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The mixed partnership structure is often a good fit for landlords who are already paying higher rate tax or are pushed into the higher rate tax bands by restrictions on finance cost relief.
The mixed partnership structure is equally applicable to individual landlords as it is to joint borrowers and existing partnerships.
As a rule of thumb mixed partnerships tend to be most effective for property rental businesses with a minimum of 10 tenancies and a rent roll which exceeds £100,000 a year. Having said that, there are no hard and fast rules in terms of business size.
The partnership is an LLP (Limited Liability Partnership), most solicitors practices are structured as LLP’s these days as you will see from their letterheads.
The LLP will have at least two members (“partners”) but there could be several. At least one of those members will be a limited company, which may or may not own a share of the beneficial interests in the business properties.
The advantage of having a limited company member is that it can charge the property owner(s) a fee for the management of the tenancies and the buildings. The company retains profits at corporation tax rates, which are substantially lower than higher rate and additional rate income tax.
HMRC’s rules on mixed partnerships are extremely complex. The latest set of guidance notes was released at around this time last year. You can read them here but to simplify matters I have provided an overview of how the rules apply to landlords.
An extremely useful tax planning feature of partnerships is that profits can be allocated to individual members disproportionately to the amount of beneficial interest they own on the partnership assets. This means that a 1% partner could theoretically be allocated 99% of all profits if it was commercially advantageous to do so. The allocated profit from the partnership is then declared on the individual member’s self-assessment return. Each partner has a capital account showing how much they have drawn from the business. Again, this can be disproportionate to both ownership of assets and allocated profits, which means that some partners can have an overdrawn capital account whilst others are in credit. This is particularly useful for family partnerships, as highlighted in the case study linked from the snip below.
Please continue reading beyond the linked snippet (which should open in a new tab in your web-browser) because I haven’t explained all of the benefits of having a limited company as a partnership member yet, nor the restrictions applied by HMRC to Limited Company members, nor the other advantages of this structure.
Whilst individual members of a mixed partnership (people) can allocate profits disproportionately to ownership of assets, the same does not apply to Limited Company members. HMRC put a stop to that because too many LLP’s were allocating profits to their Limited Company members in order to reduce their tax bills. There is yet another piece of tax legislation which describes this as “alienation of income sources” but I don’t want to over-complicate this article with too much detail. The long and short of it was that HMRC changed the rules to limit the allowable profit allocation to a Limited Company member of a partnership to its share of partnership assets, plus a commercial rate for the activity of the partner. From a landlords perspective this would be the cost at which an independent lettings and management company would provide the same service. HMRC tend to challenge more than 15% of gross rent received.
Many landlords also use the mixed partnership structure as a stepping stone towards full incorporation. Once a property rental business has been operating with its own HMRC Unique Tax Reference Number “UTR” for a period of at least three years then it will qualify for incorporation reliefs and be exempt from paying SDLT on the transfer of properties to a company structure. There is another form of incorporation relief available to mitigate CGT and there is even a structure to avoid the need to refinance. To qualify for incorporation relief, one of the rules is that you must incorporate your entire business. I cannot over-stress the importance of the words in bold. If you operate a management company independently of your property rental business HMRC could argue that you do not qualify for incorporation relief. Their argument would be that you are a passive investor and you haven’t incorporated your entire business. For this reason it is extremely important that if you decide to hive off some of your rental income into a Limited Company, that that company must be a partner in your business. You can then incorporate the entire partnership business into a new company and consider dissolving the management company thereafter.
You can read more about incorporation relief in our Landlord Tax Tutorials which are available as PDF downloads via THIS LINK.
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