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
The majority of commercial property owners have not claimed their allowances, and this is due to there being a lot of confusion in what is a very specialist area of tax.
As such, I outline some FAQs below and we’d be very happy to assist in any claim:
- Do capital allowances apply when building a commercial property?
Yes, it is important to involve a capital allowances advisor at an early stage when constructing a property, as certain energy-efficient items of plant can qualify for Enhanced Capital Allowances (ECAs) and benefit from a 100% write down.
- If the client has built the property himself many years ago and has no records of the build cost, how do we identify the costs on which to claim capital allowances?
It is not essential for the client to provide records/invoices relating to the construction expenditure, but if they are available we will request sight of them. Accounts and tax computations from the period of construction can often provide the requisite information, together with a conversation with the accountant that acted at the time. The land registry is often able to provide evidence of the price paid for land and this provides a basis from which to calculate the construction costs.
- Can capital allowances be claimed on both freehold and leasehold properties?
Claims can be made for both freehold and long leasehold interests. Short leases, with no upfront premium paid, are not eligible for a capital allowances claim as the fixed plant remains under the ownership of the landlord. However, in this scenario capital allowances can still be claimed on alterations made to the property as tenants.
- Can AIA be used against this type of capital allowances claim, or only WDA 8% or 18%?
Yes, the Annual Investment Allowance (AIA) can be claimed on this type of expenditure, providing that the expenditure took place within a tax return that remains open for amendment. For a retrospective claim on historic expenditure, the allowances can be entered into the pools for the earliest year which remains open for amendment.
- Please can you define sideways loss relief?
Sideways loss relief refers to the ability to offset losses against total income from all sources, rather than simply against profits from the same source. Losses generated through capital allowances are flexible as they are able to be offset sideways in this manner. This is subject to an annual limit for individuals of £50,000 or 25% of total income, whichever is higher.
- For accounting purposes where does the cost come from if you don’t reduce the cost for capital gains?
The cost that is to be apportioned for capital allowances purposes will be the relevant purchase price (including stamp duty paid) or, in the case of refurbishment/extensions, the total cost that has been capitalised and left unclaimed. The introduction of capital allowances will not affect the base cost for Capital Gains Tax purposes. The acquisition of land also contains the building attached to the land and the fixtures attached to the building. There is a distinction to be drawn between the fixtures & fittings (which are separate items to the building and are allocated separately in the sale & purchase agreement along with goodwill) and fixed plant & machinery (which is attached to the building). The fixed plant is not removed from the building and therefore not allocated separately in the accounts. The introduction of the capital allowances into the pool is therefore a tax concern and not an accounting consideration, i.e. it is not a case of reducing the cost for the freehold/leasehold property and increasing the fixtures & fittings. The accounts are not amended; the only change is to the pools where the capital allowances are introduced.
- Do you have to wait until you sell the building before you can claim?
Absolutely not, and we would encourage that owners make a claim at the earliest opportunity in order to benefit from the tax relief available. Should the building be sold at a later date then the balance of the claim can be retained or passed to the new owner.
- If, as a vendor, £1M is agreed for capital allowances purposes, does this represent disposal proceeds and create a Balancing Charge?
If £1m of the sale price is agreed to represent qualifying plant and machinery for capital allowances purposes, and an s198 election is entered into, then the vendor will need to recognise the disposal of £1m from their capital allowances pool(s). This may well lead to a balancing charge, but only if the assets are being transferred at a value that is greater than their Tax Written Down Value, which would not be recommended for this reason.
- How exactly does the two year time limit apply? Is there no possibility of a belated claim, and if so is that at the end of this two year time limit?
In order to fulfil the mandatory pooling and fixed value requirements, the past owner must record the pooling of any available capital allowances and dispose of them in the year of disposal. This can only be completed as long as the vendor’s tax return for the year of disposal remains open for amendment. A company has two years from the end of its chargeable period in which to make an amendment. After this time it can no longer pool/dispose of the allowances. The s198 election, which is generally used to fulfil the fixed value requirement, must be made within two years from the date that the purchaser acquires their relevant interest in the property, as outlined in S201 CAA 2001. This applies for purchases that took place post-March 2014 and where the two requirements referred to apply. If the property was purchased prior to this date, or the requirements do not apply (e.g. purchase from non-taxpaying entity), then the two year time limit will not apply.
- Can you briefly explain how a claim for capital allowances can be made for purchases pre April 2014?
The first stage in any claim is to conduct the necessary due diligence. This includes reviewing purchase documentation to confirm the extent of any former claims back to 24th July 1996. This often involves making contact with former owners to obtain details of their tax treatment. Should there be scope to proceed with a claim, a specialist surveyor will need to visit the property and conduct an inspection. Using the surveyor’s report and information gathered during the due diligence phase will then allow a ‘just and reasonable’ apportionment of costs to be made and a value placed on the qualifying plant in the property. The claim for additional allowances can be entered into the earliest tax return which remains open for amendment under the standard self-assessment rules.
Should you have any queries regarding Capital Allowances, please let us know and we’d be delighted to assist.
A complex tax system in this country can make it difficult to understand your liability as a company director. Failing to register for VAT for example, or submit your tax payments as an employer, could result in HM Revenue and Customs taking action against you, including issuing a range of financial penalties.
Keeping up with current and new legislation as a director is crucial to your company’s success, so here we look at five of the most common types of tax that you should be aware of as a company director.
Corporation tax is paid on the taxable profits of your company, and currently stands at a rate of 20%. As soon as the company was formed you should have registered to pay this tax, which is applied to all profits, as there is no equivalent to the personal allowance for limited companies.
Corporation tax becomes due nine months and one day after the end of your accounting year, and you have an obligation to complete a CT600 which is the annual corporation tax return.
So what might taxable profits include? Profits made during normal trading activities, most investments, and profits from the sale of assets are generally included in the figure. You may be entitled to claim reliefs and capital allowances to reduce your corporation tax bill.
If you are director of a limited company, you may be liable to pay income tax on the dividends and salary you take out of the business. The lower threshold is currently £11,000, so any income above this amount will be taxed under the Pay As You Earn scheme, and deducted at source by your company’s payroll system.
A new dividend taxation regime came into force on 1st April 2016, whereby individuals have a tax-free dividend allowance of £5,000 in addition to the personal allowance mentioned above.
New dividend tax rates have also been introduced:
- Basic Rate: 7.5%
- Higher Rate: 32.5%
- Additional Rate: 38.1%
If you are paid a salary of £8,060 or more from your company, then you’ll be liable for Class 1 National Insurance contributions as an employee. The company itself will also need to pay Class 1 employer’s contributions to HMRC.
The New Employment Allowance was introduced in 2014, however, which means that you can claim back up to £3,000 of employer’s Class 1 National Insurance contributions in a tax year, if you are the director and you employ other staff.
From 1st April 2016, the threshold to register for VAT is £83,000. If your turnover exceeds this figure at any point during a rolling 12-month period, you must inform HMRC. Failing to register for VAT, non-payment of the tax, or sending late payments, will all incur financial penalties.
VAT is paid on many goods in the UK, and your company collects it on behalf of HMRC. The difference between how much you receive in VAT, and how much you pay, is the amount sent to HMRC.
The standard rate of VAT is currently 20%, but schemes are available to make the collection and reporting process easier for eligible companies. For example:
- Cash accounting: helps eligible companies with their cash flow, as VAT is only paid out once the money has been received by the business.
- Flat rate scheme: this simplifies the calculation process, and makes administration easier.
Business rates are similar to the council tax you pay on your home, so if you operate from business premises you will probably be liable to pay this type of tax. The money received from non-domestic properties is used to pay for local services, including education and social care.
The amount you pay is based on the rateable value of your premises multiplied by the government-set business rate multiplier, which is reassessed every few years. Two different figures are used – the ‘standard’ multiplier and a small business multiplier which takes account of lower turnover levels.
Rateable values are generally reassessed every few years, and there are various reliefs available to eligible businesses. Some premises such as farm buildings receive automatic exemption from business rate liability, and there are various other reliefs available depending on the size and nature of your business.
Home-based companies are not always subject to business rates, but this depends on whether you employ staff to work from your home, and also the nature of the business.
Ascendis can ensure you comply with all your tax liabilities as a company director, and avoid the hefty penalties imposed by HMRC for late or non-payment.
Call if you want to discuss any of the above on 0161 359 4227/0845 054 8560
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