Understanding incorporation and the various costs, benefits and tax relief available Why might a landlord want to incorporate? When building a rental property portfolio, profit is often retained for reinvestment into buying more property or paying down debt. However, these profits are taxed heavily for individuals. Companies only pay 20% tax, which is scheduled to reduce to just 18% by 2020. There has even been talk of corporation tax being reduced to 15%. Companies are not affected by restrictions on finance cost relief. Most non-resident landlords pay tax on dividends from UK companies in their country of residence which can result in significantly lower income tax, sometimes none at all. This is highly dependent on the country of residence. Greater flexibility in terms of IHT planning. Liabilities are limited to the value of the company. Mortgage lenders often require personal guarantees but there are many other liabilities that are ring fenced as a result of incorporation. Ability to raise funding by adding new shareholders. Ability to make pension contributions. There are many more! Tax Consequences of Incorporation When a property portfolio is transferred to a company the CGT position is no different to selling the properties to a third party, i.e. base cost (purchase price and capitalised improvements) are deducted from the open market value of the property(ies) to establish a capital gain. This gain is then added to all other income and taxed at a rate of 18% for basic rate tax payers or 28% for higher rate tax payers. However, by claiming s162 relief CGT may be substantially reduced or removed completely. How does incorporation relief work for landlords? Incorporation relief is available under section 162 TGGA to help negate the requirement to pay CGT when converting a business to company status.
This relief is available to landlords contrary to some opinions that rental property is a passive investment as opposed to a business. This was tested by HMRC in court back in 2013. They lost on appeal and case law now applies. At the point of incorporation, equity in properties is converted into shares in the company. The value of those shares can be offset against the capital gain. Therefore, if equity in the property portfolio is at least equal to the capital gain there is no CGT payable. What is a rental BUSINESS? As an owner of a property rental business you remain accountable for over 180 pieces of legislation, regardless of whether you outsource. The ongoing running of your business is no less than that of directors of a company in terms of ongoing due diligence and continued professional development, all of which takes up a significant amount of time. We have listed below some of the regulations and procedures that all rental property business owners remain accountable for as follows:- Considering rent offers made by tenants sourced through agents Tenant selection decisions based on referencing organised through agents Checking to ensure that agents have organised the purchase of Rent Guarantee insurance on our behalf Organising re-quoting and/or renewal of buildings, contents and landlords liability insurance Checking that tenants deposits are registered and that prescribed information has been correctly served by our agents Checking that prescribed information in respect of tenancy deposits is re-issued by agents when fixed term tenancies end and roll over to statutory periodic tenancies Checking that annual Gas Safety checks have been organised by agents and that certificates have been issued in a compliant and timely manner Checking that rents are paid as due by agents and that accountants are notified accordingly Liaising with agents and legal advisers over rent arrears and any other breaches of tenancy Liaising with insurers over claims Paying ground rents and service charges in a timely manner Considering accounts and minutes prepared by freehold management companies and liaising accordingly Liaising with agents over maintenance issues reported by tenants Sourcing/paying for items needing to be replaced Checking that EPC certificates are up to date
Keeping up to date with selective licensing arrangements being introduced by various Councils Reviewing check in/out inventories produced by agents Dealing with deposit refunds Dealing with ADR in respect of tenancy deposit disputes Reviewing market rents Continued professional development through reading news, forums, industry websites and attending expo s and landlord meetings Liaising with accountants in respect of tax returns and other accounting matters Daily bank reconciliation Regular reviews of the mortgage market for optimal lending terms The relevant case law relating to what constitutes a property 'business' is HMRC vs Ramsay. Much has been made of this case by overly cautious accountants who assume that because HMRC accepted that Mrs Ramsay spent 20 hours a week managing her block of 10 flats this is some sort of benchmark. The matter is of course subjective because HMRC lost their case and Mrs Ramsay was indeed entitled to claim incorporation tax relief. No similar cases have occurred since. Naturally, the more properties involved in your rental property business. What about Stamp duty? Formal partnerships can be exempt from paying Stamp Duty on incorporation under schedule 15 of The Finance Act 2003. There are anti-avoidance rules to watch out for though so if you're a sole owner at the moment it's not quite as simple as forming a partnership one day and incorporating the next. For sole traders, optimal costs can be achieved by restructuring in three steps over a period of three years. Step one - two choices 1. Immediately transfer any percentage of the beneficial ownership in your property rental business to your spouse via a Declaration of Trust. There is no requirement to change legal ownership at HM Land registry or to disturb your existing mortgage arrangements... OR, if you are not married or don't wish to involve your spouse... 2. Immediately transfer 1% of beneficial ownership to somebody else (children, sibling, best friend etc.) and pay CGT on that 1% share plus SDLT on 1% of the value of the mortgage balances. As above, there is no requirement to change legal ownership at HM Land registry or to disturb your existing mortgage arrangements.
Step two Obtain an HMRC partnership "Unique Tax reference" number and submit partnership tax returns for the next three years. Step three - if you've been a partnership for more than three years already you're good to go now Transfer 100% of beneficial ownership of the partnership to new company and claim s162 incorporation relief to mitigate CGT and SDLT relief under FA 2003 section 15 land and buildings. Use a beneficial interest company trust to avoid costs of refinancing. What about the cost of refinancing? This can be avoided by using a Beneficial Interest Company Trust. This form of trust is not a legal entity such as a company. It is a paper declaration which describes the entity receiving the benefit of assets. You may wish to think of it in terms of being similar to a V5 certificate from DVLA confirming the registered keeper of a vehicle, which may or may not be the legal owner. A beneficial interest company trust transfers 100% of the beneficial interest (income and capital gain) in the property rental business to a company. This involves no change of legal ownership so far as HM Land Registry is concerned. The consequence is that existing mortgages can remain in place without affecting the mortgage lenders rights. The trust deed empowers the company to be able to call upon the legal owner(s) (settlor) of the trust to sell the property at any time and transfer 100% of the net sale proceeds to the company. In reality the persons controlling the company are the same as the legal owners of the properties, hence there should never be a conflict. Due to the structure of the trust deed, the legal owners of the property rental business now stand as bare trustees, i.e. they only hold the legal title in name but don't own any share of the rental profits or capital gains. The settlor is still legally responsible for the mortgage arrangements; hence the question is raised; how does the settlor receive the money to pay the mortgage interest? Again, this is dealt with in the trust deed. Without affecting any of the legal rights of the mortgage company, the trust deed makes the company a party to the mortgage liability, and hence responsible for servicing the contracts.
The structure allows the settlor of the trust (the legal owners/borrowers) to continue to make the mortgage payments and claim them back from the company as expenses. The outcome is that the entirety of the business sits on the balance sheet of the company and all income and expenses associated with the property portfolio accrue to the beneficial interest company. HMRC have the right to treat payment of the mortgage as income arising to the settlor of the trust. However, the settlor of the trust (as bare trustees) would only be responsible for the flat 20% tax rate payable by trustees, hence a zero-tax liability based on the ability to claim 20% tax relief on the mortgage interest. Please note that a beneficial interest company trust is very different to a typical declaration of trust used by residential conveyancers to protect the interests of family members who contribute to a property transaction. Further opportunities for tax planning at the point of incorporation Where equity in a portfolio is greater than the capital gain a further tax planning opportunity exists. This is achieved by increasing the amount of finance to the base cost of the property portfolio (original purchase price plus capitalised improvements) prior to incorporation. Here s an example:- Base costs of property portfolio = 3,000,000 Current value = 5,000,000 Current mortgages = 2,000,000 In this scenario the landlord could increase business debt to 3,000,000 and put 1,000,000 in the bank. The landlord then incorporates and offsets the 2 million of shares against the 2 million of capital gains. The company then reduces mortgage debt back to 2 million. The net result is that the company now owes the landlord 1,000,000. Repayment of a loan from company to landlord incurs no income tax. Therefore, the landlord can now withdraw the next 1,000,000 of profits from the company in the form of a loan repayment without incurring any additional income tax liability.
There is no need to remortgage or take further advances prior to incorporation to achieve the above. We have negotiated short term tax planning loan facilities with a private financier exclusively for tax planning clients of Property118. Mark Alexander - founder of Property118.com Private Consultations We are so confident we can point you towards the optimal structure for your rental property business that we are offering a no risk consultation. The price is just 400 inclusive of VAT and if you are not totally satisfied within 30 days we will refund you in full. The service we offer includes:- 1. one to one consultation (telephone and email based) 2. a bespoke illustration of how the tax changes will affect you if you do nothing 3. details of the most appropriate restructure plan for your personal circumstances together with an illustration of your tax savings 4. obtaining quotes for implementation of the restructure strategy we recommend for you and referring you to the most appropriate members of our professional adviser panel to complete matters. To book a Private Consultation please...