Tax Planning Bodge Jobs – Limited Liability Partnerships “LLP’s”

by Mark Alexander

11:33 AM, 18th August 2019
About 4 months ago

Tax Planning Bodge Jobs – Limited Liability Partnerships “LLP’s”

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Tax Planning Bodge Jobs – Limited Liability Partnerships “LLP’s”

This is VITAL INFORMATION that all landlords need to know. Please share.

Whilst LLP’s are one of the most popular structures we recommend to landlords, the purpose of this article is to serve as a warning that other firms are mis-selling the benefits of them.

If it waddles like a duck, quacks like a duck and swims like a duck it’s probably a duck

One outfit (I will not name them) seems to think and advises its clients that transferring a property investment business into an LLP structure automatically means that it will be seen as a ‘Trading Business’ by HMRC. This is wishful thinking at best.

Trading businesses qualify for a whole raft of tax breaks including Entrepreneurs Relief and Business Property Relief.

Entrepreneurs Relief reduces capital gains from 18% – 28% to just 10%, whilst Business Property Relief results in trading businesses being eligible for no inheritance tax when they are passed onto the next generation.

However, putting a baked beans label on a tin of peas doesn’t change what is inside the tin!

Property Investment businesses do not qualify for Entrepreneurs Relief or Business Property Relief, that’s a FACT, so no matter how slick the salesman is, do not be duped into believing otherwise.

Beware HMRC’s “Transfer of Income Streams” rules.

The same company touting LLP’s as automatically being treated by HMRC as trading businesses also says that profits within an LLP can be transferred to a corporate Member of the same LLP. Their rationale for doing this is that profits within a corporate Member of an LLP are taxed at the much lower rates of corporation tax as opposed to the individual Members’ marginal personal tax rates, which are often significantly higher.

To summarise the legislation; if you transfer part or all of an income stream without also proportionately transferring the underlying business assets, any tax advantage can be negated, save for any reasonable consideration for work completed by the company at market rates. The problem is that transferring the underlying business assets crystallises capital gains and is also subject to Stamp Duty or LBTT legislation. The company suggesting otherwise also uses ‘smoke and mirrors’ in attempt to disguise this fact, yet again putting baked beans labels of tins of peas.

It you are considering an LLP (also known as a “Hybrid” structure) then PLEASE be aware of the above. Likewise, if you know of anybody who is considering or advocating the Hybrid LLP structure, please draw their attention to this article. You could be saving them a lot of grief further down the line.

If you read any forums or watch video’s on You Tube where the above are mention you may well notice that the points I have mentioned above are glossed over or that questions are avoided completely!

So why does The Property118 Tax Team recommend LLP’s?

When used correctly, Limited Liability Partnerships “LLP’s” can be an excellent structure for landlords, not just for tax planning but also for the evolution of rental property businesses generally. For example, many landlords wish to eventually leave a legacy to the next generation. They also wish to consider succession planning, which is something all business owners should do. Do you want to be tied to your business until the day you die or would you like to think you can take more of a back seat when you reach retirement age?

One of the key advantages of LLP’s is HMRC accept that it is perfectly legitimate for taxable profits to be allocated disproportionately to ownership between individual Members (not Corporate Members’ though).

You can read more about this in HMRC’s own internal manuals, which are designed to provide guidance for tax inspectors but are also accessible to the general public – please see the link below.

https://www.gov.uk/hmrc-internal-manuals/partnership-manual/pm132050

An example of how this might work is your favour is as follows:-

Let’s say that Mr X has a property rental business in his own name at the moment, which produces real profits of £100,000 a year but taxable profits of £200,000 after factoring in the restrictions of finance cost relief. Let’s also assume that he also has an income of £150,000 from other profession or trading company but his wife has no earnings and neither do his three adult children who are studying at University but are already showing an active interest in the property business and getting more involved when they can.

In this scenario, I think it would be fair to say that income tax, inheritance tax and legacy planning are already very much ‘on the mind’ of this man.

By transferring the beneficial ownership of his property rental business into an LLP, his opening ‘Capital Account Balance’ would be the value of his properties minus the liabilities, i.e. his mortgage balances. This can be achieved without remortgaging and reliefs exist to ensure that CGT and Stamp Duty doesn’t fall due either.

His wife and his children can then become Members of the LLP, because they all have an active interest in the business. The opening value of their Capital accounts is £nil, because they haven’t contributed anything to the business at that stage.

The purpose of the restructure goes far beyond tax planning, because succession planning is also an important consideration.

Twelve months elapse from the transition having occurred

The business produced the same profits as before, i.e. £100,000 of real profit and £200,000 of taxable profit after factoring in the restrictions on finance cost relief.

Previously, the tax that the man would have paid would have been as follows:-

£45,000 of tax on the real profit

A further £25,000 of tax on the additional £100,000 of disallowed finance costs, after factoring his his 20% tax credit.

Total tax £70,000.

The above would represent 70% of the real cash profit of the rental property business being paid in tax.

However, under the new structure, now that his wife and his three children are taking an even more active role in the rental property business, the taxable profits are allocated differently. The man takes none of them, and instead allocates £50,000 of taxable profit each to his wife and his three children.

As they don’t have any other taxable income, they can utilise their full £12,500 nil rate band and pay only 20% basic rate tax on the other £37,500 each, i.e. £7,500. The restrictions on finance cost relief do not bite because none of the Members to whom profits have been allocated are higher rate tax payers.

The total tax ordinarily payable under the new structure is just £30,000. However, his wife and his children also get a 20% tax credit on the £25,000 of finance costs allocated to each of them, so that reduces the total tax by yet another £20,000, leaving just £10,000 of tax payable.

That’s a whopping tax saving of £60,000 in the first year alone!

To put this another way, the net effective tax rate on the real profit of the business is reduced from 70% to just 10%.

Yet another way of looking at it is that a reduction in tax from £70,000 to just £10,000 is a saving of nearly 86%.

So whose money is it now?

After paying the tax, the Capital Account values of the wife and the three children now stand at £47,500 each. A well drafted LLP Members agreement can determine that drawings against capital accounts are at the discretion of the Senior Partner, i.e. the person with the highest value capital account, or indeed until the death of the founder of the business. The Senior Partner could, of course, allow drawings to be taken by other Members if he chooses to do so. He might, for example, agree to this is their efforts result in the profitability of the business being increased as a direct result of their efforts.

Assuming no other drawings are taken by his wife and children, save for the money needed to pay their tax bills, the LLP bank account would have accumulated £90,000. That’s £60,000 more than would previously have been the case without this structure, in other words, more than double the amount!

The Senior Partner could, if he wished to do so, withdraw and spend all of the £90,000 of cash at bank. This would be recorded as a debit against his capital account, the outcome of which is that his capital account would reduce.

Over time, and assuming he lives long enough, it is quite feasible for the founder of the business to reduce the value of his capital account to zero. Meanwhile, the capital accounts of his family Members would be growing very nicely indeed. A further benefit of this is that when the founder eventually passes away the net value of his estate for Inheritance Tax purposes will also be significantly lower that it would otherwise have been. This is because his property rental business would have been transferred to the next generation in the optimally tax efficient manner, and completely within the legislation and spirit of HMRC’s rules.

Landlord Tax Planning Consultancy is the core business activity of Property118 Limited (in association with Cotswold Barristers).

Professional advice from a qualified Barrister-At-Law, insured up to £2,500,000 per claim.

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Comments

Anon

9:29 AM, 19th August 2019
About 4 months ago

Very well written and inspiring.

A few quick questions if I may:-

1) what happens when the children leave University and get jobs? I appreciate that it is unlikely they will become higher rate tax payers immediately, so there should still be some benefit, but what about if/when they do become higher rate tax-payers?

2) If/when the children decide to buy a home of their own, will being a Member of the LLP affect their ability to claim First Time Buyers Stamp Duty relief?

3) Will the children be responsible for the debts of the business?

Mark Alexander

9:51 AM, 19th August 2019
About 4 months ago

Reply to the comment left by Anon at 19/08/2019 - 09:39
Hi Anon

These are all excellent questions, which I have copied below and will append my answers to:-

"1) what happens when the children leave University and get jobs? I appreciate that it is unlikely they will become higher rate tax payers immediately, so there should still be some benefit, but what about if/when they do become higher rate tax-payers?"

ANSWER: we always recommend another review after two to three years. During that review we will look at how the business has performed as an LLP and consider the benefits of incorporation of the business - please see >>> https://www.property118.com/landlord-incorporation-checklist/

"2) If/when the children decide to buy a home of their own, will being a Member of the LLP affect their ability to claim First Time Buyers Stamp Duty relief?"

ANSWER: It depends. If the children have become legal owners of the LLP's properties then yes they would be affected. However, it would be unusual for us to recommend that. Ordinarily, the founder of the business would continue to be the legal owner and hold the economic beneficial interest in the properties 'on-trust' for the benefit of the LLP. In those circumstances the children would still qualify for First Time Buyers Stamp Duty relief

"3) Will the children be responsible for the debts of the business?"

ANSWER: The short answer is yes (sort of). The contractual liabilities to the mortgage lender will remain those of the founder. Technically, the Members of the LLP will have adopted responsibility for those mortgages with the founder, however, it is highly unlikely that he would ever enforce those responsibilities with his own wife and children and the mortgage lender would have no right to do so because that is not the basis of their contract. All Members would, however, be jointly and severally liable to any other creditors of the business (e.g. tenants and their deposits) but only to the value of their capital accounts upon liquidation.

David Lynch

12:45 PM, 19th August 2019
About 4 months ago

I am in negotiation with another company, with the intention of creating an LLP. Would it be possible to Private message the name of the other company you are referring to, in case I need to carry out further Due Diligence?

Mark Alexander

12:52 PM, 19th August 2019
About 4 months ago

Reply to the comment left by David Lynch at 19/08/2019 - 12:45
Hi David

We don't have a Private Messaging service, but I am happy for you to email me - Mark@Property118.com

All I am likely to tell you though is what I have already said above. If the company you are speaking to are telling you that a property investment business will qualify for Entrepreneurs Relief and/or Business Property Relief that's all you need to know. You don't need to do any further due diligence because it is plain FACT they are wrong about that so why would you trust them or need to dig any further?

If what I have said above is what they are telling you, then my advice is don't just walk away .... RUN!

paul thomason

14:34 PM, 20th August 2019
About 4 months ago

Reply to the comment left by Mark Alexander at 19/08/2019 - 12:52
as someone who with this company i find it very intresting that when another company has i structure very near the same as the llp you advise , there is scare storys , this is not helpfull and sorry to say inaccurate in many things , but please note it has the backing off i firm off chartered accountants , who do the tax returns

Mark Alexander

14:53 PM, 20th August 2019
About 4 months ago

Reply to the comment left by paul thomason at 20/08/2019 - 14:34
Hello Paul

Please tell me which of the details in my article are inaccurate and point me to the HMRC manuals to back that up.

If you made the mistake of falling for a salesman’s BS then best to admit it instead of pretending it’s all OK and defending the charlatans that duped you.

paul thomason

15:00 PM, 20th August 2019
About 4 months ago

Reply to the comment left by Mark Alexander at 20/08/2019 - 14:53
i am not a accountant and please correct me if i am wrong but you are not

Mark Alexander

16:14 PM, 20th August 2019
About 4 months ago

Reply to the comment left by paul thomason at 20/08/2019 - 15:00
No I am not an accountant. That doesn’t mean I am incapable of reading HMRC’s internal manuals and being regarded as a specialist though.

I do not give advice either, that is provided by Mark Smith, Head of Chambers at Cotswold Barristers who co-authors my tax related articles and reviews and adopts recommendations I make as his own professional advice, for which he is experienced, qualified regulated and insured up to £2,500,000 per case

I am, however, qualified in property, finance, tax and law by 33 years of experience.

I founded this website, the National Association of Commercial Finance Brokers and the largest finance brokerage ever in the UK.

Many of my clients are accountants.

Your point about me not being an accountant is ... ???

paul thomason

16:32 PM, 20th August 2019
About 4 months ago

Reply to the comment left by paul thomason at 20/08/2019 - 15:00
i note no answer to my last message . plus everyone should note the revenue is no longer giving section 162 clearence has anyone asked why , and if you use section 162 and its not allowed everyone will face a verry large cgt bill

Mark Alexander

16:39 PM, 20th August 2019
About 4 months ago

Reply to the comment left by paul thomason at 20/08/2019 - 16:32
I have answered your question, please see above.

I wrote about the closing down of HMRC’s non-Statutory clearance office in Southend when it happened, and why, and what landlords can do now to protect themselves. See the main Tax section of this website.

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