Incorporation is the most popular strategy advised by many accountants and tax advisors to deal with Section 24. There is no doubt about the advantages of this strategy.
However, you need to consider the pitfalls as well.
1. Section 24 Does Not Apply to The Company
The government thinks corporate landlords are good while individual landlords like you are bad! To avoid Section 24, you can incorporate and transfer your property portfolio to a company.
2. From a Tax Point of View for Limited Company
It is easy to buy a new property in a limited company. However, transferring existing portfolio to the company has a lot of tax implications.
3. From Tax Point of View for Shareholders
You (shareholder) and the company are a separate legal entity. So, when a property is transferred from you to the company, this is treated as a sale of property by you to the company at market value.
The consequences are that you have to pay stamp duty and land tax (SDLT) and capital gains tax (CGT) on the transfer! Also, you need to transfer the mortgage from your name to the company’s name.
Let’s explain these in further detail.
Capital Gains Tax on Incorporation
When you transfer the property in your name to the Limited company, you have to pay capital gains tax on the difference between the market value at the date of transfer and the cost of the property.
For example,
If you bought the property at £150,000 in 2007 and now worth £250,000, the capital gains will be £100,000. You will pay capital gains tax on this £100,000. Depending upon whether you are basic-rate tax payer or higher-rate tax payer, you will pay tax at 18% or 28% respectively on the gain.
You can deduct £6,000 annual exemption from the capital gains (from April 2023) if not used in other gains. Refer our guide on capital gains tax for further details.
Incorporation Relief
You may be thinking – is there any way to avoid this? Incorporation Relief is the answer to that for some landlords.
As we will see next, incorporation relief is available only for limited number of landlords. Incorporation relief is available if an individual transfer a “business” to the company subject to certain conditions which we will explain later.
Most important consideration for property investors is that whether property investment qualifies as a “business”. The term business is not defined in the tax laws, and so there are grey areas.
There is no doubt that normal trading business such as retail shops, factory, etc. qualifies as a business. On the other hand, a passive investment in property does not qualify as a “business”. However, in between these two extremes, some landlords are running property investment like proper business rather than mere passive investment.
In this scenario, the position is not clear cut. The good news is that a recent case in the Upper Tribunal shed some light on whether property investment qualifies as a business.
In the case ‘Ramsay vs HMRC’, the taxpayer won her argument against HMRC and Court decided in the taxpayer’s favour accepting that the letting of 10 flats in a single property meets the definition of a ‘business’ for incorporation relief.
In this case, Mr & Mrs Ramsay were actively involved in the business, and that counted to turn it into a business. In this decision, Judge said that “It is the degree of activity as a whole which is material to the question whether there is a business, and not the extent of that activity when compared to the number of property or lettings.”
To help you understand more, some of the facts in the case were:
- The Property was a single large building divided into 10 flats
- Mr & Mrs Ramsay owned the property equally at the time of incorporation
- Neither Mr nor Mrs Ramsay had any other occupation during the relevant period. The Property was their only activity of this nature.
- Mrs Ramsay and her husband had spent approximately 20 hours per week carrying out various activities in the property business (e.g. attended property to unblock drains, carried out some repairs personally, etc.)
- Mr & Mrs Ramsay carried out work in the communal areas of the property on regular basis.
- Additional assistance was provided to one elderly tenant
As listed above, many factors work in favour of the tax payer. Although the circumstances of most of the landlords will not be same as that of Ramsay, this case improved the chances to be eligible as a business if a greater level of activity is carried out than ordinary passive property investor. Still, we can’t be 100% sure if the activity carried out is not similar or more than that of Mr & Mrs Ramsay.
One of the options is to apply for Non-statutory clearance from HMRC before incorporation to reduce the risk. We have experience in getting this clearance from HRMC, and so we will be able to help you on this.
Is the Non-Statutory Clearance Conclusive?
HMRC says “Provided the information you have supplied is accurate and complete, and you carry out the proposed transactions exactly as you describe them, you will generally be able to rely on HMRC’s advice.” So, if you provide accurate and complete information, the clearance is practically conclusive (although theoretically, HMRC can go against it).
Although there is not any specific detailed guidance from HMRC on incorporation relief for property business, HMRC has provided some examples of property business in its guidance for national insurance on lettings business (NIM23800).
Stamp Duty & Land Tax (SDLT) on Incorporation
The second issue to consider is the SDLT you should pay when the property is transferred to the company. As a rule, the company must pay SDLT at same rate applicable to second property purchased by an individual landlord. SDLT will be charged on the market value of the property at the date of transfer.
The SDLT bill can be significant in case of high-value properties. There are some SDLT reliefs you can claim if you are transferring more than one property at the same time, but you will still have massive SDLT bill.
You may be wondering – is there any way of transferring property to the company without paying SDLT. There is only one legal way which is available only to partnership business. If a property is transferred from partnership business to the company, this will be exempted from SDLT if you meet certain conditions.
In most of the cases, SDLT exemption is available if the partners become shareholders of the company and partnership was running as a business. There are some complex rules around this, and so you need to consult property tax specialist for further advice in your specific situation.
Now, you may be thinking to turn your property business into partnership and then incorporate to avoid SDLT.
However, be careful about Anti-avoidance rules before embarking on such scheme. HMRC will disallow any transactions which main purpose is to avoid tax!
If you are genuinely running a partnership business for few years and filing partnership tax returns and then incorporate, this should be acceptable to HMRC.
The conclusion is if you have legitimate partnership property business, you will be able to incorporate without incurring any capital gains tax and SDLT! Consult us for any further advice on this.
Mortgage Issues in Incorporation
We considered tax issues for transferring property in the name of the company. But, don’t forget about a critical non-tax consideration in this decision: transferring mortgage in your name to the company’s name.
You need to pay off your existing mortgage, then remortgage the property in the name of the company. There is usually higher interest rate on the company mortgage compared to an individual. However, in recent months, the difference is becoming minimal.
Also, there is usually higher arrangement fee on the company mortgage. You need to consult with an experienced mortgage broker to find out further on this.
Also, the lender usually requires setting up special purpose vehicle (SPV) company for the mortgage on the property. This means there are specific SIC codes you need to choose while incorporating the company. As per our mortgage broker, following two SIC codes are acceptable to the lenders:
- 68100 Buying and selling of own real estate
- 68209 Other letting and operating of own or leased real estate
Conclusion
The decision of whether to incorporate or not should be evaluated properly taking into all tax and non-tax factors. We have seen that incorporating existing portfolio has significant capital gains tax and SDLT implication unless relief is available. You should seek advice from property tax specialist before deciding correct course of action for you.
