In April, there was a major change to the income tax rules for landlords. Tax relief is now going to be restricted to basic rate only, with the changes phased in over four years. Individual circumstances on the restriction could produce high effective tax rates.
The restriction will not apply to companies, prompting landlords to question whether it might be better to incorporate their property business.
Tax on incorporation
If existing residential properties are transferred into a company:
- This will be treated as a market value disposal for CGT purposes
- CGT will be charged at higher rates of 18%/28%
- HMRC are unlikely to accept reliefs (gift relief, incorporation relief, Entrepreneurs’ Relief) as it will be viewed that property letting as investment, and not a trade or business.
- There may be Stamp Duty Land Tax charge
Is it vital to look closely at the property portfolio before deciding whether to incorporate. There is a possibility that the tax charges arising on transferring properties into the company cancel out any potential advantages.
If this is the situation, then it could be worth considering making future property purchases through a company, and keep current properties in personal ownership.
While new mortgage interest restrictions do not apply to companies, and corporation tax rates are lower than income tax rates, the following need to be considered:
- Individuals will have tax relief at 20% on their interest payments versus 19% (falling to 17%) for companies
- Taxation of shareholders when profits are extracted
- It has been proposed that the dividend allowance, will be reduced to £2,000 in a future year (potentially from April 2018).
The level of any tax savings depends on the individual needs to draw from their business – the additional income tax payable on large dividends may cancel out any other savings.
Long term plans for the property business is important, especially any future exit:
- Individuals receive an annual exemption for CGT purposes (currently £11,300 per annum) whereas companies only receive indexation allowance
- When a company sells properties there are two potential tax charges – one on the gain and another when profits are extracted
- If a company is liquidated or sold the lower 10% / 20% CGT rates will apply to any gain on the shares (as opposed to the higher 18% / 28% rates if the properties are sold directly)
- CGT Entrepreneurs’ Relief and IHT Business Property Relief are unlikely to be available whether the business is incorporated or not
- Anti-avoidance measures such as the Transactions in Securities rules and the new company distribution Targeted Anti-Avoidance Rule can require distributions on winding up to be treated as income instead of capital if there is a tax motive.
As well as tax implications, it is important to consider wider legal implications. Practical implications of incorporation also require attention, including:
- Administrative costs of running a company
- Will a newly formed company be able to borrow at the same interest rates?
- Does the mortgage lender need to approve any transfer of properties into a company?
Pros and cons of incorporation have to be considered on a case by case basis.
It is important when making this decision that landlords and advisers do not focus on a single issue, but look at the bigger picture including the areas highlighted above.