Owning a property portfolio can create a challenge for even the most experienced investor. As of 2015, the Government’s amendments to property taxes has left most Property Investors with the question of how to make their investments financially viable.
Changes to the availability of mortgage interest relief are due to start affecting rental profits from 2017/18, along with changes to the long-standing concept of the Wear and Tear Allowance. Other barriers to entry to the property marketplace include the increasing SDLT costs for buy to let and second homes over £40,000.
In many cases, property is commonly held personally either by the individual or as part of a partnership. These portfolios are often built up over a number of years, going through the property lifecycle and morphing into a property business. Holding a property in this manner allows freedom of choice in respect of the type of property, i.e. it can be either residential or commercial, whilst also offering the investor flexibility with the asset, access to income and capital, and all within a reasonably straightforward legal and compliance environment. The question these businesses now face is what to do next?
A common theme amongst property investors is around the concept of incorporating their property business, that is taking the investors’ property business and incorporating into a UK limited company. This is suitable for those who run an active property business and want to create an Income Tax (“IT”) and Capital Gains Tax (“CGT”) efficient environment.
Whilst the advantages and disadvantages of various ownership structures are often discussed, for many property investors who wish to consider a change of ownership structure, the CGT consequences of property incorporation can be prohibitive without the ability to claim Incorporation Relief under the Taxation of Chargeable Gains Act (TCGA) 1992
Incorporation Relief allows the investor to defer their charge to CGT by rolling over the chargeable gain arising on transfer of the property to the company against the base cost of the new company shares. Therefore, the gain will become subject to CGT when the shares in the new company are sold.
Incorporation Relief is automatic and no election is required by the taxpayer.
There are three conditions to be satisfied before Incorporation Relief is given:
- The business transferred must be a “going concern”;
- All assets (except cash) must be transferred to the company to obtain the relief;
- The consideration paid to the partner/individual by the company must be wholly or partly in shares.
While the partner/individual, when determining the availability of this relief, can manage Conditions 2 and 3, the concept of “business” in condition 1 is critical. Below, the concept of “business” for the purposes of Incorporation Relief is considered and the practical steps a Property Businesses can take to ensure they qualify for this valuable relief are identified.
Transfer of a ‘Business’ as a going concern
Business is not defined for the purposes of TCGA 1992, so HMRC agree that the word must be given its normal meaning. Whilst the term ‘Business’ includes a `trade’, the two words are not synonymous.
The question arises whether the individual/partnership conducts a business for the purposes of Incorporation Relief, or whether it would be considered a passive investment. This is a question of fact and in the absence of clear definitions in legislation or from HMRC, each case must be judged on its own merits.
Six criteria for determining whether an activity is a business was set out in the case of Customs and Excise Commissioners v Lord Fisher  (“the Fisher case”) heard in the High Court in 1981:
- Whether the activity is a ‘serious undertaking earnestly pursued’;
- Whether the activity is an ‘occupation or function actively pursued with a reasonable or recognisable continuity’;
- Whether the activity has ‘a certain measure of substance as measured by the quarterly or annual value of taxable supplies made’;
- Whether the activity was ‘conducted in a regular manner and on sound and recognised business principles’;
- Whether the activity is ‘predominantly concerned with the making of taxable supplies to consumers for a consideration’; and
- Whether the taxable supplies are ‘of a kind which…are commonly made by those who seek to profit by them’.
In the absence of a definition of a “Business” for the purposes of claiming Incorporation Relief, determining a client’s entitlement to the relief is a subjective exercise. As the burden of proof lies on the taxpayer, it is imperative that the partner/individual maintains their records to ensure that any enquiry into the claim can be meet with a robust and convincing response.
All evidence should point towards the property business being a serious undertaking earnestly pursued, and not a passive holding of investments.
As the property environment continues to come under further scrutiny and taxpayers, owning residential property, look at ways of improving their tax position, advisors should have a selective and robust procedure for analysing a scenario. This will ensure that the business is a qualifying business for the purposes of Incorporation Relief, to avoid challenges in the future.
If there is anything in this article that you would like to discuss further, please contact Richard Fleming or Andy Wilson
If you have decided to start to build a residential property portfolio then you may be wondering whether to do this in your own name i.e. personally owned or whether to do this through a Limited company.
Below we have set out a brief summary of the pros and cons of holding buy-to-let residential properties in personal and company hands:
- No additional reporting requirements (all income and expenditure reported on the individual’s Tax Return)
- Possibly more choice with regards to mortgages albeit lenders are now much more willing to lend to companies.
- Mortgage Interest relief restriction being phased in from April 2017 reducing the effective rate of relief down to 20% by April 2020
- All profits taxed at the owner’s marginal rate of tax (i.e. up to 45%)
- Unlimited risk i.e. not limited liability protection
- There is no restriction on mortgage interest relief and so the full value of any interest paid is set against income when calculating profits.
- Profits are currently taxed at 20% with this rate falling to 19% from 1st April 2018 and then to 17% from 1st April 2020. Additionally, the Chancellor has indicated that rates may well come down to below 15%.
- Commercial protection should anything go wrong with the business i.e. the protection of limited liability.
- Potential additional tax should profits be taken out of the company.
- The additional filing requirements for the company (Companies House, HMRC).
- Possibly slightly less choice in terms of lenders albeit this is changing.
There has been a definite trend in the past year or so for buy to let investors to use companies and the main drivers for this are the restriction of mortgage interest relief for individuals and the much lower tax rates for companies. As a result, more and more mortgage lenders are prepared to lend to companies.
In addition to structuring your property business in the most tax efficient manner we are also able to assist with funding & mortgage requirements
To discuss your specific circumstances then please do not hesitate to contact us.
Call us on 0161 359 4227/0845 054 8560
You may have heard over the last few days that three major property investment funds operated by Aviva, Standard Life and M & G have been suspended, as investors seek to quickly withdraw funds. This indicates that the fund managers concerned are going to have to sell parts of their portfolios fairly quickly to restore sufficient liquidity to meet investors withdrawal demands.
The impact of this on the wider market remains to be seen. The property held by these huge funds is likely to be large quality property holdings with strong tenant covenants in good locations, and the quantum of such likely to be at a level that mostly institutional investors will seek to acquire rather than the smaller investor. Nevertheless, as the effect of this “offloading” cascades and transmits to the smaller/lower levels of the market, we think we will see some impacts on yields and values over the coming months i.e. likely increase in real yields & reduction in prices & values.
It is also possible (some might say) that there is going to be a reduction in Bank of England base rate – to 0.25% or lower. The ten year swap rate and therefore fixed interest rates have already fallen below 1% as the government’s 10 year gilt yields collapse. The real return to many property investors is the difference between rental yield, and the cost of debt for their property acquisitions. The combination of increased yield and lower Bank lending rates may therefore create some great opportunities for Savvy investors to make acquisitions using ultra low borrowing costs.
Here at Ascendis we would be delighted to consult with any property investors who would like to discuss matters and in particular the opportunities to borrow money at some of the lowest rates available.
In addition, if you are looking to purchase property as investments then please contact us to discuss the most tax efficient way to do so.
Call us on 0161 359 4227/0845 054 8560