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Should I Incorporate my Buy-to-Let Business Revisited 2017

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The incorporation of buy-to-let businesses remains a hot topic given the many changes to the tax treatment of residential lettings. I have previously discussed the potential tax charges arising on the incorporation of an existing buy-to-let business, but am revisiting them here as this is one of the questions I get asked most frequently at the moment.

There are many landlords now sitting on mature investment portfolios and are asking themselves the questions of whether they should be moving that into a corporate structure. The tax issues to consider are Capital Gains Tax, Stamp Duty Land Tax, Inheritance Tax and in some instances VAT.

Capital Gains Tax (CGT)

Transferring a property to a company can create a tax point for Capital Gains Tax purposes. The disposal will be deemed to take place at market value. In some instances it may be possible to roll over the capital gains, however to do so you need to be able to take advantage of business roll over relief.

HMRC do not generally accept that passively owned property is a “business” for these purposes, but it appears that size does matter, as was borne out in the upper tribunal case of Ramsey v HMRC. In this case Mrs Ramsey owned a block of 15 flats. The case turned on the amount of activity that Mrs Ramsey spent in managing the “business”. This turned out to be around 20 hours per week plus she had no other occupation during that period. The tribunal ruled in her favour confirming that she was running a business.

I take from this that it is not the quantity of properties that any landlord owns that determines whether a business is being pursued but rather the active participation they take in running the business. As always with such matters the details will be important.

Stamp Duty Land Tax (SDLT) and incorporating via a partnership

As with all property transactions, SDLT has become a major factor. A corporate buying property would be subject to the higher rate of SDLT on residential property.

The reason why this may work is that special rules apply to the transfer of properties into and out of partnerships. The incorporation of a partnership owning property would be such a transfer. Broadly, provided the ownership of the corporate matches the ownership of the partnership prior to incorporation, and provided all qualified conditions apply the value of the transaction for SDLT purposes would be nil.

The problem being encountered by landlords attempting this route is that establishing an effective partnership is not necessarily so straight forward. If partnerships are to exist there must be a business being carried on. This brings us back to HMRC’s view that the passive ownership of property does not constitute the business. Arguably using a Limited Liability Partnership may be a more robust route for incorporation, but this creates an additional degree of complexity. Also it should not be overlooked that there is general anti-avoidance legislation for SDLT purposes which may be brought into play if it is considered that the introduction of a partnership as a route to incorporation is purely an SDLT avoidance mechanism.

Inheritance Tax (IHT)

Quite often overlooked in the context of transferring property to a corporate structure is that in certain circumstances this can constitute a transfer of value for Inheritance Tax purposes. As such there is a risk that an immediate lifetime chargeable transfer may take place which would give rise to a 20% Inheritance Tax charge.

VAT

VAT will only be an issue for incorporation of a buy to let business where there is commercial property involved on which an option to tax had been made. It is likely that this could be dealt with by way of a transfer of a going concern; however this is something that would need consideration before an incorporation would take place.

Summary

In my previous article I said that the incorporation of a buy-to-let business was most likely to suit a business which had low borrowing requirements, low turnover of properties and can afford to roll up profits to take advantage of low corporate tax rates. My view is that this remains the case. The route to incorporation is alive with complexity and potential tax traps for the unwary, but in the right circumstances incorporation could be the best route. As always, each person’s circumstances will be different and you should take full advice before taking any action.

Should I Incorporate My Buy-To-Let Property? – Part 2

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Thirty-two colourful British doors from the past few centuries. Full resolution is 300dpi.

Richard Verge’s blog of 25 January asked the question should I incorporate my buy-to-let business?

It was aimed at UK persons who were looking to mitigate the impact of a future restriction of the tax relief for interest payments on their buy-to-let mortgages and the impact of the 3% SDLT increase for second properties.

Capital Gains Tax

Incorporation comes at the cost of an SDLT charge on transfer of the property into a company and the Capital Gains Tax payable on the transfer. As the company is connected with the seller the CGT is payable on the full market value of the property irrespective of the price recorded in the documentation.

Residential property

When CGT rates were reduced to 10% or 20% on 6 April 2016 the reduction did not apply to gains on disposal of residential properties. The impact is that individuals who incorporate will pay Capital Gains Tax at rates of either 18% or 28% on the gain they make on that property. This “dry charge” is a disincentive for incorporation. However this CGT rate could be reduced to 10% or 20% by investment in Enterprise Investment Scheme (EIS) shares.

Enterprise Investment Scheme

Capital gains on sale of property can be deferred if the vendor invests in EIS qualifying shares. The reinvested gain would be deferred for the period that the shares are held. When the EIS shares are sold the deferred gain becomes taxable at the rate of CGT applying at the time of the share sale. The CGT which is payable is no longer classified as a disposal of residential property but a deferred gain and therefore charged at 10%/20%. Due to a technicality this opportunity only applies to investment in EIS qualifying shares and does not apply to Seed Enterprise Investment Scheme qualifying shares.

As well as CGT reliefs, a qualifying investment in EIS shares which are held for a minimum period of (generally) three years results in a 30% income tax relief for the subscriber.

In summary, one of the concerns about incorporating a buy-to-let business is the Capital Gains Tax which is payable. With the cash resources and the appropriate appetite for risk this concern can be partially alleviated by use of EIS investments.

Should I Incorporate my Buy-to-Let Business?

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The introduction of three specifically targeted rule changes aimed at cooling the buy-to-let market have led many landlords to ask whether they should be incorporating their buy-to-let businesses. But have the goal posts really moved in favour of incorporation for rental businesses?

My own view is that for most people the pendulum has swung against incorporation due to the new dividend rules and the changes to the taxation of rental income do not alter this. There is no doubt that incorporation could be beneficial in some circumstances but there is no “one size fits all” answer and for some, incorporation could make them significantly worse off.

The changes particularly aimed at the buy-to-let market are in connection with:

  1. A restriction on the tax relief for interest payments
  2. The availability of wear and tear allowances on furnished lettings
  3. Stamp duty land tax increase for second properties

Interest relief

Commencing in April 2017, interest relief will be restricted to 20% basic rate only. This restriction is being phased in gradually over 4 years so that by the 2020/21 tax year all interest relief will be at 20% only.  There are important implications arising from this change that are examined in a previous blog.

Wear and tear allowance

With effect from April 2016, the 10% wear and tear allowance for furnished lettings is abolished. This is replaced with an allowance for renewals instead. This essentially means that the first purchase of an item of furniture or furnishings is not an allowable expense, but the subsequent replacement of such items will be an allowable expense against the property income. This wear and tear allowance has however been available to both individuals and corporates letting residential accommodation and hence its abolition affects both. Landlords have previously been able to claim renewals but it is generally accepted that the old 10% wear and tear allowance was beneficial in many cases.

Stamp duty land tax increase

The Autumn Statement announced a new additional 3% rate of stamp duty land tax (SDLT) to be applied to all purchase of second properties. We have yet to see draft legislation on this but it is going to apply to both individuals and corporates but with an exception proposed for corporates owning 16 or more properties.

Of the above three rules changes only the first does not apply to companies and it is this which is largely the reason why people are questioning whether a corporate structure would be appropriate. However, it should be noted that companies only pay corporation tax at 20% (soon to reduce to 18%) so this exclusion is of little consequence to a company.

I conclude from the above that the announced changes are not going to make a significant change to the decision that we already face over whether it is beneficial to run a letting business as an individual or company. The major factors that it is necessary to consider therefore remain largely the same as they have always been and there is no one size fits all solution:

Some people will find it advantageous to incorporate, but the reasons for this have largely not been affected by the above rule changes. The questions to consider include:

  1. Will you be able to borrow on similar terms through a corporate or as an individual?
  2. Will you need to extract profits from the company? If you do then you will be exposed to the higher rates of income tax on extraction, whereas if you are able to retain profits in the company they will suffer tax at the lower corporate rates only.
  3. Selling a property within a company gives rise to a potential double tax charge as the company will pay corporation tax on the gain on sale and the individual will suffer further tax on profit extraction.
  4. For existing buy-to-let businesses there is also the issue of capital gains tax and SDLT charges to consider on transferring property into the company on incorporation. Don’t forget that whilst there is no SDLT on gifts for no consideration, if there are loans outstanding that will be transferred to the company with the property then they will treated as consideration for SDLT purposes.
  5. The additional compliance costs of running a company also need to be factored in as they will in some instances outweigh any tax benefit.

A further point to consider is interest relief which is available on borrowing personally to lend to a company. Under current proposals the restrictions to interest relief on buy-to-lets does not apply on loans taken out by individuals to lend on to their buy-to-let companies. This would at first sight appear to be loophole. However, in most circumstances it would be necessary to fund the interest payments by charging interest to the company and hence for the individual the interest paid and received would be self-cancelling leading to no benefit. There is also a question-mark over whether banks would be prepared to lend to the individual when the property was in a company.

So, incorporation is most likely to suit a business which has low borrowing requirements, low turnover of properties and can afford to roll up profits within the company to take advantage of the low corporation tax rate. This is not your typical buy-to-let Landlord

The above gives only a brief overview of some of the issues involving the incorporation of a buy-to-let business. Each person’s circumstances will be different and you should take proper advice before taking any action.

 

 

Rising Damp? An Attack on Buy-to-Let Properties

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Growing up in the 1970’s one of many good memories was the marvellous Leonard Rossiter starring as miserable, disgruntled landlord Rigsby in TV sitcom Rising Damp, my first exposure to the UK rental property market! The series, now a cult classic, reflected a growing attraction in the UK for private property ownership, the popularity of which grew continually throughout 1970’s, 1980’s and beyond to become what is today very big business indeed!

Growth in property ownership has also of course always been strongly supported by Government of all persuasions – to a greater or lesser degree – from Mortgage Interest Relief At Source (MIRAS) on home ownership, introduced by Roy Jenkins as Chancellor of the Exchequer in 1969, to Thatcherite Britain & the Right to Buy policies of the early and mid-1980’s and so on; its popularity can still very clearly be seen every day merely with a quick glance at Daytime TV schedules.

MIRAS has of course long since perished, abolished by Chancellor Gordon Brown in 2000 and dismissed as a ‘middle class perk’, but throughout the following years full tax relief continued to be enjoyed by owners of rental properties and proved most attractive to both new and existing private landlords. Despite faint rumours, therefore, it was still somewhat surprising in his July budget for Chancellor Osborne to announce the effective removal of this favourable tax relief from private landlords!!  Though perhaps by way of concession the relief will not go all at once; rather, it will dwindle away bit by bit over a four year period commencing in tax year 2017/18, each successive year losing a further 25% slice of tax relief thus:

  • 2017/18                75% loan interest qualifies as expense; 25% basic rate tax credit
  • 2018/19                50% loan interest qualifies as expense; 50% basic rate tax credit
  • 2019/20                25% loan interest qualifies as expense; 75% basic rate tax credit
  • 2020/21                NO loan interest qualifies as expense; 100% basic rate tax credit

Hence, as from tax year 2020/21 tax relief on loan interest for private landlords will be restricted to basic rate only.

Following publication of the Finance Bill the manner of its demise has now been confirmed with basic rate relief on loan interest to be given only as a tax credit going forward, rather than being allowed to be offset against rental income as an expense. This difference might at first glance appear cosmetic but will come at some cost to private landlords up and down the country and it will inevitably increase their tax liabilities, and in more ways than one!

If we take by example our typical landlord, Joseph, whose income from earnings and other non-property investments total £40,000 and who also owns a buy-to-let property producing annual rental income of £19,000 after expenses, but before deduction of loan interest in the sum of £10,000.  For tax year 2016/17, his net taxable income amounts to £49,000 (£40,000 plus £19,000 minus £10,000).  At this point, he qualifies fully for Child Benefit (unless of course his spouse or civil partner earns in excess of £50,000!).

With effect from tax year 2017/18, where only 75% of loan interest is fully relievable Joseph, without doing anything, will see his tax liabilities increase even if his (rental) income does not. His net taxable income for the year – on the same income figures – now rises to £51,500 (£40,000 plus £19,000 minus 75% of £10,000).  As a result, if Joseph (or his partner) receives Child Benefit then as the higher income earner for the year Joseph (or his partner) will now suffer Child Benefit Tax Charge, losing 15% of any Child Benefit payments received in the year by claw-back.  That in addition, of course, to higher tax payable on his ‘enlarged’ rental income.

If Joseph’s income – rental or otherwise – were also to increase in tax year 2017/18 and beyond, Joseph would face even higher tax increases and Child Benefit Tax Charge clawbacks.

And it is not just Child Benefit!

Let’s suppose Joseph’s income, other than rental receipts, were not £40,000 but, say, £90,000. For tax year 2016/17 his net taxable income totals £99,000 (£90,000 plus £19,000 minus £10,000) and he qualifies for full Personal Allowances.  In tax year 2017/18 though with no change in income his net taxable income increases to £101,500 (£90,000 plus £19,000 minus 75% of £10,000); Joseph now loses £750 of Personal allowances this year!  and so on …….The effects of this phased reduction in the maximum amount of tax relief on finance costs would see Joseph lose his Personal Allowances as his net taxable income hits and then exceeds the annual threshold of £100,000.

Property rentals and Buy-to-Lets are, and have for some time been, very popular investments for a considerable number of taxpayers, not all of them ‘middle class’. The tax consequences of these proposed changes, however, can only damage its popularity going forward and will no doubt affect the attitudes and priorities of many private landlords up and down the country, with knock-on effects also being felt on social housing requirements and obligations.  The days of such ‘middle class perks’, it seems, are most definitely numbered.

Buy-to-let Landlords and Second Homeowners

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HM Revenue and Customs are now entering stage two of their campaign to target second homeowners. True to their word, they are starting to chase landlords who have a second property and have failed to declare rental income and capital gains on sales.

The disclosure opportunity that I referred to in my April blog closed on 8 August and already we are seeing a marked increase in HMRC investigations targeting those who ignored this opportunity to bring their tax affairs up to date.

A question I often get asked as a tax practitioner is “How will the Tax Inspector find out about undeclared income?” The answer is that there are many different sources of information available to the Tax Inspector to help identify potentially undisclosed rental income. These include Land Registry records, information requests to letting agents and tenant deposit registers, to name but a few. Information sharing with overseas authorities is becoming increasingly common and we have also seen that HMRC Inspectors are increasingly making use of technology to help them, from the relatively low tech searching of the internet for property adverts to the higher tech use of demographic profiling to track likely areas and candidates for investigation.

My experience has been that a lot of individuals who are now finding themselves on the wrong end of an HMRC enquiry have got into trouble due to a head-in-the-sand approach to their tax obligations rather than a deliberate attempt to avoid paying their dues. However, HMRCs view is very much that, having given taxpayers an opportunity to disclose, they will now take a tough line with anyone who hasn’t come forward voluntarily.

If you find yourself receiving an enquiry letter from your local Tax Inspector or if you know you have income to declare, but don’t know what to do, then I encourage you to speak to your accountant as soon as possible. It is always better, as you will pay lower penalties, to disclose before HMRC comes calling. We have a great deal of experience in dealing with tax enquiries and investigations. If you need our help then please contact a member of our tax department.