This is something that I have been asked a lot lately, largely in response to the changes to tax relief available on loan interest which will be phased in over the next 5 years. Granted, the changes may well see some of the more heavily geared residential property portfolio owners paying tax at an effective rate well in excess of 100%, but many people have a worryingly simplistic view of how property incorporation works and focus on the tax savings of operating within a company without fully appreciating the potentially significant costs of getting there.
So what things do we need there to be to achieve a cost efficient incorporation? Well, firstly an amenable lender, secondly a ‘business’ and thirdly a partnership!
Often the biggest hurdle to negotiate will concern the financing aspect of the portfolio and whether it is possible to transfer loans and mortgages to the company. As it is likely to be the more heavily geared portfolio owners looking to incorporate, it may follow that the costs proposed by the banks to renegotiate their borrowings will be significant enough to be a prohibitive factor in some cases.
We are aware that some people may have ideas of beneficial company trusts that may sidestep this problem but it is not something that I will comment further on here as it is not something that I would generally recommend. In fact, I would not advise on any arrangements, entered into with the intention of withholding information from a lender, without a considerable risk assessment of what happens when the lender does find out, or when you want to refinance.
Next, tax relief is only available in certain circumstances and without relief there can be hefty Capital Gains Tax and Stamp Duty Land tax implications.
For Capital Gains Tax the key point is that, in order to qualify for relief one must actually have a ‘business’ and this is not always the case with a buy to let portfolio. To satisfy the ‘business’ requirement, there must be much more business activity than that of a normal landlord/tenant relationship. Whether or not there is a business it can be difficult to substantiate. HMRC distinguish between passive rental and a more active rental business and generally their starting point will be that the letting of property is no more than that of the passive receipt of rents.
This view has been tested in the courts, in the case of Elizabeth Moyne Ramsey v HMRC (2013) UKUT 266 (TCC), it may be that some of the points discussed during the case are useful, but there is still no statutory basis which means that each case will need to be considered on its own merit.
I have seen cases in recent weeks where, perhaps naively, rental profits have altered to be reported to HMRC on the partnership pages of the self-assessment returns, where they had previously been disclosed as property income. This may be appropriate, in the light of the Moyne Ramsay case where there is a ‘business’ to report, but the mere change in reporting of rental income does not in itself change the substance of the arrangements. For more certainty, you can apply for non-statutory clearance and in view of the numbers that are often involved, this may seem sensible but you do risk not receiving the answer that you want by taking this route.
An added complication is that a disparity in the SDLT legislation means that, even if there is a ‘business’, there is a problem with SDLT for landlords who are not in partnership as only partnerships can achieve SDLT relief on incorporation.
As such, a landlord incorporation may be tough to achieve without a significant SDLT liability arising even where there is a genuine business being undertaken and even if the lender is agreeable to novate the loans without material penalties and fees.
The incorporation of a property partnership can be somewhat more efficient, but HMRC are often suspicious of any partnership that is formed shortly before a property portfolio is transferred to a company and they have widely drawn anti-avoidance provisions at their disposal which enable them to ignore the interposition of the partnership prior to the incorporation and apply the normal charging provisions at market value.