10:29 AM, 20th February 2017, About 4 years ago
I first came across the assignment tax structure around 10 years ago. It quickly became a popular method for private landlords with larger portfolios to hive off profits into company structures, which benefit from much lower tax than for individuals who would have otherwise been taxed at the higher rate (40%) or the additional rate (45%).
The business model involves granting an informal commercial periodic tenancy to a company to sublet properties on behalf of the owners. All income and profits accrue to the company The company is owned by the property owner or nominees. The property owner receives either a salary or dividends to service day to day living costs. Mortgage interest is serviced by the company on behalf of the owners as part and parcel of the arrangement. The mortgage interest is deemed as income payable to the property owner and until April 2017 that entire income has been allowed to be offset against the mortgage interest as an expense. The net result is retained profits being taxed at the lower corporation tax rate of 20%.
The problem from April 2017 onwards
The above arrangement has worked well for many landlords and will continue to do so until April this year. However, the phased restrictions on finance cost relief with effect from April 2017 will cause a problem. This is because the mortgages are in the individual owners names and the payments from the company will have to be shown on their own tax return. In the 2017/18 tax year 25% of the mortgage interest will be disallowed as a business expense, the year after 50%, then 75% the year after that and 100% from 2020 onwards. This progressively eats into the owners basic rate tax allowances, meaning that any PAYE or dividends they earn elsewhere will increasingly be taxed at 40% or even 45%. It is also important to note that every £2 of taxable income over £100,000 results in the loss of £1 of nil rate band tax allowance. This is known by accountants as the 60% effective tax rate.
I have produced an illustration of this below to show the effects of a property owner with £40,000 of mortgage interest who receives other taxable income of £80,000. As you will see from the “Tax Due” line, the effects are devastating.
I was never particularly comfortable with the business model. One of the reasons was that insurance is often invalidated by the subletting. However, we resolved that problem last year – details HERE. There are other reasons but that’s not the point … let’s not digress and just leave it that solutions exist.
The solution to the tax changes restricting finance cost relief to the basic rate of tax involves creating a partnership between the assignment/sublet business and the owner. It isn’t an immediate fix and doesn’t result in any tax saving for three years. There are other aspects to this planning which can result in some immediate tax benefits but I do not want to over-complicate this article because it is too dependent on individual circumstances. The work that goes into this is reserved for my paying consultancy clients. However, needless to say, given the phased nature of the tax changes it pays to start the restricting process at the earliest possible opportunity.
When a property portfolio is transferred from individuals to a holding company the CGT position is no different to selling the properties to a third party, i.e. base cost (purchase price and capitalised improvements) are deducted from the open market value of the property(ies) to establish a capital gain. This gain is then added to all other income and taxed at a rate of 18% for basic rate tax payers or 28% for higher rate tax payers. There is also SDLT to consider on the transfers. However, incorporation reliefs exist to mitigate both CGT and SDLT if the business is correctly structured as a formal business partnership and other General Anti Abuse Rules (GAAR) are followed.
Once the partnership has been established for three years the entire “business partnership” can be incorporated into a holding company. This three year partnership period is particularly important due to the need to demonstrate the company is not operating on a stand-alone basis, otherwise HMRC will consider the owners properties to be ‘passive investments’ which invalidates claims for incorporation relief. To formalise the partnership it requires its own Unique Tax Reference number “UTR”.
The above is a very short summary of the problem and a brief insight into the potential for solutions. I have purposely not delved to deep into the legislation regarding incorporation reliefs and the associated rules but I am happy to provide guidance as necessary to my paying clients and their accountants. This includes highlighting the specific legislation they need to be aware of.
In most cases it is possible to restructure without having to pay SDLT, CGT, refinancing costs. However, there in’t a ‘one size fits all’ tax planning strategy because we are all different.
I would welcome the opportunity to help you to understand and consider a bespoke strategy for you to enjoy the the optimal tax structure. Please see my consultation booking form below.Show Book a Tax Planning Consultation