Landlords: should you move your portfolio to a limited company structure?
As a result of the recent changes to how income tax relief on finance costs – such as mortgage interest – has changed, consideration should be given to whether rental property should instead be held in a company, where such restrictions do not apply.
The issue isn’t whether extra tax relief can be obtained by a company, as opposed to an individual, incurring such finance costs – the rate of corporation tax is already lower than the 20% income tax relief available to an individual.
Instead, when weighing up the advantages and disadvantages of personal ownership vs corporate ownership, these new changes very much fall into the category of a disadvantage to personal ownership.
This is particularly the case for higher and additional rate taxpayers. Where there is personal ownership, and that person’s income tax liability increases as a result of these changes, it might now be the case that corporate ownership is the best way forward.
There are various taxes to consider here, both in setting up a company and the ongoing running of it.
We take a brief look at them, although professional advice should be sought before any transactions are undertaken as every case will be different.
Capital Gains Tax (CGT)
Property transferred by an individual to a company will be liable to CGT, based on the market value of the property. This is regardless of what level of consideration (if any) the individual charges the company for acquiring the property.
A rate of 28% will apply on the gain. Some tax relief could be available if the individual ever lived in the property themselves.
Potentially this could be such a high cost, especially with multiple properties, that there is no benefit in undertaking incorporation. This would be very case-by-case dependent.
Fortunately, in some cases incorporation relief will be available to defer some or all of such capital gains.
Incorporation relief should be available where there is a functioning property rental business already in place, rather than just a collection of rental properties.
The distinction is a very grey area, and HM Revenue and Customs (HMRC) has been known to challenge such claims. As such, it should never be assumed that incorporation relief will definitely be available.
The nature of an individual’s activities (in relation to the properties), the time spent by the individual on those activities, and whether the individual has any other trades or employments, are all of relevance when it comes to deciding whether there is a functioning property rental business.
For incorporation relief to be available, it must also be the case that all the assets of the unincorporated rental business are transferred (with the exception of cash, if so desired).
Stamp Duty Land Tax (SDLT)
Assuming no partnership exists, SDLT will be payable on the market value of the properties. This could be anything up to 15% of the value being transferred. Therefore, this too could be such a high cost that there is no benefit to incorporation.
If multiple properties are being transferred, multiple dwellings relief could be available to potentially reduce the SDLT liability.
Alternatively, if at least six properties are being transferred, then the lower non-residential rates of SDLT would apply.
Annual Tax on Enveloped Dwellings (ATED)
ATED applies to UK residential property held in a company. It is a flat annual charge per property.
However, where a property forms part of a property rental business, relief is available to avoid any charge. An annual ATED return will still need to be submitted to HMRC each year though, to claim such relief.
Corporation tax (on rental income)
Annual net rental income, including the full deduction of allowable finance costs, would be charged at 19% (falling to 17% from April 2020). This compares to up to 45% income tax on net rental income from property held personally (including the restriction on the relief for finance costs, when calculating such net rental income).
So potentially an individual could effectively pay a higher rate of tax on a larger figure, despite there being no difference in receipts and expenses.
In a company, the rental income, after corporation tax is paid, would belong to the company. The shareholder would need to extract it out of the company, should they require it for personal use.
Commonly extracting profit out of a company would be by way of a dividend. As of 6 April 2018, the first £2,000 of dividends are tax-free, with anything above this amount liable to income tax at 7.5%, 32.5% or 38.1% (depending on the personal tax rate of the shareholder). The £2,000 allowance applies to all dividends received each tax year, rather than one allowance per dividend source. No national insurance is payable on dividends.
However, it could be that the company is first created by way of a loan. Rather than gifting the property to the company (i.e. no consideration is charged), the property could be sold to the company for anything up to market value – with the proceeds left on loan account, owed by the company to the shareholder.
Repayment of that loan over time, by using the profits generated, would be tax free. A loan repayment is not a receipt of income.
Unfortunately, where consideration is partly or wholly provided by way of loan, this will reduce the amount of incorporation relief available (if it is even available to begin with).
This is broadly because incorporation relief is somewhat tied to the market value of the shares in the new company, and the existence of debt owed to the shareholder will reduce such market value.
Of course, it may be that the shareholder doesn’t want to extract profit out the company. It might be their wish for the company to use it to acquire further properties.
By not having this potential second layer of income taxation (or at least, not until any later decision is made to extract), then the fact that corporation tax rates are lower than income tax rates does become an even greater factor.
Corporation tax (on property disposals)
If a property is sold by an individual, the disposal would be liable to CGT as above. However, if sold by a company then the lower rate of corporation tax applies. This is an important consideration in relation to possible future sales.
Under current rules, a tax saving would be achieved on a gain realised where the seller is a company.
Other points to consider
Tax is not the only consideration; among the advantages of a corporate structure the limited liability protection afforded by a company and ease of transferring future ownership, e.g. to family members, by way of shares (rather than potentially having to directly transfer a variety of interests in multiple properties).
However, there are also the administrative costs of running a company to consider and whether a mortgage lender would allow an existing mortgage to be transferred to a company.
In summary, every case is unique and you will most likely need professional advice to work out which option is best.
Alex Wavell is a chartered tax adviser at Moore Blatch