The costs of refinancing can be a major stumbling block for many landlords when considering the viability of transferring their property business into a Limited Company. After factoring in valuation fees, lenders arrangement fees, conveyancing and searches the cost can be upwards of 3% of existing finance balances. In addition to that, the you need to factor in the ongoing costs associated with swapping historically low mortgage rates for potentially more expensive mortgage products.
Where existing mortgage terms are particularly competitive, and/or when the costs typically associated with refinancing are prohibitively expensive, that is when the Substantial Incorporation Structure “SIS” comes into its own. The structure is equally effective in England, Scotland, Northern Ireland and Wales.
How does it work?
SIS involves substantially completing the sale of the ‘whole business’ of a rental property partnership.
Contracts are exchanged to sell the ‘whole business’ to a Limited Company, but long-stop completion dates are agreed based on outstanding mortgage terms.
A deposit is paid in the form of the equity in the properties (gross value minus liabilities) being exchanged for shares in the company the properties are being transferred into. This involves the transfer of Beneficial Interest.
Completion of the transfers of legal ownership in properties is deferred until the end of the existing mortgage contracts, or earlier at the behest of the company.
A business sale agreement acknowledges that, as a condition of the sale, the company adopts responsibility for servicing any mortgages which have yet to be redeemed. The legal owners (now Bare Trustees) contract to act as Agents for the company (the Beneficial Owners) and make payments to their mortgage lenders on behalf of the company, which has adopted responsibility to service the mortgages. The insurable interest in the properties reverts to the company at exchange of contracts.
Also, as a condition of the Business Sale Agreement, from this point forwards the business is conducted within the company.
The business sale transaction is substantially completed when contracts are exchanged and the net equity in the business assets is exchanged for shares in the company.
When the company wishes to sell a property, the completion of the contracted sale of the corresponding property to the company is executed simultaneously with the onward sale of the property. The net proceeds of sale belong to the company along with any taxation, e.g. corporation tax on any capital appreciation in the property from the date the company contracted to buy it.
The company can take legal ownership of the property at any time, by completing on the purchase contracts already exchanged. If the company requires new finance to complete the purchase, it can apply to borrow on the basis that it is completing a property purchase, in just the same way as it would when buying any other property. The deposit has already been paid.
The key factor from a taxation perspective
Anti-avoidance tax legislation includes provisions to say that where a sale is “substantially” completed it is deemed to have completed after 30 days for tax purposes, whether the sale has been legally completed and registered or not.
The process described above is quite the opposite of avoidance from a tax perspective, in that it utilises anti-avoidance legislation to hasten the deemed completion of a business sale from a tax perspective.
Legislation already exists to help landlords running business partnerships to transfer the business to a company structure without paying Stamp Duty and/or LBTT, and to roll capital gains into shares. The substantial incorporation structure dovetails with these arrangements to facilitate the process of incorporation without immediately needing to refinance.
Landlord Tax Planning is the core business activity of Property118 Limited (in association with Cotswold Barristers).
Professional advice from a qualified Barrister-At-Law, insured up to £10,000,000 per claim.