Selling some properties to reduce our exposure to risk

I'm not sure the response from the Property118 tax team is correct with regards to interest on mortgages. The team said "you will be paying income tax at 40% or 45% on any rental profits you retain in your property business, which under your existing structure will not have allowed for mortgage interest to be offset against rental income either".
My understanding is that you even if you are a 40% or 45% taxpayer, you will receive tax relief on mortgage interest at 20%. With a limited company structure, the company will receive tax relief at 19% so arguably, you get more tax relief as an individual or partnership.
The downside for an individual or partnership is that you have to pay tax at 40% or 45% NOW rather than potentially leaving the profits in the company and having the company profits taxed at only 19%.
However, when you draw the profits out as dividends, you are then taxed at 33.75% if you are a 40% taxpayer, so the profits from the company end up being taxed at 52.75% which is a lot more than 40%!
Drawing out a huge sum as dividends in one year could push you into the 45% tax bracket.

Reply to the comment left by Martin Thomas at 31/08/2022 - 10:23
I think you may be confusing the 20% tax credit applied to finance costs with tax relief. They are very different.

For example, a landlord who is making zero real profit (no other income) after finance costs of say £100,000 would pay tax on the full £100,000 of those finance costs. In other words, the landlord would have to pay tax despite having actually made no money at all. The 20% tax credit deducted from the landlords tax bill would provide little comfort in that scenario.

In a Limited Company, the same landlord would pay no tax at all, i.e. no income tax and no corporation tax.

Every situation is different of course. Where profits are made, the correct company structure provides significantly more flexibility to 'manage' the distribution and/or retention of that profit. For example, a typical husband and wife setup could pay themselves a salary of £12,570 each tax free and this would reduce their corporation tax bill by a similar amount. If they had young adult children or elderly parents with low or no incomes they could do the same for them. In addition, they can each take £2,000 of annual tax free dividends if they have their own class of shares.

Each shareholder could then be allocated dividends to fully utilise their basic rate tax band and any remaining profits could be retained in the business. Retained profits could also be used to pay down mortgages or Directors Loans without further personal taxation.

Any dividends declared to basic rate tax-payers would be taxed at 8.75% so there is an argument to say that equates to 27.75% tax after factoring in corporation tax at 19%. That's significantly less than 40% or 45% income tax but the comparison isn't a direct one. This is because individuals and Partnerships cannot offset finance costs against rental income but a Limited Company can, so the levels of profits exposed to any form of taxation can be significantly different. That's why Property118 uses bespoke software to calculate the "real" net effective rate of tax to compare both scenario's side by side.

The above is just a high level overview of what can be achieved. With advanced tax planning the results can be further enhanced.

Perhaps a more important point though is that your analysis is based purely on income tax, whereas the original poster had correctly raised the question about the Capital Gains Tax planning benefits associated with incorporation. The CGT savings might well dwarf the income tax benefits in the scenario he outlined. Furthermore, potential to mitigate Inheritance Tax on future growth in property values (if they incorporate into a SmartCo structure) could make even those huge CGT savings look small.

There is no 'one-size-fits-all'

Hello Mark
Thank you for your reply and I take note of your comments on Property118.
I take your point that there are a number of other factors to consider and it is a very complex area - "one size fits all" certainly doesn't apply here!
However, I was just looking at the impact of mortgage interest in isolation because the tax team response implied that if they were 40% or 45% taxpayers there wouldn't be any relief for mortgage interest, whereas there would be, albeit as you correctly commented, it is a "tax credit" and limited to 20%.
I think the other points I made about the tax credit being larger than the interest relief available to the company is correct as is the effect of dividends on the marginal income tax rate, particularly if you are lucky enough to have a substantial share portfolio that uses up the £2000 dividend allowance.

Reply to the comment left by Martin Thomas at 31/08/2022 - 12:31
I do understand the points you are making and your logic isn’t wrong. However, our experience is based on 1,000’s of the ‘side-by-side’ tax comparisons, as mentioned in my previous response and I can assure you that the vast majority of these reveal incorporation and the clear winner for tax savings. the savings become more pronounced the larger the portfolio and the more exposed the landlords are to finance costs.

Reply to the comment left by Martin Thomas at 31/08/2022 - 10:23
Hi Martin

I also wish to pick up on the following line in your comment ...

"With a limited company structure, the company will receive tax relief at 19% so arguably, you get more tax relief as an individual or partnership."

Based on this logic, if corporation tax was to fall to say 10% and the basic rate of tax remained at 20% your argument implies that the private owner would receive just half the "tax relief" of an incorporated landlord. This is confused logic. You only have to run the numbers based on a realistic scenario to prove this to be the case.

Here's a worked example.

Rental Income £150,000
Finance costs £100,000
Other allowable expenses £50,000
Real profit = £0
Other income £0

Regardless of the rate of corporation tax, the Limited Company owner pays £nil tax.

Based on the current tax legislation for 2022/23 the private owner pays tax of £27,428.40 less 20% tax credit on £100,00 of finance costs = £7,428 of tax to pay.

Here's a second worked example ...

Salary £100,000
Rental Income £150,000
Finance costs £100,000
Other allowable expenses £50,000

Regardless of the rate of corporation tax, the Limited Company owner still pays £nil tax in the company and £27,428.40 of tax on his salary.

Based on the current tax legislation for 2022/23 the private owner would be exposed to tax of £91,799.45 less 20% tax credit on £100,000 of finance costs = £71,799.45 of tax to pay.

It's quite a difference whichever way you look at it, isn't it?

If you would like to share a different scenario, where finance costs are a significant expense to the landlord, I will be happy to run the numbers for you.

Meanwhile, below is a link to another Case Study scenario explaining why some landlords with no debt whatsoever can still be significantly better off in an Limited Company combined with carefully thought through advanced tax planning ...

https://www.property118.com/benefits-incorporating-rental-property-business-no-mortgages/

Mark.
I have tried my best to follow all of your observations and I am probably going ask your company to analyse my situation, with 8 let's. 1 block of 4 converted flats. Value 800k, mortgage 200k.
1 block of 3 flats (good for holiday let, sea views & Close to seaside and town and train station) value 700k, mortgage 340k.
1 house, that I did live in for 7 months, value 350k, mortgage 140k.
My main house. No mortgage.
Looks quite good on paper.
However, all my fixed rate mortgages finish within 12 months.
If I switch to a Smart Company, can I draw down the Capital that I've introduced to the company free of tax. I'm 60 next year & have no other income. Savings of 100k.
I'm due to inheritance of around 500k at some point in the future, as an only child.
I don't need a lot to live off, just can't be taxed to the hilt.
Obviously I could sell one property every other year. That would give me plenty in the bank and make me 76.
I could then sell my main house, buy a yacht and sail around the world. If I'm fit enough.
Thanks in advance for any input.

Reply to the comment left by Royston Olner at 31/08/2022 - 14:46
Without completing the full consultation process we cannot make recommendations, but your understanding of what might be achievable is definitely on the right lines.

Below are links to two other readers questions and our answers should provide you with further clarity on what is achievable. For absolute clarity and certainty you will obviously need to book a bespoke tax planning consultation and we will then be able to assist you to weigh up all of the pros and cons including the investment required to restructure.

First linked article >>> https://www.property118.com/should-we-consider-a-capital-account-restructure/

Second linked article >>> https://www.property118.com/capital-account-restructuring-capital-vs-equity/

We look forward to assisting you further.

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Campaign to start to protect landlords, utility suppliers, local councils from the rogue fraudster, criminal tenants and also their supporters’ friends and families who provide fraudulent, misleading documents to gain access to rental properties.
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Prafula Copp