Posted by Jane Condon on 07 Sep 2018
Property Partnership Incorporation and SDLT
The government has recently been focused on directing private investment away from property and into areas that are more likely to stimulate economic growth, leading to a series of policies targeted against buy-to-let property owners. Following these changes, incorporation may hold some significant advantages, and where properties are held in a property partnership incorporation may be structured to be tax-free.
From 1 April 2016 of a 3% Stamp Duty Land Tax (SDLT) surcharge for people buying second homes and buy-to-let properties. Put simply, if you own more than one residential property at the end of the date of purchase (including overseas properties) the surcharge will apply to that purchase, adding a further 3% to the SDLT that is due.
This was followed by the introduction from 6 April 2017 of a limit to the tax relief available for mortgage interest on letting residential property, which restricts the relief to the basic rate of tax for businesses. This change, which is currently being phased in between 2017/18 and 2020/21, could be crippling for property portfolios with significant borrowing. In some cases, landlords could end up paying income tax on loss-making rental properties!
The restriction on mortgage interest relief has made limited companies more attractive vehicles for property ownership as the relief for mortgage interest is not restricted for corporation tax purposes. In addition, liability from legal challenges is limited, the rate of tax charged on profits is lower and succession planning is simpler.
Transferring properties into a limited company will normally trigger capital gains tax (CGT) and SDLT, but CGT can be avoided if the scale and character of property investment is sufficient to allow the portfolio to be treated as a business. If this is the case, incorporation relief can postpone tax on any increase in property values prior to the date of incorporation until the shares in the incorporated business are sold.
Due to the lower tax on profits enjoyed by companies, greater reinvestment of profits is possible in order to reduce mortgages and grow the business, and although further tax arises when funds are extracted from the business (usually as dividends), the overall tax paid on those profits should not exceed the tax currently paid by an individual or partner, even with the recently increased tax rates on dividends.
However, Stamp Duty Land Tax is normally chargeable on the incorporation of a property business, based on the market value of the portfolio being transferred into the new company. Now that this charge would include the 3% surcharge, there appears to be a significant barrier to incorporation of a property business, but this is not the case for property businesses that are run as partnerships.
Property Partnership Incorporation
If a property partnership incorporation exists, i.e. the partnership is registered with HMRC, has a written partnership agreement, separate bank account etc, or the properties are within a Limited Liability Partnership (LLP), relief of up to 100% of the SDLT charge is available. Broadly, full relief from SDLT is given as long as the ownership of the new company matches the original partnership shares.
This means that a genuine property partnership incorporation can be made with no immediate charge to tax, preventing the changes to the taxation of buy-to-let properties from making a significant impact, whilst enjoying the benefits of a limited company.
The changes to taxation of buy-to-let properties have been well-publicised and we have seen a number of solutions suggested, many of which seem unlikely to stand up to scrutiny under the anti-avoidance legislation that is available to HMRC. A common suggestion has been to transfer the equitable interest in a property portfolio to a limited company while retaining the legal ownership so as to not disturb the existing borrowing. Even if the lenders are willing to allow beneficial interest to be transferred in such a situation, it is important that any restructuring that you undertake is carried out on a sound commercial basis rather than being an artificial arrangement that HMRC can overturn using the General Anti-Abuse Rule or other, more specific legislation. It is our opinion that a contrived arrangement such as the transfer of beneficial interest while legal ownership is retained will be very hard to justify as a commercial arrangement meaning that the scheme would be ineffective for tax purposes.
It is important that the shock of the potentially large increases in tax payable on buy-to-let properties does not lead to taxpayers forgetting the basis of sound tax planning: any steps taken should be sensible, commercial decisions that reflect the underlying reality of the taxpayer’s position, rather than contrived arrangements with no commercial basis that distort the taxpayer’s situation in order to obtain a tax advantage. However, if you have a genuine property partnership incorporation, it could be a tax efficient way and sensible way of restructuring.
This area of tax planning needs to be approached in a level headed manner. We are able to bring such an approach to your personal situation and indeed give our view on any of options that may have been put to landlords as a way of managing the exposure to the new regime.
If you would like any advice regarding the above article or would simply like to discuss other ways in which we could help you or your business, please contact us on 01962 856 990 or firstname.lastname@example.org
- Non-Resident Landlords – UK Tax Update
- Tax Relief For Residential Mortgages
- Property Partnership Incorporation and SDLT
- Overseas Pension Changes 6 April 2017
- Non-Resident CGT – April 2019 Changes