Buy to Let Incorporation?
Mike Chapman, Senior Manager at Knill James Chartered Accountants Corporate Tax department, looks at the significant impact government changes will have on the booming buy-to-let market and considers whether incorporation is the way forward.
If private landlords thought that George Osborne had something against the buy-to-let industry following the Summer Budget, further measures revealed in the Autumn Statement make Government policy seem more like a full blown vendetta. In quick succession the following have been announced:
• The phasing out by April 2020 of higher rate tax relief on interest on property borrowings of private landlords;
• The abolition from April 2016 of the ‘wear and tear’ allowance in respect of furnished rental properties;
• The introduction of higher rates of Stamp Duty Land Tax (SDLT) from April 2016, specifically aimed at buy-to-let properties and second homes; and
• From April 2019, an acceleration of the payment date for Capital Gains Tax (CGT) due on the disposal of residential property.
It’s clear that the fiscal pressure being exerted on the buy-to-let sector is intended to free up property to enable first time buyers to enter the market, but in the short-term this has had the opposite effect. As recently reported by the Royal Institution for Chartered Surveyors, the number of homes coming onto the market during the first quarter of 2016 has been insufficient to satisfy the demand generated by landlords seeking to boost their property portfolios ahead of the SDLT increase scheduled for April.
What recent activity in the market also shows is that there has been a significant swing towards the acquisition of rental properties by corporate investors, something that was predicted following the apparent focus of the new legislation upon buy-to-lets in private hands. The fact that the Government is also consulting on SDLT exemption for companies holding more than 15 properties has led commentators to believe that the trend towards incorporation will continue to increase beyond the uplift in SDLT rates on 1 April.
Apart from the possibility of a more benign SDLT regime there are other fiscal advantages to the holding of rental properties in a corporate structure:
• The restriction to the interest relief on borrowings to acquire rental properties does not apply to companies;
• Corporation tax (CT) rates applying to rental profits accruing to a company are significantly lower than the income tax rates applicable to an individual landlord. The single CT rate currently stands at 20 per cent while income tax rates can be as high at 45 per cent;
• On the disposal of an investment property in a company a CT rate of 20 per cent applies to the gain and companies are still able to claim indexation relief, a deduction that removes the impact of inflation from the gain calculation. For individuals, capital gains are taxed at rates up to 28 per cent and there is no indexation allowance.
Given the apparent tax advantages enjoyed by property letting companies are we likely to see a swathe of private landlords opting to incorporate their businesses? Maybe not. Apart from increased compliance costs and the disadvantage of the ‘double charge to tax’ (profits and gains are first taxable within the company and then on the landlord when funds are extracted), incorporation involves the disposal of the chargeable assets by the individual landlord or landlords to a company, which has separate and distinct legal personality. This means that a capital gains tax (CGT) charge on the individual landlord is a distinct possibility.
There does exist ‘incorporation relief’ whereby any gain on transfer can be deferred until the shares in the new company are themselves disposed of, but HMRC has traditionally taken the view that the relief could not apply to property investment activities. HMRC’s attitude was based on the perception that property investment could not fulfil the ‘business’ criteria required for incorporation relief.
In a recent case however (Ramsey v HMRC) this position has been challenged and HMRC has shifted its position, now stating in its guidance:
“The Ramsey case endorsed the approach … that for there to be a business for incorporation relief there has to be ‘activity’ and that just a modest degree of activity would not suffice. It also shows that it is the quantity and not the quality of the activity that is important.”
The facts of the Ramsey case involved the landlord in management and maintenance of the properties for approximately 20 hours per week with no other occupation undertaken. The HMRC guidance however, remains somewhat vague so any landlord considering incorporation, where the potential gains could be material, would be well advised to seek an HMRC non-statutory clearance to see if the relief applies prior to undertaking the transaction. Even after obtaining a CGT clearance, incorporation may not be tax free as, unless further criteria are fulfilled, the transfer of property into corporate ownership may give rise to an SDLT charge on the market value of the property transferred.
As with all material transactions, the watchword must be to obtain advice. The current landscape concerning the property rental sector is however far from static and there is always the risk that today’s advice could soon be overtaken should the Government’s next target be property investment companies and not just individual landlords.
Mike Chapman, Senior Manager, Corporate Tax, Knill James Chartered Accountants
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