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Markel Tax

27 Apr 2017

An open door to property incorporation?

Most of you will be aware of the measures which have now been introduced to disallow mortgage interest (and related finance costs) affecting owners of residential investment property.

These measures apply for income tax purposes and companies are specifically excluded from the measures. 

The main benefits of incorporation are that a company pays tax at only 19% on rental profits and a company is not subject to the higher rate interest relief restrictions. Incorporation can, therefore, result in significant long term tax savings for investors.

When a property portfolio is transferred to a company, the investor is effectively selling their property to the company. This can result in capital gains tax (CGT) implications for the investor and stamp duty land tax (SDLT) charges for the company. The tax charges to incorporate, accompanied with the refinancing costs, can outweigh the tax savings available via company ownership. There are, however, reliefs available for investors whose property investments are operated as a ‘business’ to mitigate the CGT and potentially the SDLT tax liabilities.

The new restriction on tax relief for mortgage interest does not affect property held in a company.

It takes advantage of statutory tax reliefs that enable individuals to transfer businesses to a limited company without triggering a capital gains tax charge, subject to various conditions.

We are currently receiving an increasing number of calls from accountants and their clients who are in the process of transferring their properties to a company or who are looking for some incorporation advice. 
We thought it would be useful to share some of those questions here. 

Q: What are the capital gains tax implications of transferring properties to a company?
A:  The transfer of properties to a limited company is a disposal for CGT purposes. However where the property portfolio constitutes an actively managed property business then a statutory relief should apply such that the gains are rolled over into the base cost of the shares issued.

Q: Is the capital gain always held over in full?
A: Generally yes but the hold over can be restricted where the debt secured on the properties exceeds the base cost for tax purposes.

Q: Does the legislation define what an actively managed property business is?
A: No, but there is a substantial amount of case law which has looked at the definition of a business. Typically a property business would constitute at least 10 or more separate rental units which are actively managed. Dependent on the type of property and how they are held the number of properties required may be less.

Q: What if the company disposes of one or more of the properties in the future?
A: Any such disposals are subject to corporation tax. However the gain would be calculated using the market value at the date of transfer as the base cost. In other words the company would only pay corporation tax on future (post incorporation) increases in value.

Q: Will the properties need to be valued?
A: Yes the value of the properties as at the date of incorporation will need to be established. Where there is bank financing involved, this is likely to be required in any event as part of that refinancing exercise.

Q: How is the rental income taxed in the future?
A: All rental income received by the company would be subject to corporation tax, which is currently 19%, reducing to 17%.

Q: Are companies subject to the new interest relief restrictions due to come into force in 2017?
A: No, a company will get full relief for any interest costs it incurs as opposed to individuals who are higher rate taxpayers who will effectively only be able to deduct half of their interest costs. There are company interest restrictions coming into force, however these should only bite companies with a net interest expense of more than £2million. 

Q: Briefly how does it work?
A: The steps are as follows:

  • The investor would establish a limited company.

  • The investor would be appointed as shareholder and director of the company.

  • The properties would be transferred to the company.

  • The company will issue shares to the investor. 

  • The properties would become conveyed so held in the name of the company.

Q: What if the properties are subject to mortgages or if any charges are secured against them? 
A: Where there are mortgages then the lenders approval would be needed before the properties can be transferred. Alternatively the investor could refinance the properties with another lender.

Q: Do banks lend to property companies?
A: Yes of course but you may find that the pool of lenders is smaller and the mortgage rates are not always as competitive compared to standard buy to let mortgages. Our experience of this is evolving as more and more clients are incorporating. Certain banks are more proactive than others.  Of course, investors should consult with their usual mortgage broker if they require further information.

Q: What are the stamp duty land tax implications of transferring properties to the company?
A: The transfer of property to the property investment company may trigger stamp duty land tax charges depending on the value of the properties and how the properties are currently owned. 

Q: Is there an SDLT charge on transferring properties from a partnership to a company?
A: In broad terms no SDLT charge should arise although every situation should be considered based on its specific circumstances.  Specific advice should be sought on this as not all jointly owned investment property will be treated as a partnership.

Q: What if the investor does not currently operate as a partnership?
A: In this case an SDLT charge is likely to arise on the transfer of the properties. However this charge may be as low as 1% for residential properties if Multiple Dwellings Relief applies.

Q: Can the investor transfer some of the properties to the company?
A: No, it is a condition of the legislation that the entire property business must be transferred as a going concern to the company for the various tax reliefs to apply. However, there may be more than one property business.

Q: Can I use an existing company?
A: Yes, although in some circumstances it may be preferable to incorporate into a new limited company.

Q: What are the tax implications if the rental income is extracted from the company?
A: Any rental income extracted from the company, either as salary or as a dividend, would generally be subject to income tax in the normal manner.

Q: What are the inheritance tax (IHT) implications of transferring properties to the company?
A: Broadly there are no IHT implications; the value of the investor’s shares will remain in their estate for IHT purposes. However, incorporating is often useful in establishing different classes of shares that can then be gifted to young generations as part of normal general inheritance tax planning. 

Q: What are the IHT implications for the shares in the company?
A: The shares would be subject to IHT in the event of the investor’s death, depending on the value of their estate and available allowances.  The shares will not qualify for business property relief or any other reliefs from inheritance tax. As noted above, it may however be possible to use different classes of shares to reduce this inheritance tax exposure.

Next article in series

15 Feb 2017

Excluded Property Case