Buy-to-let landlords Time for smart planning, not a siege mentality

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1 HW Fisher Tax Talk Buy-to-let landlords Time for smart planning, not a siege mentality Media coverage of the recent tax changes affecting buy-to-let landlords has talked breathlessly of the Exchequer declaring war on the estimated two million people who earn income by investing in British bricks and mortar. Yet while many buy-to-let landlords and those wishing to become one have been impacted by the new tax rules, the effects are far from universally negative. For starters, stamp duty Stamp duty is the tax charged on residential property purchases. Reforms introduced at the end of 2014 abolished the old slab system, making the increase in tax rate between thresholds more gradual, and making smaller properties more affordable for all including landlords. While there were increases in stamp duty for the most expensive properties, the Chancellor claims that the changes have resulted in 98% of homebuyers paying less tax than they would have done under the old system. April 2016 saw the introduction of a 3% stamp duty surcharge on all purchases of additional residential properties in other words, second homes or buy-to-let property. While this extra tax applies to both individuals and companies purchasing a buy-to-let property, there are some reliefs available: Multiple Dwellings Relief where a purchaser acquires more than one property in a single transaction, the average price per unit can be taken for the purposes of calculating the SDLT due, subject to a minimum charge of 1% of the total consideration. Non-residential rates a purchaser of six or more residential units in a single transaction can opt to pay commercial property stamp duty rates rather than the residential rates of SDLT. Commercial property rates are typically lower. Another important change to come in this April was the abolition of the old, flat rate wear and tear allowance that landlords letting out a furnished property could deduct from their gross rent. Under the new rules, the owners of furnished properties must now deduct the cost of replacing individual capital items. While less straightforward than the old flat rate system, the new requirement could prove beneficial for landlords with a significant outlay ahead. Mortgage interest From next April, the tax relief available to higher rate taxpayers who have a mortgage on their buy-to-let property will be gradually reduced.

2 By 2020 the ability to offset mortgage interest payments to be offset against a landlord s income tax liability will be limited to 20% of the amounts paid. For those high earners who currently receive tax relief at 40%, or even 45%, this could translate into a substantial tax hit. However there are options for landlords seeking to mitigate the impact: 1. Split up ownership of the portfolio between individuals to ensure basic rate tax bands are being fully utilised. However when taking this approach, the capital gains tax and SDLT impact of transferring existing property must be considered. 2. Transfer the existing portfolio to a limited company although there are SDLT and potentially capital gains tax implications to consider when doing this. It is important to take advice on any transfer of an existing portfolio, but it should certainly be considered for a new acquisition. The continued appeal of buy-to-let With UK interest rates likely to remain low several more years, buy-to-let s combination of rental yield plus potential capital growth is still a compelling one. The tax implications of property investing can be complex, and both those who already own a portfolio and those planning to acquire one should take expert advice. Choosing the right strategy, whether with purchases or existing ownership, can mitigate or even eliminate the impact of the recent shake-up in the way such investments are taxed. Tim Walford-Fitzgerald, Private Client Principal T E twfitzgerald@hwfisher.co.uk Shoot first, ask questions later Help is at hand for those who fall foul of the VATman s get tough regime The decision to penalise a company for making an error on its VAT return is supposedly at HMRC s discretion. For years, it seemed that penalties were only issued for the most egregious inaccuracies and in any case companies could usually nullify any penalty simply by flagging the mistake themselves. No longer. HMRC s new iron-fist regime is still supposedly discretionary, but penalties are now so commonly issued they appear to be automatically generated. HMRC is supposed to assess any significant errors on a VAT return before deciding whether a penalty should be applied. But what we re increasingly seeing is a skipping of this judgement phase, and penalties applied seemingly as a default. HMRC then decides whether the error is, in its opinion, careless or deliberate and whether the investigation was prompted (by it) or unprompted, with the penalty rates being higher for deliberate and/or prompted errors. Yet a careless unprompted error, the least severe category, can still be subject to a penalty of 30% of the VAT amount in question. What we re left with is a system that leaves no room for errors of any kind, and no brownie points for voluntary disclosure either.

3 We ve heard that on internal appeal 50% of penalties are withdrawn suggesting these penalties should never have been issued in the first place. For those that remain, the penalty can range between 30% and 100% of the VAT due to HMRC, but all is not lost penalties for careless errors can be suspended by agreement with HMRC. The problem is that, from our experience, businesses are either not made aware of this by HMRC, or don t understand how to negotiate the suspension of a penalty. But this is need-to-know stuff because provided businesses meet the stipulated conditions a suspension effectively reduces a penalty to nil. Moreover, businesses can write their own suspension conditions, as long as they are acceptable to HMRC. If all conditions are met and no more errors are made within the suspension period usually 6-24 months the penalty will not need to be paid. The conditions might be as simple as meeting your filing obligations, and not repeating the same mistake again. For example, if you sold a second hand car, and didn t account for VAT on the sale, your condition might be that you ll sell no more used cars without accounting for VAT during the suspension period. Only if you breached this condition would the penalty become payable. The only possible way to avoid a penalty once issued is to push for a suspension. Businesses armed with a knowledge of how the VAT penalty system works can therefore neutralise the impact of a penalty by asking for errors to be reclassified as careless rather than deliberate. But it s a flawed system. We ve seen as many blatantly deliberate errors reclassified as careless as we ve seen genuine mistakes penalised without suspension. With so little consistency from HMRC, no business should meekly accept a VAT penalty without challenging it. Mike Block, VAT Principal T E mblock@hwfisher.co.uk New limits on the tax deductibility of corporate interest Could they trigger a switch from debt to equity finance? Debt finance is the lifeblood of many companies, and arguably the banking system s greatest contribution to the continued functioning of UK Plc. British businesses have traditionally favoured debt finance which can include loans and certain lease finance costs over equity finance. But this could change from next April, with the introduction of restrictions on larger companies ability to deduct the costs of their debt finance from their corporate tax liability. Limit for the large The new rules will only apply to organisations with more than 2million of UK finance costs a year. But while this threshold will ensure that Britain s army of SMEs is not affected, the limiting

4 of such an important tax break for many larger companies could net the Treasury a substantial tax windfall. Under a new fixed ratio rule, companies will only be allowed to deduct debt finance costs of up to 30% of their UK EBITDA. Historically, the amount of finance costs for which a UK entity could claim corporation tax deductions was based on an arm s length standard, which relied on an assessment of the fundamentals of each business. This frequently led to deductions of much more than 30% of EBITDA. Back to BEPS The new rules are more than just a tax grab on larger companies. They are the latest in a series of measures designed to prevent multinationals moving profits made in one country to another in order to avoid tax a practice known as Base Erosion and Profit Shifting (BEPS). Earlier this year the UK introduced laws requiring larger companies operating across multiple jurisdictions to give full details of how the business is structured. Such companies must now file tax returns to HMRC showing not just their UK revenue, but which also reveal the relationship between all sister companies and any subsidiaries across the international group. But whereas the idea behind these enhanced disclosure requirements was to force greater transparency on multinationals and thus limit tax avoidance the limiting of corporate interest deductibility is a standalone, and more indiscriminate, structural restriction. Is equity finance the answer? Companies that pay more than 2million a year to service their debt costs could take a substantial tax hit as a result of these changes. However, for most, equity finance is unlikely to emerge as a panacea as interest is generally tax deductible but dividends paid to shareholders are not. The changes are thus likely to reduce the current bias towards debt funding, but not eliminate it. In fact, given that the new rules contain some leeway a Group Ratio Rule may allow multinational companies with high levels of third party debt to deduct additional financing costs in many cases the most likely outcome will be changes to intra-group funding arrangements rather than external funding raising. Such complex and important changes and their implications for individual organisations need thorough research. Next April may seem a long way off, but now is the time for affected companies to assess the potential impact and plan accordingly. Andrew Jones, Corporate Tax Partner T E akjones@hwfisher.co.uk

5 IR35 The government ups the ante for contractors working in the public sector The government s long-running drive to limit the ability of individuals to avoid tax by working through personal service companies has stepped up a gear. IR35 is the name of the tax regime governing contractors who don t meet HMRC s definition of self-employment, and who instead work for their clients through an intermediary such as a limited company. Under changes announced in this year s Budget, the system is to be reformed to force public sector organisations to tax contractors as employees, rather than paying them without deducting tax. What s behind the proposals? The government has had its eye on IR35 for a while as it believes there to be widespread noncompliance under the current system. There are, of course, many advantages for public sector organisations that use individuals for contract work. For example, they avoid employer obligations such as sick pay, pensions, etc. For this reason, they often ask individuals to provide services through a limited company. This also has benefits for the individual as they can take out money as dividends, and so pay less income tax and National Insurance. However, HMRC say this type of arrangement is still leading to tax avoidance, with contractors taking the benefit of any doubt when self-assessing whether the rules apply. Who will be affected? It s not just classic IT contractors who will be hit. The new rules will apply to any contractors operating via a limited company and working for a public sector body. This includes the NHS, schools, universities, government departments, local government and the police. Many front line service providers will be affected, such as NHS locums. It s worth bearing in mind that some contractors work for both the public and private sectors. For example, they may do contract work for the BBC but also have their own production company. How will it be assessed? It will no longer be up to the individual contractor to decide if they meet the IR35 conditions or not. The public sector body will be responsible for operating the new rules, including assessing who should be classed as an employee for tax purposes. They will get access to an IR35 digital test to help with the decision-making process, although there are concerns that this might not always be the most reliable or objective tool. If a contractor is deemed employed, they ll have to pay the full amount of income tax and NI, with the public body paying these taxes to the government. The rules will be applied on a contract-by-contract basis so each time a contractor starts a new contract with a public sector client, they will need to be assessed. Wherever possible, we advise getting an expert to look over a contract, for example a lawyer or accountant, or through the professional contractors trade association, IPSE.

6 Of course, the new rules will put contractors in a detrimental tax position as they will pay higher rates of tax and pay the tax earlier- but without many of the employee rights and benefits. You may feel that this latest development won t affect you directly. But all contractors should take note of these changes, whatever sector they work in. While the government is currently only clamping down on public sector bodies, it doesn t mean its plans will stop there. With HMRC determined to improve Treasury cashflows, in future the new rules- meaning more PAYE- could easily be extended into the private sector too. Tim Walford-Fitzgerald, Private Client Principal T E twfitzgerald@hwfisher.co.uk