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

by Mark Alexander

11:33 AM, 18th August 2019
About a month 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

Mark Alexander

11:58 AM, 27th August 2019
About 4 weeks ago

Reply to the comment left by Neil Patterson at 27/08/2019 - 10:59
All good points Neil, especially in regards to Awards and endorsements are no guarantee of anything. One must consider that there may well be commercial relationships in play, which are always factored into pricing models.

Mark Smith (Barrister-At-Law)

12:42 PM, 27th August 2019
About 4 weeks ago

Reply to the comment left by paul thomason at 27/08/2019 - 12:26
Dear Paul,
As the Hon. Legal Counsel of Property118 I will be happy to review the arrangements you have entered into and then complete a follow-up review once the first year's accounts for the LLP have been filed at Companies House. I will then advise accordingly.

As you are a Lifetime Founder Member of the Property118 Landlords Union and the first to raise this matter I will provide this service on a pro-bono basis, i.e. at no cost to you. Please get in touch via the Contact form on my Member Profile page if you would like to take up this offer.

I should add that in the many events I have spoken at I am often asked to comment on other structures that are made available from other providers. I have expressed reservations about some solutions that I am asked about, but we do not engage in gratuitous unfounded criticism. The issue we have with other providers we are asked about is the lack of public transparency in their explanations of what they intend to do. Looking at certain elements from the outside has led to concerns being expressed on behalf of the questioner, but I am always happy to be educated to a clearer conclusion, hence my offer.

Mark Alexander

15:05 PM, 27th August 2019
About 4 weeks ago

Entrepreneurs’ Relief: trading company and holding company of a trading group - the meaning of "substantial"

Most companies and groups will have some activities that are not trading activities. The legislation provides that such companies and groups still count as trading if their activities “… do not include to a substantial extent activities other than trading activities”. The phrase “substantial extent” is used in various parts of the TCGA92 to provide some flexibility in interpreting a provision without opening the door to widespread abuse. Substantial in this context means more than 20%.

The question to ask is how should a company’s non-trading activities be measured to assess whether they are substantial?

There is no simple formula to this but some, or all, of the following are among the measures or indicators that might be taken into account in reviewing a particular company’s status. These indicators, adopted for Entrepreneurs’ Relief, are the same as those used for the old taper relief and in the Substantial Shareholding Exemption for corporation tax.

Source: https://www.gov.uk/hmrc-internal-manuals/capital-gains-manual/cg64090

MY CONCLUSION

If the trading element of your business is not worth at least four times the value of your investment properties then you will not be entitled to claim Entrepreneurs Relief.

Mark Alexander

15:26 PM, 27th August 2019
About 4 weeks ago

What doesn’t qualify for Business Relief?

You can’t claim Business Relief if the company:

mainly deals with securities, stocks or shares, land or buildings, or in making or holding investments

source >>> https://www.gov.uk/business-relief-inheritance-tax/what-qualifies-for-business-relief

BERNIE

15:27 PM, 1st September 2019
About 3 weeks ago

There is a company out there (I suspect it's the one that's being referred to in the previous comments) that explains their 'scheme' as follows: The equity and income is given to an LLP. The members of the LLP are yourself, wife/husband/civil partner and maybe son/daughter along with a limited company that said persons are also the owners of (corporate member). By doing this it is claimed that HMRC now recognise this structure as converting an investment business into a trading business.

I view this as palpable nonsense and am amazed so many intelligent people are falling for it. HMRC are very clear in the way they tax businesses. An investor with a property investor business must account for their rental profits under the specific rules applying to property income. It makes no difference to HMRC as to how complicated the ownership structure of a business is. Simply changing the ownership structure of of a business does not change it from being an investment business to a trading business.

How on Earth these charlatans are getting away with this is a mystery to me. The people falling for the 'scheme' are obviously not doing even the most basic due diligence and are falling for a salesman's spin. A salesman incidentally whose previous business went bust owing over £300,000.

It is only a matter of time before HMRC coming knocking on the door. I wouldn't like to be one of the victims of this 'scheme' when that day comes.

Well done Mark for warning other potential victims. Keep up the good work.

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