TaxAntics Newsletter - July 2022

Welcome to the TaxAntics  July 2022 newsletter...

Structuring a property business for tax

It’s an age old tax debate as to whether personal or corporate ownership is the right way to invest in buy to let residential property, even before hybrid (partnership/LLP) or Trust structures enter the fray. In many ways “structuring for tax” is a dangerous phrase simply because there are so many other factors that can influence a decision. These can include income requirements, exit strategies, lifetime goals and family considerations. To coin an old phrase “don’t let the tax tail wag the dog”. What does that even mean anyway?

What every business owner should understand is that both circumstances and tax rules will inevitably change. We all learnt to walk before we ran and there are always methods of restructuring if necessary although some routes are more riddled with traps and pitfalls than others. The only bad decision is not making one or making one without a full understanding of the potential outcomes.

Landlords have seen many changes to the tax rules that apply to them in recent years. Established landlords may well recall wear and tear allowance and the introduction of the “replacement of domestic items” relief which now instead offers a form of capital allowances to traditional buy to let landlords.

By far the most controversial and punitive change is the mortgage interest relief restriction introduced under s24 of the Finance (No.2) Act 2015 which specifically applies to individual landlords with buy to let property portfolios. The rules do not apply to furnished holiday lets and most serviced accommodation.

Interest relief restriction

Since 6 April 2017, all finance costs and related expenses have been gradually restricted on an increasing scale for all individual landlords letting residential property. From 6 April 2020, no finance costs have been allowed as a gross deduction. Instead an income tax reducer is given as the lower of: 

• 20% of the prescribed finance costs;
• the property business profits; or  
• total income (except income derived from investments) that exceeds the available personal allowance.  

Basic rate tax payers are generally unaffected although the inability to deduct interest does increase taxable income. This puts some landlords into the higher rate tax bracket even though there has been little fundamental change to their actual income. Becoming a higher rate tax payer has other implications, such as for those with young families and who claim child benefit.

The restriction of mortgage relief can actually push effective tax rates on property income to well over 50% or even 60% for landlords who are heavily geared and are higher rate taxpayers. It would therefore be prudent for all landlords to understand their exposure and take steps where possible to maximise efficiency to ensure maximum profitability of their property business.

Tax Planning Opportunities

Whilst the new rules effect all residential landlords with finance arrangements, larger unincorporated property businesses and those reinvesting profits into further acquisitions are among those likely to feel the pain more. Property tax planning can have significant Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) implications.

Husband and wife/civil partnerships or family businesses can review their profit sharing agreements and ratios although this could carry tax and legal complications. HMRC generally require married (including civil partnership) couples to share joint property income equally. To change this, a declaration of Trust or similar deed declaring differing beneficial ownership accompanying a “Form 17” would be required by HMRC. This is not a flexible solution and could have adverse consequences in the future, say in the event of a separation or divorce.

For more flexible solutions such as partnership arrangements, HMRC have wide reaching settlements tax avoidance provisions that would require careful consideration. Carefully drafted supporting documentation and commercial rationale for decisions made are helpful in these situations.   

Incorporation

An existing property business can be transferred to a limited company on a tax neutral basis in certain circumstances. The mortgage interest relief restriction has already led to many successful incorporations of property businesses. Besides the main tax issues described below, practical issues include the potential need to rearrange finance arrangements (often at a higher ongoing cost), formally convey properties between entities and revise legal documents including tenancy agreements. The whole process can be costly as well as very time consuming. That said, it can also lead to opportunities for tax efficient restructuring of the portfolio as well as potential estate planning.

Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) Relief

Where a business is transferred to a company in exchange for shares, incorporation relief can apply for CGT purposes. There have been many tax cases that challenge the presence of a business where property had been transferred to a company and incorporation relief applied for to rollover the latent gain into the share value.

The most prominent case which went in the taxpayers’ favour is Elizabeth Moyne Ramsay v HMRC [2013] UKUT 0226 (TCC). This case has served as a benchmark in considering whether a business exists for incorporation of a property business.

It is also possible to seek a pre transaction clearance from HMRC Stamp Office where it is considered that SDLT does not apply. This generally applies where the business being transferred is carried on in partnership although it is not always clear cut as to when a partnership exists.

Conclusion

It is important that landlords have a basic understanding of taxation and the treatment of their property business during its lifecycle. There is no hard and fast precedent as to what structure to operate via for tax purposes and what’s good for one is not always good for all. It is important to analyse your own situation carefully rather than follow sweeping statements or advice that is not considered.

Any landlord considering the incorporation of their property business should take full tax advice on the suitability of such arrangements in their particular circumstances. It is possible to seek HMRC clearances to give certainty that they will not challenge transactions carried out as described to them.