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11:33 AM, 18th August 2019, About 5 years ago 26
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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.
Show Book a Tax Planning ConsultationThere will never be an optimal ‘one-size-fits-all’ business structure for tax purposes. The presentation below provides a useful overview of some of the options you might like to discuss with us.
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Mark Alexander - Founder of Property118
19:22 PM, 20th August 2019, About 5 years ago
Reply to the comment left by paul thomason at 20/08/2019 - 19:10
I am stating facts so that people don’t get into something which has been sold to them under false pretenses.
I recommend LLP’s more often than incorporation, but only ever for the right reasons and never EVER would I imply that a property investment business could be eligible for entrepreneurs relief or business property relief. These reliefs only apply to trading businesses, NOT investment business. That isn’t advice, nor is it opinion, it is FACT
James Mann
10:19 AM, 24th August 2019, About 5 years ago
Hello Mark,
I have been reading these reports from you for several years now and as a customer of the company that I am sure you refer to, I feel that your advice is mistaken. As you clearly have not been through the process with them, you will not understand that the potential customers are checked out very carefully to see that their businesses are suitable for this type of structure. I have been a landlord for 35 years now and it is my full time occupation, I run all the maintenance through one of my companies (now under the umbrella of the LLP) and all the contracting and tenant work through another income flow.
HMRC are very happy with my accounts and structure. I am saving very considerable tax and feel confident that on the death of my elderly parents who are business partners that I am prepared as well as possible for minimal tax.
I have also recommended other landlords to the said company who are not so hands on as I am and the company has given them free upfront meetings and decided that they cannot take them on as clients due to their investor type status.
This company may appear expensive but I would like to say that the services provided provide far more than setting up and LLP and Limited company. All accounting of Ltd companies, LLP and personal returns for all members of the partnership, Family tax planning, business statregic planning and personal mortgage broker are all included and co ordinated in this professional service. The accountants are well known and won the north of England best accountants award last year. They say that they have never had a HMRC tax return returned with the structure that is used and I have no reason to disbelieve them. I have my ear to the ground on all landlord matters.
I get the feeling that you constantly call them charlatans and rip off merchants so that you can make your similar, but not so complete service look like good value and trustworthy at the expense of another business.
You clearly do not operate your business on a day to day basis as working landlords do such as myself and so would not be acceptable to the said company as a client. They would likely not accept you, but certainly be sure that they would not be in breach of the HMRC regulations before they considered it.
I am not impressed with your articles regarding this and having been to check out Mark Smith at one of his lectures I cannot see that he offers anything like the same business service.
I hope that you will refrain from putting down other businesses who you believe provide a similar service to you and Mark Smith in the future.
James Mann
Mark Alexander - Founder of Property118
10:52 AM, 24th August 2019, About 5 years ago
Reply to the comment left by James Mann at 24/08/2019 - 10:19
Hello James
Thank you for your comments. From what you have said you appear to have a mixture of both trading and investment businesses.
Are you saying the company you are dealing with only works with landlords who are actually engaged in trade AND investment businesses?
If you are referring to the company I was thinking of when I wrote this article then I may well have misunderstood their offering.
If that is the case though, that business model is very different to the one provided by the Property118 Tax Team, because the solutions we provide are always bespoke to our clients needs and circumstances, which in our experiences are extremely varied.
We do work with clients who operate trading businesses and we have recommended LLP's to some of them, incorporation to others and in some cases we have advised them not to change their existing structure at all.
Likewise, we have worked with sole owner landlords who own just a few properties through to companies with hundreds of properties, to help them to identify and implement the optimal structure for them.
I am very sorry that you have taken my critique articles personally, but they exist to ensure that Property118 readers ask the right questions from those advisers they choose to consult, whether that is the Property118 Tax Team or any other business which appears to be offering a competing service.
PS - the Property118 Tax Team includes:-
1) A panel of award winning ACCA qualified practicing accountants
2) A panel of award winning FCA qualified IFA's and mortgage brokers
3) A panel of award winning Solicitors in both England and Scotland
4) Cotswold Barristers
5) A panel of award winning Estate Planners
6) A team of Consultants who are Portfolio Landlords in their own right
If you are happy with your existing advisers that's great. There is plenty of work to be done and plenty of room in the business for healthy competition to exist.
Mark Alexander - Founder of Property118
20:10 PM, 24th August 2019, About 5 years ago
Reply to the comment left by James Mann at 24/08/2019 - 10:19
Hello again James
I do have a few further questions if I may please?
1) are some or all of your buy-to-let properties still owned beneficially by individual Members of your LLP?
2) if they are, how is the mortgage interest accounted for?
3) If some of all of the properties are still owned beneficially by the individual Members of the LLP and mortgage payments are deemed to be paid by the Corporate Member(s) of your LLP, on what basis does this occur without falling foul of the Transfer of Income Streams legislation?
4) if beneficial interest was transferred to the Corporate Members of the LLP, how was Stamp Duty and Capital Gains accounted for?
Thanks
Mark A
James Mann
9:10 AM, 27th August 2019, About 5 years ago
Dear Mark,
I think that it is worthwhile pointing out the correct and legal basis that mixed partnerships can be used for the benefit of your readers.
My concern is not the rules however, these are fully understood and complied with by the award winning accountancy company who employ 70 staff in 7 offices throughout the UK, who prepare all of the accounts for the clients of the said company. My concern is that you are using your platform over a long period to unjustifiably attack another business who happens to be providing a similar service to yours.
Your language is highly critical of the sort which I would regard as an uninformed attempt to undermine their commercial position to the benefit of your own. Is it normal to used words like charlatans and bodgers to describe other people in your area of business?
If you have evidence of poor practice, I would be the first to want to see that, and I suggest that you take it up with the relevant bodies rather than embarking on a long and sustained attack of online bullying ( which is what this looks like to me). This would not be the case if you did not run the platform.
From my point of view it demonstrates a complete lack of professionalism, expertise and potentially a lack of knowledge.
I do not think that it is necessary to behave like this if you simply wish to point out regulations that it is easy to fall foul of for your readers.
I read your landlord news everyday, and generally find it very helpful and interesting, but articles in this area of Tax planning appear uninformed with regard to the company we are talking about and a direct attack designed to undermine their business. I do not like it!!
James Mann
Mark Alexander - Founder of Property118
9:32 AM, 27th August 2019, About 5 years ago
Reply to the comment left by James Mann at 27/08/2019 - 09:10
Hello again James
It's a shame you feel the way you do, but I disagree with your comments. If I had named and shamed a particular company that might be different, but I haven't. That is not bullying.
I have raised what I believe to be very valid questions, but you have chosen not to answer any of them. May I ask why?
James Mann
10:07 AM, 27th August 2019, About 5 years ago
Dear Mark,
I am no expert and rely on qualified and award winning accountants to keep on the correct side of the law.
I can however confirm that all beneficial interest of our properties is with the LLP. Currently no beneficial interest lies with the corporate members of the LLP and no allocation of profit goes to the corporate members.
I hope that this clarifies
James
Mark Alexander - Founder of Property118
10:21 AM, 27th August 2019, About 5 years ago
Reply to the comment left by James Mann at 27/08/2019 - 10:07
Hi James
Your response only answers my questions partially, but nowhere near fully enough. On this basis, nothing is clarified.
How are your finance costs accounted for?
If a Corporate Member of your LLP is claiming the finance costs as an expense (thus avoiding the impact of the S24 restrictions on finance cost relief), but the underlying assets and loans do not belong to that Corporate Member, it is our considered opinion that such a structure would fall foul of tax legislation.
The above is one of the reasons we write these articles. If the firm advising you hasn't used this structure then you have no reason to be concerned in regards to this point, and no reason to be angry with us for raising this point for those who have been advised incorrectly in this regard.
Best wishes
Mark
Neil Patterson
10:59 AM, 27th August 2019, About 5 years ago
Reply to the comment left by James Mann at 27/08/2019 - 10:07
Dear James,
Any LLP solutions recommended in the right circumstances by the Property118 Tax Team and advised upon and implemented by Cotswold Barristers are always referenced and linked to legislation and HMRC manuals, so that any accountant qualified to deal with the accounting of an LLP and its statutory returns to Companies House may do just that. In fact we encourage working with client's accountants from the start.
I would suggest it rings alarm bells if a company advising does not provide such levels of transparency, but instead insists upon dealing with the ongoing tax returns and filing of statutory accounts and compliance with Companies House Rules.
My advice to anybody considering the restructuring of their business is not to do anything until you fully understand what is being recommended to you and you have a positive second opinion in writing from your existing and trusted professional advisers.
Unfortunately awards and endorsements are no guarantee of specific individual bespoke advice being accurate.
paul thomason
11:17 AM, 27th August 2019, About 5 years ago
Reply to the comment left by Neil Patterson at 27/08/2019 - 10:59
the point been if the said firm off accountants are wrong , thy can or will be closed down , furthermore thy have 2.500000 per client cover, its a very negative feedback from both off you and to be honest not why i became a founding member off property 118 for, so kindly stop ,