14 October 2016
The recent changes affecting buy-to-let landlords have prompted a number of articles in the financial press, and elsewhere, on the topic of the incorporation of a buy-to-let portfolio. However this is certainly more “minefield” than “no brainer” on the decision making scale. Let’s first of all re-cap on the changes that might be troubling landlords:
- Withdrawal of the wear and tear allowance
Prior to April 2016, landlords had been able to claim a wear and tear allowance (10% of rental income) which reduced the tax they paid on furnished properties irrespective of whether such wear and tear led to expenditure on replacing items. Now, deductions are only available where expenditure is incurred on replacing items. This change will not be well received by the more, shall we say, parsimonious in the landlord community.
- Stamp Duty Land Tax
April 2016 also saw the introduction of new higher rates of Stamp Duty Land Tax (SDLT) for additional residential properties such as buy-to-let or second homes. Essentially we’re talking about a 3% margin on top of the regular SDLT rates for each valuation band.
- Losing interest
Tax relief on mortgage costs is to be restricted from April 2017 onwards, and by April 2020, no higher rate (or additional rate) tax relief will be available. Additional rate taxpayer landlords, whose modus operandi has been to borrow heavily in order to grow portfolios quickly, are clearly the group most affected by these changes.
Meanwhile, there are at present no plans for such restrictions on the deductibility of interest to be applied to companies. It is really this difference which is prompting some landlords to consider “incorporating” their property portfolio, but what else should be taken into account when contemplating such a move?
Well, for starters our landlord – let’s call him Rigsby – needs to decide whether he wants to have one company owning all of the properties, or if it should be one property per company, or somewhere in between. There is quite a bit that goes into even that decision – too much to cover here so let’s work on the basis of a single company. With Rigsby Housing Limited (RHL) duly incorporated, what would happen next?
How is the company going to buy the houses?
We have here in RHL a brand new company with no track record, and no credit rating, and we have also introduced the concept of limited liability status – not necessarily an enticing prospect for a lender. The one thing in Rigsby’s favour may be that the values of the properties have increased since he acquired them; meaning that the ratio of the amount he needs to borrow versus current market value is now lower. There will be lenders prepared to look at such situations but the overall cost of borrowing will be higher than on the mainstream buy-to-let market. Some commentators have suggested that there may be means by which current financing arrangements can be left in place by separating legal and beneficial ownership of the properties, but it would take a brave or desperate landlord to try this manoeuvre in the current anti-tax-avoidance climate.
Won’t tax be payable on the transfer?
On the face of it, yes. The assets would be transferred to the company at their market value, and if that’s higher than the prices paid by Rigsby, he could be looking at a Capital Gains Tax (CGT) charge, though he will have an annual CGT exemption available. Rigsby could however, if the facts supported it, look to utilise incorporation relief so that the CGT charge is effectively rolled over into the shares he will own in RHL. This relief doesn’t cover SDLT so that will be payable by the company, although there are some intermediate steps that could be looked at in order to have the relief extend to the SDLT charge – too much detail for here though.
What’s the year-on-year tax position?
For the purposes of calculating profits, there would no real difference from owning the properties privately, other than the fact that, (we stress again) at present, there would be no practical restriction on the amount of interest relief that could be claimed. Corporation Tax at 20% (falling to 19% from 1 April 2017, and 17% from 1 April 2020) will be payable on the company’s taxable profit and Rigsby would probably be looking to take a dividend each year on which he would pay tax (at up to 38.1%) but only on amounts over the £5,000 dividend allowance.
Another thing Rigsby will need to be aware of is the Annual Tax on Enveloped Dwellings (ATED) – or put more simply tax on expensive houses owned by companies. The ATED charge now applies to residential properties over £500,000 with an annual charge of £3,500 on properties valued between £500,000 and £1,000,000. Although there are exemptions for landlords, there’s still a requirement to complete returns, with the usual ‘stick’ of penalties if not completed on time.
Won’t there be some landlord & tenant niceties to take care of if the landlord changes?
Yes, but we’ll have to leave that area to our learned friends. Suffice to say, advice should be sought.
What if Rigsby sells the properties from within the company?
The properties are likely to have been transferred into the company at market value, so a property sale soon after transfer is not likely to give rise to much of a gain and therefore not much of a tax charge. For more distant disposals, the property cost for tax purposes will be inflated by the rise in the Retail Price Index, so the level of taxable gain will depend on how much property value rises outstrip that index. Gains are taxable at Corporation Tax rates, so dependent on timing, 20% or less.
What if Rigsby sells the shares in the company rather than the properties?
The cost of the shares for CGT purposes will be the original cost of the properties (ie. what Rigsby paid), so if the properties have continued to increase in value and/or borrowings have been repaid, it’s likely that the company value will be much higher than its cost for CGT purposes. CGT will be payable on such gains at 20%, if current tax rates and rules prevail.
Rigsby also needs to think about what would be involved in unravelling all of these arrangements, and evaluate the chances of the Government passing legislation that meant company landlords were equated with private landlords. This is not something to enter into lightly.
If you are a buy-to-let landlord and would like to discuss your options in detail, please contact your local tax expert.