incorporate Archives - London Chartered Accountants Blog

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.

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:

A restriction on the tax relief for interest payments
The availability of wear and tear allowances on furnished lettings
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:

Will you be able to borrow on similar terms through a corporate or as an individual?
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.
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.
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.
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.