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  • Tax

    Why BTL incorporation is an expensive mistake



    Why, in our option, incorporation is the worst and most expensive mistake landlords will ever make.

    Overview

    Since the introduction of the 3% Stamp Duty (SDLT) uplift and George Osborne’s now infamous S24 landlord tax and everything that went with it, such as the removal of the wear & tear allowance, and the additional 10% Capital Gains Tax (CGT) surcharge for ‘investment’ assets, landlords are being told that the only answer is to incorporate, i.e. move their property portfolio into a limited company.

    And, as limited companies can deduct 100% of their finance costs and the like, that would be the obvious thing to do.  The trouble is that what landlords are not being told is that incorporation is a one-way street and will be the most expensive ‘business’ decision/mistake they ever make.

    Here’s why.  Apart from the transactional costs (re-mortgaging, professional fees, etc.) and the significantly higher tax regime that you’ll eventually find yourself in, you’ll have to qualify for what is known as S162 Incorporation Relief.  In basic terms, that means the transfer of ownership of all your ‘investment’ properties at the same time from being in your name, to that of your limited company without having to pay CGT or SDLT in the process.  By the way, you can’t transfer properties one at time, incorporation and S162 is an all or nothing one-way street.

    Pretty much up until the end of 2017 HMRC was happy to give non-statutory clearance for S162 applications, meaning that you had the certainty that there wouldn’t be a massive and wholly unexpected tax bill upon completion.  Sadly, that’s no longer the case, which means that you won’t know whether you have a tax bill or how much it’s likely to be until it’s too late to stop.  BTW, there’s no way back once you incorporate and, as you’ll see later, the tax position gets progressively worse.

    By the way, when it comes to mortgages, upon incorporation you go from being a private individual with a whole raft of consumer legislation to protect you, to becoming a commercial borrower whom the law expects to be able to look out for themselves; which if you’ve ever entered into a non-regulated finance agreement you’ll know is a very different world.

    If, perchance, you’re being told that by using a Beneficial Interest Company Trust (BICT) you can avoid the need to remortgage, then think again.  BICTs constitute a breach of your mortgage terms and conditions, and some lenders have powers to call in the debt if any others do so even if your account with them is otherwise in good order.

    The transactional costs

    The value of your time to one side, moving from being a private landlord to a corporate one will incur you in the following costs: -

    • CGT and SDLT if you don’t qualify for S162 Incorporation Relief (you won’t know until it’s too late)
    • Early redemption charges
    • Brokers fees
    • Lenders fees
    • Legal fees
    • Loss cannot be carried forward

    Whilst not in themselves direct transactional costs, being a commercial borrower impacts you in the following ways: -

    • Significantly reduced choice of lenders and higher interest rates; the majority won’t lend to limited companies, and none are keen on BICTs as they fundamentally weaken their ability to pursue the debt.
    • Lenders will mostly require full personal guarantees on a joint & several basis from all the directors and shareholders (if the company goes bust you remain responsible for the debt).
    • Lenders will take a debenture (legal charge) over the company’s balance sheet, which restricts your ability to make best use of your director’s loan account if at all.
    • You’re tied in to the first lender and their appetite for further lending, if any, meaning that each new acquisition or remortgage may need a new lender and a new company if your existing lender isn’t interested.
    • If property prices fall thereby increasing the loan to value beyond the point to which the lender originally agreed, you’ll have to find the cash difference
    • Restrictions on what you can borrow for i.e. remortgage to fund lifestyle.

    The tax position

    Limited Companies and the individuals within them are taxed up to seven different ways: -

    • Corporation Tax (19% falling to 17%, but could be uplifted for ‘property/investment’ companies, as CGT was for individuals)
    • Capital Gains Tax on personal withdraws of capital resulting from selling assets (10%, 18%, 28%)
    • Directors Loan Account Tax (32.5%)*
    • Dividend Tax (7.5%, 32.5%, and 38.1%)
    • Income Tax (20%, 40%, 45%, and 60% on the slice between £100,000 and £123,700)
    • Employees and Employers NIC (12% and 13.8% respectively)
    • Inheritance Tax (40% - ‘investment’ companies, i.e. those that hold residential property for 12-months or more for the sole purpose of collecting rents, are fully subject to IHT)

    *FYI, very short duration bridging loans where the money never leaves the conveyancer’s client account(s) and has no obvious commercial purpose is tax avoidance!

    Compare that with the benefits Mixed Limited Liability Partnerships enjoy, and you’ll see why we prefer them over the simple limited company route.

    When properly arranged and managed, hybrid tax and property ownership delivers a recognised business arrangement that means: -

    • No need to remortgage or change title, thus no CGT or Stamp Duty
    • Tax from your property income at basic rate regardless of how much you draw
    • Seamless succession planning with Inheritance Tax typically mitigated within two years
    • Two layers of commercial limited liability and protection against family/marital break up
    • Maximum commercial flexibility and choice of finance
    • Being fully in line with Government policy to professionalise the sector and compliant with both the letter and spirit of the law
    • Quick, easy, and cheap to unwind if the rules change
    • No tax on the withdrawal of capital
    • More money in your pocket ?!

    The legal position

    “Every man is entitled if he can to order his affairs so that the tax attaching under the appropriate Acts is less than it otherwise would be. If he succeeds in ordering them so as to secure this result, then, however unappreciative the Commissioners of Inland Revenue or his fellow tax-payers may be of his ingenuity, he cannot be compelled to pay an increased tax.”  Lord Justice Tomlin - IRC v Duke of Westminster (1936)

    • HMRC clearance is NOT required
    • Hybrids do NOT fall under the Declaration of Tax Avoidance Schemes (DOTAS) provisions
    • Hybrids do NOT fall foul of the General Anti-Abuse Rule (GAAR)
    • Hybrids ARE allowed under the Generally Accepted Accounting Principles (GAAP)
    • Hybrids are legitimate business structures and NOT tax avoidance schemes
    • Hybrid income IS treated as trading income
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    Tony Gimple

    Founding Director

    Less Tax For Landlords

    There is a Major Plus with a Company formation which you never mention

    With Pension freedom today Pensions can pay a very large Part in a Company formation

    I don't need to out line the benefits but they are there and can make a Company strategy very tax efficient

    when I help BTL in my own name I had very limited opportunity to fund a pension even thought it would have been handy as a 40% tax payer

    Now as a Company Director I can fund my pension up to 40k a year and its a super way of extracting profits with Zero tax implications and that's not to say nothing about the hedge it has for IHT planning

    I do follow your blogs with great interest

    Regards DL


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    Learn Change and Adapt ?????


    I do wonder if the Mixed Partnership scheme falls foul of HMRC’s ‘transfer of income streams’ rules. HMRC do not like income from an asset passing through a company owned by the same person as the asset without the underlying asset also transferring to the company.

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    Thanks for the interest DL, but before I answer your point, I must state that we're not authorised to give investment advice, and anything to do with pensions and the like should be run by a financial adviser.

    The ability to make pension contributions is a function of being in receipt of earned income, which doesn't have to come from a company employment as a director.  LLP's can pay also pay salaries, although in either case there limits to how much can be put in i.e. the so called 'pension cap'.  Self-administered/invested pensions can buy commercial property, albeit they can be expensive to set up and run, and there are limits to how much of the fund can be used.

    BTLs are, in their own right, pensions.  Moreover, they are far more flexible, are not subject to same limits or regulation, you don't need a financial adviser to administer them, and are far less susceptible to the kind of volatility that equities experience.

    Would I incorporate my portfolio just to gain a limited pension benefit?  No.


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    Tony Gimple

    Founding Director

    Less Tax For Landlords


    I have to say with you that I disagree

    Today we have all seen changes and my own feeing is that its not either BTL or Pension  it should be both

    None of us know what the Govt has up its sleeves against this sector

    If a Landlords has the Brains to set up a company and run a business they have the Brains to set up a pension at Zero cost

    Most Professional Landlords read about wealth creation so reading a book on the new pension rules and advantages is not hard to do

    Its my own intention to exploit to the Maximum  SIPP

    Any investment which is totally tax deductible and Tax free in just about every way should not be ignored

    I agree just setting up a Company to pay a pension is stupid

    But I look at my Pension as my Tax Free Haven for IHT and it also can not be taken from me if I went Bankrupt

    But I have done it for a number of  reasons as an older Landlord

    My main reason is succession

    If I pass away tomorrow God Forbid My shares pass to my family with out the problem of having to refinance all the Mortgages ect

    You and I know One Size doesn't fit all and every aspect of Taxation should be used

    for some a Company can work quite well.

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    Learn Change and Adapt ?????


    Hi Tony

    Would you be kind enough to expand please on the extracted parts below?

    When properly arranged and managed, hybrid tax and property ownership delivers a recognised business arrangement that means: -

    • Tax from your property income at basic rate regardless of how much you draw
    • Seamless succession planning with Inheritance Tax typically mitigated within two years
    • Two layers of commercial limited liability and protection against family/marital break
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    Debbie Franklin

    Director of Tax Peplows Limited

    CTA ACA FCCA


    It is a good job you are not permitted to give advice given the many things you got wrong here.

    • Director's pensions have nothing to do with earned income. They can be paid up to £40k even if you have no qualifying income.
    • SIPPs need not be expensive to set up and run.
    • Pensions need not be wholly invested in equities.  They can be invested in anything (even residential property though not directly).
    • Being able to take £40k out of a company free of all tax may be a limited benefit but it is quite a high limit.
    • If the purpose of your properties is to act as a pension then having them in a company so that the profits go into an actual pension tax free is a good scheme.

    If the purpose of your property io provide income before 55, or you are making more than £40k pa  from property than you might not  want to incorporate, but otherwise it can work well.

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    Can Ltd Cos not also get Taper Relief to reduce Capital Gains for Inflation ?

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    Indexation is no longer available from 1 January 2018.

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    Debbie Franklin

    Director of Tax Peplows Limited

    CTA ACA FCCA

    Hi Tony,

    I know Chris Bailey is the Chartered Accountant promoting your mixed partnership.I also know that Chris is a landlord. Does Chris himself own his properties in a mixed partnership?

    The only reason most landlords will not do the mixed partnership is because they are worried about an HMRC investigation years down the line.

    A Real Estate Investment Trust seems to be a possibility.

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    Hi Bill,

    Best that you speak with Chris about his own tax affairs Smile.

    As to a possible future HMRC investigation, that exists whether you're in a mixed partnership or not.  Our PI covers all investigation costs, as well as fines and penalties on the off-chance we lost.  Moreover, they are not something that can be done on a DIY basis or by the vast majority of high street accountants, as it's being able to prove that it's being done for commercial reason and not simply to gain a tax advantage.  Sadly though, a general forum makes it difficult to give a more personalised response.

    REITs are an option, but the costs, limits, and regulation make them unattractive.

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    Tony Gimple

    Founding Director

    Less Tax For Landlords