Three Methods of Financing a Buy to Let Business Incorporation

Three Methods of Financing a Buy to Let Business Incorporation

7:05 AM, 16th February 2022, About 3 months ago 2

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There are three main methods of financing a Buy to Let business incorporation. However, one of them is fraught with risks and high costs and it unlikely to be the method you might think of as being risky at first either. The three methods are: –

  1. The acquiring company provides an contractual indemnity to the original owner to adopt liabilities, i.e. to service debts and to pay them when they are due. In other words, the company ‘takes over’ the liabilities of the business it is acquiring
  2. The acquiring company arranges new mortgages to purchase the properties of the existing owner. Completion requires a solicitor to simultaneously complete the new loans and redeem the previous loans of the owner.
  3. Novation is an agreement between the existing borrower and lender to re-write the existing loan terms so that the company becomes the borrower. Lenders such as Paragon, Handlesbanken and other commercial challenger banks offer this method, as do the High Street banks including Barclays, Lloyds, Bank of Scotland, RBS, Clydesdale etc. However, some banks are ‘milking’ this opportunity to charge extortionate fees whilst other are very reasonable and charge less than £400 per property. If you encounter this problem then you need to seriously reconsider your existing commercial banking relationship.

I have put the important text from HMRC manual CG67545 below in bold and red underlined text …

CG65745 – Transfer of a business to a company: computation: transfer of liabilities

“The transferor is not required to transfer business liabilities to the company but often does so. This is normally done in practice by the company giving the transferor an indemnity in respect of those liabilities.

In strictness, business liabilities taken over by the company represent additional consideration for the transfer and relief under TCGA92/S162 should be restricted. However, ESC/D32 enables any business liabilities taken over by the company to be ignored when quantifying `other consideration’ in recognition of the fact that the transferor is not receiving cash to meet any tax liabilities on the transfer and that the shares in the company are worth less than if the business had been transferred unfettered by liabilities.”

ESC/D32

Where liabilities are taken over by a company on the transfer of a business to the company, the Revenue are prepared for the purposes of the ‘rollover’ provision in TCGA 1992 s 162, not to treat such liabilities as consideration. If therefore the other conditions of s 162 are satisfied, no capital gain arises on the transfer. Relief under s 162 is not precluded by the fact that some or all of the liabilities of the business are not taken over by the company.

The concession applies only to business liabilities. Personal liabilities of the transferor taken over by the company should always be treated as part of the consideration. In particular any tax liability arising from the business transferred is a personal liability.

The concession applies only for the purpose of establishing the extent of `other consideration’. It does not operate in the computation of the net cost of the shares, see CG65740.

The general caveat that a concession will not be given in any case where an attempt is made to use it for tax avoidance should be borne in mind.

CONCLUSION

The Substantial Incorporation Structure (previously known as BICT) which is advocated by Property118 and implemented by Cotswold Barristers is by far the safest option. Why else would HMRC use the the following words in their manual?

“This is normally done in practice by the company giving the transferor an indemnity in respect of those liabilities.”

Novation and Indemnity are quite clearly acceptable to HMRC and incorporation reliefs will apply, but there is a huge risk that HMRC might regard the redemption of a existing mortgages simultaneous with the drawdown of a new mortgage in the company name as not meeting the TCGA92/S162 legislation.

Now here is the terrifying thing; most mortgage advisers and accountants are oblivious to the existence of Novation and whilst they might have a general understanding of what an Indemnity is they are not trained lawyers and do not recommend them. As a result of this, most mortgage brokers and accountants are recommending new mortgages in the company name and the redemption of existing mortgages. Not only does this carry taxation related risks, it can also be prohibitively expensive for the business owners when considering the viability of incorporation.

OUR RECOMMENDATION

Substantially complete the incorporation using a Barrister who is experienced in drafting Business Sale and Purchase Agreements using indemnities to take over existing liabilities. Property118 and Cotswold Barristers are widely regarded as the UK’s most experienced in this area of law. Where possible, novate any mortgage liabilities soon thereafter to maintain close relationships with your existing commercial bankers.

DO NOT arrange new mortgages in the company name at the point of incorporation.

If you do have a genuine commercial reason to refinance then do so before or soon after incorporation. Always seek our advice on your tax position if you plan to refinance pre-incorporation, because this has potential to expose you to Capital Gains Tax if your liabilities exceed your base costs for CGT calculation purposes at the point of incorporation.

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Comments

by FOX30

12:26 PM, 16th February 2022, About 3 months ago

So if I use the BICT process, do I not have to Inform my lenders of any changes before or after the process of incorporation ?

and what happens when the mortgagee rate expires when I reapply for a remortgage, do I not have to mention with the next lender my incorporated setup ?

by Mark Alexander

14:40 PM, 16th February 2022, About 3 months ago

Reply to the comment left by FOX30 at 16/02/2022 - 12:26
Correct on both counts


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