Should we consider a Capital Account Restructure?

Should we consider a Capital Account Restructure?

17:05 PM, 16th March 2020, About 2 years ago 18

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Dear Property118.

When my husband and I first started investing into rental property in the mid 1990’s we invested £250,000 of our own savings into the business, which has been a Partnership from day one. We subsequently borrowed a further £250,000 to inject into the business, making a total of £500,000 of personal investment.

In the early days we borrowed a further £500,000 in the form of buy-to-let mortgages. We have always been quite risk averse and invested for cashflow. Against what appears to be the ‘herd mentality’, we have since repaid those mortgages too. The result of which is that we have invested £1,000,000 of our taxed income into the establishment of our property rental business, which is now unencumbered, save for the £250,000 we borrowed against our home.

With the benefit of the wonderful capital appreciation enjoyed in the South West, our property portfolio is now worth in excess of £3,000,000.

We are contemplating incorporation for a number of commercial reasons. Section 24 isn’t one of them, because we have no BTL mortgages. However, we do like the additional layer of protection that Limited Liability status provides and we are also considering business continuity and legacy planning. Furthermore, we are contemplating selling a few of the lesser performing properties and reinvesting into commercial units and holiday lettings for ‘staycations’

It was always our intention to repay the £250,000 we borrowed against our own home. We could, in theory at least, refinance a few of our BTL properties and release cash to repay that. However, to date we have not done so because personal mortgage rates on are so low. Nevertheless, we understand that doing so would be regarded as withdrawing our own capital from the business and would have no tax consequences.

EDITORS NOTE – correct, see HMRC manual BIM 45700LINK

However, we are not convinced that it makes sense to swap very cheap debt for slightly more expensive BTL mortgage debt.

The other potential problem we might face is that my husband and I are now in our late 70’s, so BTL mortgage financing may not be a viable option anyway?

Furthermore, we understand the process of incorporation would automatically result in ‘incorporation relief’ being applied. In our case we would ordinarily exchange £2,750,000 of equity in our business for shares in our own company. No CGT would fall due at the time because it would be rolled over into the shares. This would essentially ‘wash out’ the capital gains from the properties, thus making the sale and transition in commercial and holiday lettings far more viable too.

EDITORS NOTE – correct, see HMRC manual CG65700c – LINK 

However, we feel we could be ‘shooting ourselves in the foot’, because it would be nowhere near as easy to sell £750,000 of shares in a private company as it would be to raise £750,000 of BTL mortgages to facilitate the withdrawal of our capital now.

It might be possible for us to raise the full £1,000,000 on BTL mortgages now and withdraw the cash from the partnership before we incorporate. The problem with that is that it would leave us with £1,000,000 of mortgage debt to service and early repayment charges if we were to lend the cash back to the company in the form of a Directors/Shareholders loan to repay it.

For the reasons stated above, we are extremely interested in the bridging finance you are able to raise, based on your page which describes Capital Account Restructuring. Presumably, we could borrow and repay such a facility either side of the proposed incorporation far more economically than by remortgaging?

QUESTIONS

  1. Is our understanding of the tax position correct?
  2. Based on the limited amount of information provided above, particularly our ages, would we qualify?
  3. Does this type of planning constitute tax avoidance under DOTAS? I can’t see how it could because it doesn’t avoid any tax, insofar as I can tell

EDITORS FURTHER NOTES

We have checked our responses with our Hon. Legal Counsel, Mark Smith, Head of Chambers at Cotswold Barristers. Our responses to your questions above are as follows:-

  1. Yes, you have interpreted the HMRC manuals and legislation correctly in our opinion
  2. Yes, there are no age limits in regards to the bridging finance we are able to arrange and based on what you have said it seem you will qualify for up to £1,000,000 of funding
  3. It is also our opinion that no tax is being avoided in scenario’s of this nature, and for that reason we have not registered under DOTAS
  4. To progress matters, please book a consultation with us 

Book a Tax Planning Consultation

  • Please provide an overview of your circumstances and what you are looking to achieve.
  • Landlord Tax Planning Consultancy is the core business activity of Property118 Limited (in association with Cotswold Barristers).


Comments

by david porter

10:02 AM, 17th March 2020, About 2 years ago

At your time of life why take on more?
Holiday lets are labour intensive.
You have enough assets to see you through you life times.
Pay off your outstanding mortgage gradually and have nothing to worry about. Are you just contemplating buying more because you are bored? Buffet would tell you to suck your thumb! In the current emergency stay home and smell the roses!

by Beaver

11:00 AM, 17th March 2020, About 2 years ago

You did not say whether you have children or grandchildren.

by Mark Alexander

15:53 PM, 17th March 2020, About 2 years ago

They did say "we are also considering business continuity and legacy planning".

I concur with the benefits of both incorporation and capital account restructuring, but I also agree with David Porter's point in regards to not needing to continue to invest. Why not just sell a few properties post incorporation, repay the Directors loans, enjoy an easier life and treat the family?

by Mick Roberts

8:05 AM, 19th March 2020, About 2 years ago

Reply to the comment left by david porter at 17/03/2020 - 10:02Ha ha yes, what do we know cause we don't know these people personally.
I get people frown at me sometimes when they hear I do something. I say Never frown till u know the full story & reasons & why & u tell 'em why u doing that & they say Ooh yeah that's good din't realise.
But I have to say this post, in their late 70's, with all the legislation being chucked at us & potential prison & fines for ticking a box wrong, if some'at does float your boat like going on skidoo's in Russia like Mark or going to Egypt like me last week & getting Egypt Belly or going to buy a Ferrari or helicopter, or giving to the RSPCA, PDSA, to me this sounds better than all this Rented accommodation legislation past the age of 60.

by Navro18@gmail.Com

18:37 PM, 8th March 2021, About 7 months ago

Just tuning on to this as I am contemplating similar. Am I right in thinking that capital account restructure works best where existing debt is low, because otherwise you end up with a significant 'latent gain' (i.e. difference between capital gain and equity), leading to a CGT charge on incorporation?

by Mark Alexander

18:43 PM, 8th March 2021, About 7 months ago

Reply to the comment left by at 08/03/2021 - 18:37
Yes, because a Capital Account Restructure involves you borrowing money to finance the withdrawal of your capital. If you don’t have any capital in the business it’s a non-starter.

by Navro18@gmail.Com

19:04 PM, 8th March 2021, About 7 months ago

Also, how would bridging work, as I read elsewhere on P118 guidance that as the loan is not secured against property the mortgages are not affected. What security is required if not against properties?

by Mark Alexander

19:13 PM, 8th March 2021, About 7 months ago

Reply to the comment left by at 08/03/2021 - 19:04

The alternative to taking property as security could be for the lenders to secure against undertakings.

Obviously, that can only happen if there is actually a way to repay the loan. One example would be for the company to take a mortgage to repay the bridging finance. Another way would be for the owners of the business to lodge cash in an escrow account to make a replacement loan to the company.

It doesn’t have to be a bridging loan though. It could be a long term mortgage or overdraft facility that’s used to finance the withdrawal of owners capital. Whichever way you finance the withdrawal of capital, you need to be sure the lender is also OK with the fact you’re planning to incorporate, or that you have a basis for the company to indemnify the business owners of the debt so that the lenders security is unaffected, in which case they don't even need to know about the transaction.

There are so many ways to achieve a Capital Account Restructure. For example, Paragon Bank are quite happy to Novate their loans to the company providing the borrower isn’t in default and it can be proven the borrower has sought professional advice from a suitable qualified and experienced solicitor or Barrister

by Navro18@gmail.Com

15:15 PM, 9th March 2021, About 7 months ago

Reply to the comment left by Mark Alexander at 08/03/2021 - 19:13
Thank you Mark, that clarifies!

by Navro18@gmail.Com

15:16 PM, 9th March 2021, About 7 months ago

Reply to the comment left by Mark Alexander at 08/03/2021 - 18:43
Sure Mark, I get that but was just trying to get my head round whether capital account restructuring increases latent gain?

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