BUY-TO-LET LANDLORD CLIENTS SEEKING TO INCORPORATE? LAWYERS TAKE CARE!
Former Chancellor George Osbourne’s last summer budget saw the introduction of new restrictions on buy to let mortgage relief.
Historically buy-to-let landlords who owned their portfolios personally (as opposed to via a company) could offset their interest costs from the rental income received to reduce the amount of profit charged to tax.
From April 2017, this relief will be phased out over 4 years and be replaced with a new system whereby landlords will no longer calculate taxable profit with the ‘deduction of interest costs’, but rather will apply a basic rate 20% tax relief.
The detail of how this all operates is quite complex, but in simple terms a landlord who is a higher rate income tax payer will, by 2020/2021, only get half as much tax relief.
As a result, landlords with a high amount of gearing and interest on their portfolios (in comparison to rent received) could actually see their profits eliminated or worse still their portfolios running at a loss.
This has prompted many landlords to consider restructuring their portfolios into companies which can continue to offset finance costs.
However, great care should be taken when acting for a client who wishes to incorporate his or her portfolio, as significant tax charges can arise if certain conditions are not met.
In very basic terms, an unincorporated business can be transferred into a company in return for the company issuing shares to the transferor. There will be no capital gains tax on the transfer of the business assets if certain conditions are met (incorporation relief) but this may not always be the case. For example, it is necessary to determine whether there is even a ‘business’ which is being transferred? Or is it simply the transfer of an investment asset? The principles which determine this require detailed analysis. Fail to meet the conditions and a capital gain tax charge could arise.
Likewise, Stamp Duty Land Tax (SDLT) is another potential bear trap. If the portfolio is transferred by an individual landlord, the company is seen as ‘buying’ the property for market value and must therefore pay SDLT on the value (this could be up to 15% of value given new surcharge rates).
If however a partnership (rather than an individual) incorporates a business, it may be possible to benefit from a special SDLT provision which in effect means the company would not pay SDLT. However, if the transferors fall short of qualifying as a partnership or the partnership has been created for a purely tax avoidance motive, the relief will not be available and the company could end up with a crippling stamp duty bill.
In summary, all property lawyers instructed to convey portfolios from personal ownership to a company in which the client is to receive shares, should take expert tax advice to protect their clients from unexpected tax charges that could have serious consequences for the businesses involved.