Landlord Incorporation StructureMake Text Bigger
Concerned about the impact of restrictions on finance cost relief?
Interested in optimising your CGT position?
What if you could retain your most advantageous mortgage terms?
Landlords should seriously consider the viability of transferring their property rental business into a Limited Company structure if they meet the following criteria:-
- They are, or will be, pushed into the higher rate tax bracket by restrictions on finance cost relief
- At least 20 hours a week is invested by themselves and/or employees and/or agents into running their business
- The majority if not all properties are held jointly, preferably registered as a partnership or an LLP with HMRC. However, this is not absolutely essential providing it can be evidenced that the business is owned and operated by two or more people or entities running the business as “co-adventurers”, i.e. sharing income, risks and costs
Below are two examples showing, side-by-side, the effective tax rates for the same landlord maintaining a private ownership structure vs a Limited Company structure.
The first example (below) assumes that all profits will be retained in the business.
The second example (below) shows the net effective tax rate assuming the same landlord declares 100% of the company profit in the form of dividends.
As you can see, in both cases incorporation is advantageous from an income tax perspective.
There are other benefits to incorporation too. For example, capital gains to date can be rolled into company shares. This creates a new base cost for capital gains calculations when the company sells the property. In effect, the capital gains are washed into the shares, meaning that when properties are subsequently sold by the company the only sold, the capital gains crystallised are based on the sale price minis the value at which the properties were transferred into the company. The rolled over capital gains are only cystallised on the disposal of the company shares.
But what about the costs of incorporation?
The four key issues to consider are:-
- Capital Gains Tax crystallised when properties are transferred to a company
- Stamp Duty Land Tax “SDLT”
- The costs of refinancing (interest rates and fees)
- Legal fees associated with restructuring the bsuiness
Legislation already exists to help landlords running business partnerships to transfer their business (including their properties) into a company structure without paying Stamp Duty, and to roll capital gains into shares.
The incorporation strategy we recommend is not designed to avoid or defer tax. In fact, it does quite the opposite in that it triggers taxable events early and then utilises the available reliefs to mitigate the tax which would otherwise fall due. It dovetails with the available reliefs to enable the incorporation to “substantially complete” without immediately needing to refinance all of the properties.
The phrase “substantially complete” is contained in HMRC’s General Anti Abuse Rules “GAAR”. It is that tax anti-abuse legislation which makes ‘substantial completion’ possible whilst satisfying HMRC’s incorporate relief requirements to transfer the ‘whole business’ .
HMRC have tested the eligibility of these reliefs for landlords to at second Tier Tax Tribunal level. The outcome was that, providing the landlords can demonstrate they are running a property rental business as a partnership, both forms of relief can be claimed. This is now enshrined in case law and HMRC’s own internal Manuals.
Ordinarily, transferring the ‘whole business’ would involve refinancing an entire property portfolio at the point of incorporation. This can be prohibitively expensive, particularly where some of a landlords existing mortgage arrangements pre-date the credit crisis and extremely low tracker rate mortgages have several years to left run. On the flip-side, mortgages arranged post 2008 may well have come to the end of an attractive fixed or discount rate and associated early repayment charge periods. Such mortgages may well be viable for refinancing. Since the introduction of new buy-to-let mortgage underwriting rules, which took full effect in January 2018, it can now be far easier to borrow in a company name than personally.
Where landlords have some existing mortgage terms which are particularly competitive, that is when our recommended structure comes into its own. It allows for some mortgages to be refinanced into the company immediately (where it is beneficial to do so) and for other mortgages to be retained until a valid reason for refinancing exists, e.g. further capital raising.
How does the structure work?
Contracts are exchanged to sell the business of the rental property partnership ‘as a whole’ to the company. Under GAAR rules this triggers the CGT and SDLT payment if the transaction is “substantially completed” after 30 days.
The SDLT relief for partnerships and incorporation relief is then applied as of the completion date at which the transaction is deemed to have substantially completed. This is the date at which equity in the properties (value minus liabilities) is transferred to the company “The Business Transfer Date” in exchange for share capital.
For each property owned by the business, contracts are also exchanged.
The completion date is set for all properties being instantly remortgaged on the same fixed date as the The Business Transfer Date.
For properties which are not to be remortgaged immediately, a long stop completion date is set at the date of the expiration of the existing mortgage agreement or any date prior to that at the behest of the company.
A Business Sale Agreement binds the company to reimburse the legal owner of the properties for payments on mortgages secured against properties remaining in the personal names of the partners.
An Agency Agreement between the company and the partnership appoints the legal owner/borrower as its agent in regards to making mortgage payments and paying down debt as required. The partnership will receive no remuneration for acting as an Agent of the company in regards to the servicing of the mortgage debt the company is contractually obliged to pay, hence the company will be able to claim the mortgage interest as an expense and the Agent will not be treated as having received income in regards to the transactions.
Testing viability “due diligence”
We have already seen Counsel’s opinion and we are comfortable that the structure we are recommending is complaint and goes not fall foul of GAAR and DOTAS regulations.
We work very closely with Property118 Limited and Cotswold Barristers in regards to helping you to identify whether incorporation using our recommended structure is appropriate for you.
In the first instance, a consultation with Property118 Limited includes a detailed fact find leading to a bespoke report and recommendations being produced. This is then checked by Cotswold Barristers and where they concur they will adopt the recommendations of Property118 Limited as their own professional advice for professional indemnity and regulatory purposes, subject to you agreeing to them coordinating the implementation of the necessary legal work. Counsel’s Opinion in regards to the full structure is also shared with you at this point. This entire service costs just £400 inclusive of VAT and comes with a guarantee of total satisfaction or a full refund.
The second level of due diligence we recommend is that you ask your finance broker to review your existing mortgage terms, to establish which of your current arrangements could be improved upon by refinancing in a company name. You can then make an informed decision in regards to which of your mortgages are to be retained for the time being and those to be refinanced immediately.
Cotswold Barristers deal with the Business Sale Agreement, the Agency Agreement and SDLT returns. Note that in most cases the SDLT payable is £nil but returns need to be filed nevertheless. This entire packaged is priced at £8,000 + VAT.
Our firm deal with the necessary conveyancing. As a guide, you should budget around £400 for our work (including disbursements) for each separate property title making up your whole business.
The next step
To check whether transferring your property rental business to a company struture is viable for you at this stage we recommend you book a Tax Planning Consultation with Property118 Limited via the link below.