the partners, under special rules there may be no SDLT charge.
If you are fortunate enough to operate your properties through a partnership, this can be quite easy. What if you don’t?
Some landlords have seen a possible solution in creating a partnership to run the properties and then transferring them to a company. Unfortunately there are a number of anti-avoidance provisions to carefully take into account.
Where properties are jointly owned, an alternative approach taken by some has been to argue that there is already a partnership even though there is no formal partnership agreement. The definition of a partnership is two or more persons carrying on a business in common with a view to profit. Depending on the specific fact pattern, HMRC may consider that joint ownership of property is a partnership.
HMRC say in their guidance that the absence of a partnership agreement isn’t conclusive. Yet they also say that in the majority of cases, joint ownership of property will fall short of a business and thus a partnership.
The First-tier Tribunal case of SC Properties Ltd v HMRC (2022) is worth noting here as a cautionary tale.
A husband and wife owned a property which they claimed was owned in partnership. The couple had submitted a partnership tax return but did not have a formal partnership agreement.
The Tribunal decided that there was insufficient evidence to conclude that a partnership existed. The main reasons for this conclusion were that the wife seemed to be unaware of the existence of the partnership and many of the legal documents that should have been entered into by the couple jointly were not. The lack of a partnership agreement was commented on but wasn’t the main point in reaching the decision.
This does muddy the waters a little and it is safer to document joint ownership as a partnership. Even this won’t be conclusive as HMRC could still deny the existence of a partnership if they argue that the portfolio is not a business. The anti-avoidance provisions mentioned above can also kick in if HMRC don’t accept that a partnership existed before it was formally documented as such.
With so many tax pitfalls for the unwary, it’s wise for anyone considering property incorporation to seek expert advice. 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.
In the next part of this two-part article, we’ll explore the danger posed by specialist property incorporation boutiques making unworkable claims.