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 Mark Alexander

16:28 PM, 9th March 2021, About 7 months ago

Reply to the comment left by at 09/03/2021 - 15:16
You cannot finance the withdrawal of more capital than you have invested in the business.

If you have a latent gain already, a capital account restructure cannot happen.

by Navro18@gmail.Com

16:13 PM, 11th March 2021, About 7 months ago

Thanks Mark, but just to clarify, you could if you clear the latent gain first i.e. inject capital by e.g. paying off some debt.

by Mark Alexander

16:26 PM, 11th March 2021, About 7 months ago

I don't see the point of introducing capital just to draw it straight back out again.

It you want to reduce a latent gain then paying down mortgages is one way to do it.

However, if you want to end up with a Directors loan you might as well just lend your cash to your Limited Company based on the circumstances you have outlined above.

by Navro18@gmail.Com

16:28 PM, 11th March 2021, About 7 months ago

So, for example, if I pay off a mortgage later this year when my five year fix ends, I reduce debt/increase equity, and narrow (/eliminate, depending on the numbers) the latent gain don't I?

by Mark Alexander

16:31 PM, 11th March 2021, About 7 months ago

Correct, assuming you actually have a latent gain of course.

by Navro18@gmail.Com

16:50 PM, 11th March 2021, About 7 months ago

Reply to the comment left by Mark Alexander at 11/03/2021 - 16:26
Me being a dummy thinking whether I can have my cake and eat it...how to avoid CGT on latent gain when incorporating yet still retain access to capital post-incorporation using capital account restructure...

by Mark Alexander

16:53 PM, 11th March 2021, About 7 months ago

Reply to the comment left by at 11/03/2021 - 16:50
Sorry I could not give you the answer you were hoping for.

by Navro18@gmail.Com

17:28 PM, 11th March 2021, About 7 months ago

Not at all...thank you for the learning 🙂


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