Why a ‘One-Size-Fits-All’ Approach Should Never be Applied to Landlord Tax Planning
Prior to introducing the Section 24 legislation “restricting finance cost relief for private landlords to the basic rate of tax” in his Summer 2015 Budget, the Chancellor at that time (George Osborne) commissioned the OBR (Office of Budget Responsibility) to produce an impact report. That report suggested that 19% of all private sector residential landlords would be affected by the legislation and pay more tax. Therefore, we can deduce that circa 400,000 UK landlords have mortgages and are higher rate tax-payers.
The Property118 Tax team are specialists in advising on incorporation relief, but very few landlords actually qualify for reliefs to make a viable case to actually proceed. Therefore, it is important to note that Property118 and Cotswold Barristers also recommend a variety of other ownership structures. All recommendations are bespoke, we do not believe in a ‘one-size-fits-all’ approach.
Before I move onto some of the other solutions we recommend (and others we don’t) I will outline the profile of landlords who are more likely to be recommended to transfer their ‘whole business’ into a Limited Company in exchange for shares.
These landlords will commit at least 20 hours a week to run their established rental property businesses and meet the definition of the Partnership Act 1890, i.e. “two or more persons engaged in business with a view to profit”. Their rental property business will comprise a minimum of 10 dwellings. That could be 10 separate houses or flats, one large property comprising 10 dwellings or even two or three properties such as student lets or HMO’s comprising 10 or more dwellings between them. All ‘partners’ will also be higher rate tax-payers. Please note this is an absolute minimum guideline.
Given that less than 5% of all UK rental property owners will meet the above criteria, this means that alternative solutions will need to be considered for the others who might well be paying more tax then is necessary.
In many cases, forming a partnership with other family members will be the way forward. Such arrangements facilitate business succession planning and opportunities for both income tax and legacy planning. This is because the profits of the rental property business can be allocated between family members to fully utilise their lower rate, tax bands. Furthermore, profit allocation is very different from drawings. A very good example of the use of a family partnership structure can be found via the article I have linked to below.
HMRC’s manuals sate as follows:-
“There are few restrictions on who can be a partner. Both natural and artificial persons, such as companies, can be partners.
It is not a requirement of a partnership that each member is physically capable of performing the full range of the activities of the partnership business, but each must be capable of performing a part of the activities, even if that role is only to provide finance. A partner who plays no active part in the business but has contributed capital is often described as a ‘sleeping partner’.”
“Spouses and civil partners can enter into a partnership with each other. Sometimes this is done for tax planning reasons as it may be advantageous for a person to share their business profits with his or her spouse to maximise the use of their personal allowances and basic rate tax bands. HMRC is unlikely to challenge such an arrangement.”
Mixed Partnerships are another structure we consider but recommend even less often than we recommend incorporation. There are several reasons for this, but the most common are:-
- Mortgage Lenders do not like mixed Partnerships – Paragon Mortgages criteria specifically precludes lending to them
- The advantages of being able to transfer income to a corporate Member of an LLP in order to facilitate a lower rate of tax on retained profits has been legislated against year after year for over a decade by HMRC
- Mortgage liabilities cannot be transferred to a corporate Member of an LLP without transferring the underlying assets at either a legal or beneficial ownership level. These transfers trigger Capital Gains Tax because mortgage liabilities cannot be offset against the transfer of legal or beneficial ownership and there is no ‘incorporation relief’ either unless the ‘whole business’ is transferred and all other eligibility criteria for incorporation relief are also met.
Where a landlord intends to acquire further investment properties, we often recommend two separate solutions. This might be a family partnership for existing rental properties and a Family Investment Company for future acquisitions.
Family Investment Companies are an extremely popular structure with our clients. For further details please read the linked article below.
There can also be massive tax advantages associated with emigrating to another country, but be careful which one you pick!
I fully appreciate that moving to a different country is a huge decision to make. Whilst this step may not be appropriate for you now, I think it is worth pointing out the benefits. They can be significant!
For example, when you are non-resident you don’t pay tax on dividends in the UK. Instead, you pay tax in your country of residence. However, some countries do not charge tax on overseas dividend income. The most tax-efficient country in Europe at the moment is Portugal under their NHR scheme. Not only do you pay no tax on UK dividend income for the first 10 years, you only pay CGT on capital gains made on UK property since April 2015, regardless of how long you owned it for or how much it rose in value up to that date.
Dozens of landlords that Property118 has consulted have taken advantage of the planning opportunities associated with moving abroad, either before incorporating their property rental business or afterwards. Others don’t incorporate at all, they just relocate before selling up, to reduce the amount of CGT payable of course. Some landlords with particularly valuable property businesses save millions in tax just by retiring to a place in the sunshine.