Tax Planning

Text Size

Book A Tax Planning Consultation

The correct ownership structure is a vital ingredient to your success as a property investor.

The following Case Study and explanatory notes explain why, by comparing a property privately owned rental property business owner with a private hotelier.

The Section 24 restrictions on finance cost relief prevent the private landlord from offsetting finance costs against income as a business expense.

CASE STUDY – Section 24 worked example

Let’s assume that both the private landlord and the private hotelier’s businesses each own assets worth £2,000,000 and have mortgages at 75% of value secured on them at an interest rate of 5%. In other words, their annual finance cost bill is £75,000.

Now let’s assume that both businesses make profits after finance costs and all other expenses of £50,000.

The hotelier will pay £7,500 of income tax. This is broken down as follows; £nil on his first £12,500 of net profit and 20% tax on the next £37,500 (based on the 2021/22 tax bands).

However, the private landlord cannot treat his finance costs as a legitimate cost of the business in the same way as the hotelier. Accordingly, his tax bill is £27,500. This is because his taxable income is treated as being £125,000 due to being unable to claim his finance costs as business expenses. Furthermore, for every £2 of taxable income over £100,000 he loses £1 of his personal allowances (also known as his nil rate tax band). Accordingly, the landlord pays tax at a rate of 20% on the first £37,500 (which equates to £7,500) and then 40% tax on the other £87,500 (which equates to £35,000). This adds up to a whopping £42,500. The government then grant him a tax credit equal to 20% of his finance costs, in other words, £15,000 off the £42,500 leaving him with a net £27,500 of tax to pay.

To summarise, the private landlord pays more than three times as much tax as the private hotelier, even though their financing costs and business results otherwise produce identical levels of actual profit.

HOWEVER, if both the landlord and the hotelier operated their businesses within a Limited Company structure, they would pay exactly the same amount of tax.

Believe it or not, taxation is only a fringe reason to consider operating your rental property business within a “SmartCo” Family Investment Company Structure. An old adage used by many tax professionals is; “never let the tax tail wag the dog’.

There is no ‘one-size-fits-all’, but some of the main reasons for operating a rental property business within a corporate structure will usually include at least two or three of the following:-

  • The greater ease of borrowing, e.g. mortgage affordability criteria, such as the difference in interest cover requirements between Limited Company Buy-To-Let and unincorporated borrowers;
  • Elderly, ex-pat and overseas landlords find it much easier to arrange finance within a Limited Company;
  • The protection of limited liability;
  • To be able to appoint Directors to run the business later in life without them taking on personal liability associated with alternative structures such as being made a Partner in the business;
  • The ease of transmission of shares in the company (e.g. to family members);
  • The greater ease of effecting an outright sale;
  • The greater ease of securing third-party investment;
  • The ability to exercise control over when income is drawn down, to allow the accumulation and reinvestment of rental profits;
  • The opportunity to benefit from contributions to a registered pension scheme, whereas, as proprietors of an unincorporated property-owning business with no other sources of income, no such opportunity is available beyond £3,600 per annum.

Now let’s delve deeper. We suggest you watch this short video first.

Introducing the “SmartCo” Family Investment Company Structure

Off-the-shelf limited companies with model Articles of Association and a single class of shares are not optimised for your benefit. They are ‘cheap‘ for a reason!

By way of example; with an off-the-shelf company all shareholders own the same types of shares and each share carries the same rights. This may not suit your circumstances at all, never mind tax reasons. For example, you may want to modify the share structures for business continuity or legacy planning purposes, to attract investment, or to ensure that voting rights are not proportional with the percentage of all company shares.

Whilst this page looks primarily at the tax position, you must not confuse that with the main benefits of Family Investment Company structures, which are different for every business.

Unlike trading businesses, property companies do not qualify for Business Relief. This means that the value of your company shares will automatically be exposed to inheritance tax on your passing – unless you take action now.

However, HMRC has accepted that Family Investment Company structures are legitimate forms of business continuity and legacy planning for a few years now.

One typical structure is to create multiple classes of shares, some with voting and dividend rights and a cap on value (Freezer shares) and others with negligible if any voting rights that accrue all future growth in the value of the company (Growth shares). Gifting the Growth shares whilst they have a negligible value removes them from the estate of the existing owners for inheritance tax purposes without incurring significant tax consequences. This requires legal work such as changing the company Articles of Association and re-filing a Confirmation Statement with Companies House. Often, a Shareholders Agreement is also necessary to achieve the required outcomes optimally. Likewise, the arrangement can also encompass gifting the Growth shares to a Discretionary Trust to preserve the benefits of the planning across several future generations of the family.

A further benefit of a Family Investment Company structure is that each family member can own a separate class of shares. This simplifies tax planning for dividend allocation significantly. This is because the Directors can then allocate dividends to each class of shares separately to utilise nil rate bands or the lower tax rates applicable to individual shareholders. A standard company share structure is limited to a single class of shares, meaning that any dividends are divided pro-rata to the percentage of the shareholding.

Can an existing company with SIC Code 68209 be converted into a Family Investment Company?

The simple answer to this question is YES. However, the benefits of doing this will only apply to future growth in the value of the business and, likewise, for dividend tax planning. For this reason, it makes sense to implement the restructuring of an existing company as soon as possible.

Why hasn’t my Accountant told me about this?

Don’t feel too bad, you are not alone. Less than 1% of the 350,000 landlords who invest in rental property through a UK Limited Company know about Family Investment Company structures. This isn’t because they have bad Accountants. It’s because several of the elements of this form of planning are reserved legal activities. There are also very few lawyers who specialise in this area because it is expensive to reach their target audience and far from the mainstream. People rarely walk into a law firm to ask about Family Investment Companies in the same way as they do about conveyancing, divorce, litigation, probate, etc.

Implementation

We only ever recommend implementation of this type of planning is carried out by qualified Barristers, Law Society and STEP-regulated Solicitors. However, whilst many professionals carry such qualifications, most of them are generalists. Property118 Consultants will only ever refer you to professional advisers who are both qualified and highly experienced in advising landlords.

Are mortgage lenders happy with Family Investment Company structures?

In a word, YES, mortgage lenders are very happy with FIC structures. We have yet to come across a lender that isn’t, providing the Growth shares comprise only a tiny fraction of the overall share capital. We’ve even come across a few forward-thinking mortgage lenders that go as far as recommending Family Investment Companies to their borrowers.

How much does this type of planning cost?

Initial consultations with a Property118 Consultant come at a fixed price of just £400 inclusive of VAT.

Before meeting your Property118 Consultant in person, usually via a Zoom video conference, you will typically engage in email and telephone conversations. This aims to establish your current position, the challenges you are facing, and your short, medium and longer-term objectives.

Your Consultant will then work on a bespoke plan of action to present to you via a Zoom video conference. These presentations typically last for around one hour, so you will have plenty of time to ask questions, either during that meeting or in subsequent email correspondence. You are most welcome to involve your existing professional advisers to participate, e.g. your Accountant, Financial Adviser, and mortgage broker. We actively encourage this.

The investment required to implement the plan will also be discussed and confirmed in writing. You will not be charged more if a follow-up meeting or further correspondence is required.

At this point, the proposed action plan is very much provisional. It should not be regarded as professional advice.

If all parties are in agreement with the plan ‘in-principal’ your Property118 Consultant will then propose a fee to confirm the plan in writing and to ask the recommended professional advisers we recommend for implementation to review it with a view to them adopting our recommendations as their own insured, regulated professional advice. If they agree to this we can then proceed to implementation. If not you will be given the choice of receiving a refund of all fees to date or an amended plan of action and costs of implementation. If that is not acceptable the refund remains available.

Typical investment required to create a “SmartCo” Family Investment Company Structure

Assuming you use excellent professional advisers with significant relevant experience you can expect to pay around *£15,000, which would typically include the following legal work: –

  1. Forming a new Limited Company (if applicable)
  2. Capping the value of existing shares at current value (Freezer shares)
  3. Creating a new class of Growth shares
  4. Creating further classes of Freezer shares as required
  5. Amending and filing new Articles of Association for the company
  6. Drafting and registration of a Discretionary Trust into which the Growth shares will be settled
  7. Drafting of a letter of wishes to the trustees of your discretionary trust
  8. Lasting Powers of Attorney for the founders of the business (registration fees not included as this can be deferred until if/when the LPA’s need to be activated)
  9. Drafting of a shareholders’ agreement

The cost of not doing this type of planning or getting it wrong could prove to be catastrophic to future generations of your family. For example, during the reign of Queen Elizabeth II, UK property values increased 128-fold. To see what that could mean to your family, put the gross value of your rental properties into a calculator, multiply by 128, and then deduct any current mortgage values. Then multiply by 40%.  The figure shown on your calculator at this point will be the amount of inheritance tax your family could pay if history repeats itself over the next 70 years but only one generation passes away in that amount of time. If two or three generations were to die over this period the inheritance tax paid would be far more.

*The above does not include the costs of transferring existing properties into the structure or any associated planning. This is always quoted separately.

NEXT STEP

If you would like to experience the peace of mind that comes with completing this type of planning, the first step is to complete and submit the form below.

Book a Landlord Tax Planning Consultation

  • Hidden
  • Hidden
    Please provide an overview of your circumstances and what you are looking to achieve.
  • For the avoidance of doubt, we are able to assist landlords who own properties in England, Northern Ireland, Scotland and Wales. Where you reside is not a problem, even if you are resident outside the UK.

TESTIMONIALS – LINK

Download our free eBook by clicking on the image below

Landlord Tax Planning Book Now
Related Pages

Videos

More Videos