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1:18 AM, 14th January 2023, About A year ago
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The Substantial Incorporation Structure is quite the opposite of avoidance from a tax perspective, in that it utilises anti-avoidance legislation to hasten the deemed completion of a business sale from a tax perspective, thus triggering both CGT and SDLT, together with all applicable reliefs including incorporation relief.
Anti-avoidance tax legislation includes provisions to say that where a sale is “substantially” completed it is deemed to have completed whether the sale has been legally completed and registered or not.
In regards to Stamp Duty, HMRC internal manual SDLTM07700 states the following.
where such a contract is substantially performed before it is formally completed, the contract is treated as if it were itself the transaction provided for in the contract.
Broadly, substantial performance is the point at which
■ any payment of rent is made
■ payment of most of the consideration other than rent is made
■ the purchaser is entitled to possession of the subject matter of the transaction
The legislation in regards to Capital Gains Tax is TCGA92/28(1), which states the following.
where an asset is disposed of and acquired under a contract the time at which the disposal and acquisition is made is the time the contract is made (and not, if different, the time at which the asset is conveyed or transferred).
The Substantial Incorporation Structure involves substantially completing the sale of the ‘whole business’ of a rental property business.
Contracts are exchanged to sell the ‘whole business’ to a Limited Company, but long-stop completion dates are agreed based on outstanding mortgage terms.
A deposit is paid by the company in the form of shares to the value of the equity in the properties (gross value minus liabilities).
Completion of the transfers of legal ownership in properties is deferred until the end of the existing mortgage contracts, or earlier at the behest of the company. A business sale agreement acknowledges that, as a condition of the sale, the company adopts responsibility, in the form of an Indemnity, for the servicing and repayment of any mortgages yet to be redeemed. HMRC expects this is how business transfers are “normally done in practice” in their manual CG65745.
The legal owners contract to act as Agents for the company and make payments to their mortgage lenders on behalf of the company.
The insurable interest in the properties reverts to the company at exchange of contracts.
Also, as a condition of the Business Sale Agreement, from this point forwards the business is conducted within the company.
The business sale transaction is substantially completed when contracts are exchanged in regards to the Business Sale Agreement.
When the company wishes to sell a property, the completion of the contracted sale of the corresponding property to the company is executed simultaneously with the onward sale of the property.
The net proceeds of sale belong to the company along with any taxation, e.g. corporation tax on any capital appreciation in the property from the date the company contracted to buy it.
Stamp Duty Land Tax
An exemption against paying Stamp Duty Land Tax “SDLT” automatically applies when a business partnership transfers its ‘whole business’ to a company at the point of incorporation.
The applicable legislation in England is FA2003/sch15, as amended by FA2004/Sch41.
The Partnership Act 1890 Act describes a partnership as ‘the relation which subsists between persons carrying on a business in common with a view of profit.’
Please see https://www.legislation.gov.uk/ukpga/Vict/53-54/39/section/1
In order for a Partnership to fully benefit from the SDLT exemption it will need to have enjoyed the benefit of the business assets for three or more years.
If you operate your property rental business in partnership with one or more other people and share risks and rewards as ‘co-adventurers in business’, you might legally be operating a Partnership, despite not registering it with HMRC.
The existence of a Partnership is a matter of fact, so if this applies to you, your accountants should have advised you to register the Partnership with HMRC and submit SA800 Partnership Returns.
Retention of competitive existing mortgage terms
Contrary to advice often given by people selling mortgages, there is absolutely no requirement to refinance at the point of incorporation. In fact, HMRC manual CG65745 makes this very clear, as follows:
The transferor is not required to transfer business liabilities to the company but often does so. This is normally done in practice by the company giving the transferor an indemnity in respect of those liabilities.
In strictness, business liabilities taken over by the company represent additional consideration for the transfer and relief under TCGA92/S162 should be restricted. However, ESC/D32 enables any business liabilities taken
over by the company to be ignored when quantifying `other consideration’ in recognition of the fact that the transferor is not receiving cash to meet any tax liabilities on the transfer and that the shares in the company are worth less than if the business had been transferred unfettered by liabilities.
The costs of refinancing can be a major obstacle for many landlords when considering the viability of transferring their property business into a Limited Company. After factoring in valuation fees, lenders arrangement fees, conveyancing and searches the cost can be upwards of 3% of existing finance balances.
In addition to that, you then need to factor in the ongoing costs associated with swapping historically low mortgage rates for potentially more expensive mortgage products.
Where existing mortgage terms are particularly competitive and/or when the costs typically associated with refinancing are prohibitively expensive, that is when the Substantial Incorporation Structure (SIS) comes into its own.
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