If you own a business which lets out residential property, you will not be alone if you are finding it difficult to assess the impact of the many tax changes that have been made in recent years.
It doesn’t help that some of these changes only affect incorporated businesses (limited companies) whilst others only affect unincorporated businesses (private landlords & partnerships).
But of all the changes, the one that is likely to have the biggest impact on most landlords is the restriction of tax relief on interest and financing costs, and that applies only to unincorporated businesses. As a result of that particular change, some highly geared property businesses may find that future tax charges actually exceed the profits they make!
So why not incorporate and avoid the new rule? To answer this question you will need to consider various complex issues, including the following:
Refinancing
First of all, you will need to establish if your lender is prepared to allow the proposed new company to take on the debt attached to your portfolio. If you have to refinance, rather than novate your loans, it may affect the availability of ‘incorporation relief’ (referred to below) so that a Capital Gains tax liability is crystallised.
Capital Gains Tax
If your properties have increased in value since you acquired them, transferring them into a company will ordinarily give rise to a capital gains tax liability, even though you don’t actually receive any cash in the process.
This outcome can be avoided if you are in ‘business’ for the purposes of ‘incorporation relief’, but until recently HMRC have routinely denied that a property rental business could ever be a ‘business’ in this context.
Since Ramsay v HMRC [2013], they have had to revise that view in circumstances where the requisite level of ‘business activity’ can be demonstrated. However, relief is by no means a foregone conclusion and it is therefore essential to get expert advice and clearance before incorporating.
Stamp Duty Land Tax (SDLT)
A transfer of properties by an individual to a company will give rise to an SDLT charge, but a transfer of properties from a partnership to a company may not.
If a genuine partnership exists it would be best practice to formalise it by way of a partnership agreement before transfer, but forming a partnership immediately prior to incorporation simply to eliminate the SDLT charge does not work and simple co-ownership does not qualify as a partnership in this context.
If SDLT is payable it may be possible to claim relief on transfers of multiple properties.
The SDLT liability on a property portfolio can be significant so once again you need expert advice.
Inheritance Tax
If you intend to leave your property portfolio to your heirs on death, incorporation could leave your beneficiaries with significantly increased tax liabilities if they decide to sell off parts of the portfolio at a later date.
More changes to come?
If you are prepared to contemplate dealing with all of the above hurdles, it may be worthwhile considering incorporation of your property business, but before you do so you might wish to consider the possibility that new legislation could make companies subject to the same tax relief restrictions as unincorporated businesses.
It wouldn’t be the first time businesses have rushed to incorporate only to have to unwind things when the law subsequently changes, and that would be even messier than incorporation and very expensive!
We may be able to offer you a better solution.
Sutton McGrath Hartley is a multi-disciplinary firm of chartered accountants, chartered tax advisers, financial advisers and lawyers offering comprehensive financial expertise for all business, personal and family interests. Our specialist Taxation department can help with property related tax planning. To discuss your requirements please contact David Sutton on 0114 266 4432 or dsutton@suttonmcgrathhartley.co.uk.
