18:25 PM, 3rd February 2020, About 4 years ago
Our client was a higher rate tax-payer and also owned four properties in his own name with the benefit of mortgages. Accordingly, he was affected by the restrictions on finance cost relief.
His wife is also a higher rate tax-payer, so there was no scope to save tax by forming a partnership and allocating profits to her either.
Incorporation also wasn’t viable, because ‘incorporation relief’ would not have been available to roll over capital gains into company shares.
They were using their rental profits to pay for the school fees for their young children.
In this instance, our clients parents also owned one rental property and their incomes were well below the higher rate tax threshold. This presented an opportunity too good to miss.
They had all considered forming an LLP together for commercial reasons other than tax, i.e. to ring fence some of their potential business risks away from their personal wealth. This is because they are worried that legislation landlords must comply with continues to intensify, as do the consequences of making mistakes.
LLP’s are transparent for tax purposes, which means that so long as the LLP’s opening capital account balance for each individual Member reflects the market value of the equity in properties they each introduce there are no consequences in regards to Capital Gains Tax or Stamp Duty. This can be achieved by legally documenting the economic beneficial interest in rental properties are held ‘on-trust’ for the LLP. There is no requirement to refinance or even obtain consent from mortgage lenders, because the legal ownership of the properties, the existing mortgage contract terms and the lenders security all remains completely unchanged.
From a tax planning perspective, forming a Limited Liability Partnership enabled our clients to allocate profits in the business disproportionately to ownership, by allocating a profit related “Partners Salary” to his parents. Please note that there is a subtle difference in the words “Partners Salary” and “Salaried Partner” but the legal differences are very significant. You can read more about this topic in this HMRC’s Manual.
Accordingly, once the LLP was formed, it was agreed that all taxable profits would be allocated to the Parents, who would then pay tax at the basic rate of 20% instead of our client paying 40% tax and being subjected to the Section 24 restrictions of finance cost relief. The tax savings on this would be immense.
In his instance, it made sense for the parents to be able to withdraw 100% of their taxable profits from the business in the form of drawings, but this isn’t always necessary. The reason it made so much sense in this case was because the Parents then had the funds to pay for the private education of their grandchildren out of the income they had paid only 20% tax on. If our client had paid for the school fees, he would have been doing so out of income that he had paid 40% tax on.
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