Following on from part 1 of the Property Investor Blog´s extended interview with Simon Misiewicz of Optimise Accountants, in this post we explore the pros and cons of some of the prominent strategies touted as a means of reducing Capital Gains Tax (CGT) and Stamp Duty (SDLT) when transferring properties into a Limited Company. Simon also discusses how investor landlords can engage in a cost-benefit analysis to examine if incorporation is genuinely worthwhile, seek approval from the HMRC and ensure that any future Limited company buy to let purchases are undertaken in an efficient manner.
(5) What are Optimise advising clients who are considering transferring personally owned properties into a Limited Company, particularly with regards to ensuring that General Anti-Abuse Rule (GAAR) are observed? For example, there is a lot of talk of transferring properties into a Limited company and it would be great to hear your thoughts and insights into this.
My view is that investors can incorporate properties but they really need to understand their own liabilities. There are often significant tax issues involved, namely Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT), which are stopping people from incorporating.
Capital Gains Tax can be mitigated through incorporation relief – this will mean that the investor would transfer properties to a limited company at market value by means of the now famously quoted “Ramsay” case (Ramsay v HMRC, 2013). In this scenario, however, there would need definitive proof that the property operates as a business – i.e. you do not use lettings agents or third parties to run the portfolio (the legal precedent was set at 20 hours to demonstrably be working on the business).
In relation to Stamp Duty Land Tax (SDLT), one mitigation strategy is multiple dwellings relief where the taxable amount is based on the average value of the properties being transferred into a Limited company in exchange for shares. Note that the Stamp Duty will be subject to the surcharge of 3% in this scenario. It is possible to be exempt from the surcharge when over 6 properties are transferred concurrently – here, however, multiple dwellings relief would not be available and Stamp Duty would be applied to the total value of the entire portfolio.
By virtue of the 1890 Partnership Act and Section 15 of the 2003 Finance Act, you can also incorporate free from Stamp Duty. Below are the relevant considerations:
- There needs to be two people working together in a genuinely commercial business environment, both with no other form of income;
- One person at the very least must also be in the business managing existing properties. Any work attending networking meetings and seeing new properties will not count;
- One person in the business will need to manage the tenants, not using letting agents;
- One person in the business must be responsible for sorting out maintenance work directly with tradespeople, again without using lettings agents.
The valid incorporation process would therefore necessitate a more hands on approach to the business. Using external companies to manage the properties, for example, would not be permitted unless the partnership employs someone directly themselves but the work is not delegated or outsourced. If these criteria are met, then the following will need to be undertaken:
- Contact HMRC by completing the Partnership form. HMRC will then provide a Unique Tax reference code for the partnership;
- Transfer the income / costs / profit from the property section of your Self-Assessment (SA) to the partnership section and submit for 2-3 years’ (in the most tax-efficient way by allocating the majority of the income to the lowest rate taxpayer for two to three years). Please note that this is not a Limited Liability Partnership (LLP) and any property losses will then be lost as they cannot be offset against partnership profits;
- Once 2-3 years’ worth of accounts as a legitimate partnership have been produced, it is now possible to incorporate the property business into a newly formed company. It will need to be decided what shares each person gets in the Limited company. This can be based on the net assets that each person has brought into the partnership.
However, as this is not a straightforward process, as well as closely assessing your own financial situation with your accountant, you will also need to communicate directly with a mortgage broker as the loans are transferred into the company (when you incorporate, you will need to refinance). We also strongly recommend working with a solicitor to draw up your partnership agreement.
Moving properties into a limited company is an all or nothing process to benefit from the SDLT / CGT reliefs. In other words, you cannot leave some properties as they are in your own name and incorporate others. Furthermore, investors would need to refinance their properties (with a lender that works specifically with Limited Companies); incur redemption penalties owed to existing lenders; pay arrangement fees for new mortgages and take on the extra administrative obligations that comes part of owning a property in an incorporated structure. Both annual accounts and corporation tax returns will need to be submitted for the Limited company by the partnership as well as Self-Assessments as Directors of the business.
Some would quote the use of a mechanism called Deed of Trust, which personally I do not agree with. Here, you are assigning ownership of the property to a company and, in most cases, breaching the terms and conditions with your lender. I have also heard talk of Beneficiary Income Company Trusts (BICTs) – but my fear is that it these schemes are fundamentally operating against General Anti-Abuse Rules (GAAR).
In these situations, everything has to be looked at on a case-by-case basis – unfortunately, there is no “generic” methodology. Above all, it is important to understand your real financial circumstances. Indeed, you may discover that following the above steps to mitigate CGT and SDLT has not saved any costs – particularly if you are considering disposing of any assets in the short to medium term.
(6) Apart from an intention to sell negating any potential savings, are there any simple steps that an investor can take to verify if he/she actually needs to incorporate at all?
Mortgage interest relief is likely hurt those who are employed and are also earning a significant amount of property income. Firstly, although most accountants would advise such people to incorporate, I would always want to look at the losses on their property pages. Should your losses be significant, you might be able to “ride out” these taxation issues in the medium term. For instance, it is worth remembering any large refurbishment costs will create substantial losses to be used for the future. So then in, say, 5 years-time that person may think that they have enough income from their property portfolio that they don´t need to work and then, as their employment income drops to zero, they will remain a basic rate taxpayer and live off the portfolio profits. Therefore, they will not need to worry about the mortgage interest relief.
Another potential avenue is to reduce earned income by putting money into your employment pension, meaning that you will be deemed to be a basic rate taxpayer and, again, the mortgage interest relief issue goes away. Obviously these are very specific examples, but investors may find ways to mitigate the impacts based on their own circumstances and engage in a cost-benefit exercise which takes into account the potential transfer taxes explored above (CGT and SDLT), extra costs and implications of running a Limited Company.
(7) With regards to any tax-planning decision that a landlord decides to make, for peace of mind can any approval (such as via formal letter or confirmation) be sought from the HMRC?
Yes they can. Tax evasion is a serious issue and HMRC will closely examine “intention”, retrospectively where necessary. As long as investors fully disclose the tax mitigation scheme, then it is possible to obtain a “pre-transaction ruling” or a “non-statutory clearance” (in writing) from the HMRC to be certain that there are no contraventions of General Anti-Abuse Rules (GAAR), Disclosure of Tax Avoidance Schemes (DOTAS) and other tax evasion laws.
(8) Apart from interest payment tax relief, what do you feel are the main benefits from a taxation perspective of purchasing a property through a Limited company (Special Purpose Vehicle)?
The first obvious one is that, if you are not receiving any dividends, then a Limited Company can pay you up to £5,000 tax free (note that this will be reduced to £2,000 from April 2018). The second is that it can pay money into your personal pension and, by doing so, the amount of profits that the company is making can be reduced and therefore the amount of tax owed also decreases. There are others ways of building into trust funds that can be used to pay for your children´s private education as well as ways of making family members shareholders of that company, making dividend payments and reducing inheritance tax liabilities (you are effectively passing shares of a company to the beneficiaries). The company would need to be structured in the correct manner – for example, if you are looking for mortgages that will lend to the Limited company, investors would need to ensure that they hold at least 80-85% of the shares.
Paying yourself dividends from an SPV to subsequently invest in more properties can end up being tax inefficient. However, investors can lend between SPVs – so, as an individual, if you were to extract trading profits from one company to lend to another property company to pay for the deposit, you have not become involved in the process and so there are no income tax liabilities. I would caveat this by stressing that the lending company would need a financial return to overcome any potential GAAR issues. A commercial rate of interest would be the most appropriate in these circumstance, and the transaction would need to be demonstrably viewed as operating at arms-length.
(8) What would be the best and most cost-effective way to undertake the process of purchasing a mortgaged buy to let property using a SPV – appreciating the need for speed in most circumstances? Should one property be purchased in an individual SPV or can multiple units be acquired under one “umbrella” SPV?
The best way is to be open, transparent and have all the information to hand. So if you know that you´re buying a property in a Limited Company, you will need have everything you need to satisfy the needs of the lenders. The classification should either be 68100 (buying and selling of own real estate) or 68209 (other letting and operating of own or leased real estate) and you will need to have an appropriate name, registered office (your accountant), trading address (your office / home) and established Directorships. We recommend discussing share classifications with your accountant, solicitor and/or estate planner. Prior to purchasing, investors should have their company set up with an associated bank account so that there are no administrative hold ups. Investors should also ensure that they are working with an experienced mortgage broker that understands their specific circumstances. In addition to information related to the personal guarantee and confirmations of a clean credit rating, any capital being injected into the deal will need to be readily transferable. As long as you work with your broker in a timely manner and nothing is withheld, things should move forward quickly. My personal mortgage actually took me longer to get compared to borrowing through my Limited company.
I would not recommend purchasing an “off the shelf” Limited company – and it is always best to obtain the correct advice whilst ensuring that the company is clean (i.e. with no historical issues that could adversely affect any loan applications). Investors would need to be certain that they can legitimately issue dividends out to other family members, for example. Using the standardised online forms may not have the right clauses in accordance with how you would want to tax plan and futureproof you property business(es) in the most appropriate manner.
(9) Bar additional annual returns, confirmation statements etc. to Companies House, what would be the extra obligations that a landlord with property/properties purchased in a SPV would have to take into account?
Investors need to know about their responsibilities as Directors of companies. Annual accounts will need to be submitted to Companies House as well as HMRC tax returns – both after 9 months and 1 day of the year end. In most cases, you will also need to notify the banks and loan providers of the performance of the company and forward year-end financials. This will mean that bookkeeping and related administration should not be left to the last minute. Lenders, for example, will normally want to see accounts before 3 months of the year end. This all depends on how choosy the lender is – some are satisfied with the information received during the initial due diligence process but many are become increasingly strict.
Uniquely positioned in the marketplace to specifically serve buy to let property investors and traders, Optimise Accountants offer a range of services from advice on starting a portfolio, profit maximisation, Limited company structuring / restructuring, tax returns and fully compliant mitigation strategies. Book a free consultation by clicking here.