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8 December 2015
We are approached by a number of Clients directly, and through their accountants, who are looking to incorporate their property portfolios.
This something that we have been involved with for many, many years. However, various tax changes over the last couple of years have made this become particularly germane of late.
Is incorporation the right thing to do?
Why might it be attractive?
First of all, it is worth looking at what the benefits, or at least the perceived benefits, of such an incorporation might be.
First of all, the net rental income, in the first instance, will taxed at lower rates of corporation tax (currently 20% but reducing to 18%). This is very attractive if the property entrepreneur is reinvesting the net proceeds back in to the business. It is of little benefit if the chap is looking to extract most of the money for personal expenses as there is a second layer of tax (the changes with effect from 6 April re dividends will further erode any benefit of using a company where most of profits are for personal expenditure).
Secondly, for the moment ignoring any tax issues on the transfer of properties to a new Company, the by-product of the transfer is that the Company acquires the properties at the current market value. This has the effect of ‘washing out’ a capital gain. In other words, if a property was sold shortly afterwards then there would be no gain on which the Company would pay corporation tax. One must be aware that the gain does not magically disappear. It attaches itself to the shares. However, in practice, this generally does not become a practical issue.
Going forward, the surprising restriction to relief for interest relief for individuals running residential property businesses will also create a flight to the corporate structure, as the rules only apply to individuals. It should be noted that the value of interest relief is worth less in a corporate. However, the effect of the removal of interest relief for some portfolios will be devastating and will result in tax liabilities where there is no economic gain. Does this represent a fair share of tax?
It is also relatively easy to deal with a property portfolio held through a Company when it comes to Inheritance Tax (IHT) planning.
Tax issues to address
So the above highlights some of the attractions of operating a property portfolio as a Company and not as a sole trader or a partnership or Limited Liability Partnership (“LLP”).
Stamp Duty Land Tax (“SDLT”)
Where there is a transfer of a property business to a ‘connected company’ then there will be deemed market value consideration regardless of whether any actual consideration changes hands.
It is extremely helpful if the transferor business is a partnership or a LLP. This is because the deemed market value rule is disapplied for transfers from or into a partnership or LLP. Instead, the deemed consideration is the change in the income rights of the property business. If the ultimate beneficial owners are the same then there is unlikely to be any SDLT at stake.
It should be noted that a 3% surcharge will be introduced from 6 April 2016 for residential property investments.
SDLT super charged rate
The 15% super charge applies to ‘non-natural persons’, such as Companies, acquiring residential property to be used as a residence (ie it is not let). As such, where there is an underlying commercial activity (such as letting), then it should be possible to claim a relief.
Annual Tax on Enveloped Dwellings (“ATED”)
This applies an annual tax based on the value of a property. However, again, this is designed to discourage the ownership of private residences through structures. Therefore, as such, should not apply where a property is let to a third party.
Capital Gains Tax (“CGT”)
This is probably one of the more interesting areas. In principle, it might be possible to avail oneself of incorporation relief. Note that the requirement here is for there to be a business and not the higher hurdle of a trade. Of course, it will be fact sensitive. However, the availability of the relief means the properties can be transferred without any CGT.
New dividend tax
Inheritance Tax (IHT)
An incorporation should not create any IHT problems. However, one should bear in mind that the shares in the property investment company will not qualify for Business Property Relief (BPR). Relatively simple steps could be taken to take the value of the shares outside of UK IHT.
Non-tax issues to address
If there is existing borrowing then one needs to consider how this should be dealt with. Of course, the simplest method will be to refinance existing debt. However, many banks / lenders will take the opportunity to hike interest rates and charge an arrangement fee.
Would a transfer of a beneficial interest in the property business alone circumvent the need for bank consent? It certainly would be enough to maintain the availability of incorporation relief for CGT purposes. In any event, specific legal advice would need to be taken here.
For new finance it will be merely a question of whether the bank will be prepared to lend to the new Company. If so, the Company should not suffer any restriction on interest relief against profits. Do HMRC agree where there are substantial personal guarantee. Their view might surprise you!
Consider the Landlord / Tenancy law!
Finally, there are some fairly complex legal areas here. Tenant’s rights are protected in some weird and wonderful ways. In short, you don’t want find you have a really good tax outcome only to find you have the tenant’s lawyers knocking on your door!
In sum, an incorporation might be an attractive route for many property entrepreneurs. However, there is no cut out and keep advice which will have universal application.
As with all tax planning, any decision to act, or refrain from acting, should be based on advice provided specific to the facts of the particular case.
If you have any queries about the planning covered in this note then please let us know.