High Level Tax Planning For Property Rental Businesses
Partnerships operating a property rental business can convert to a Limited Company status (“incorporation”) and claim tax relief to offset both capital gains tax and Stamp Duty that would otherwise be payable.
The benefit of incorporation is that it allows landlords to retain profits at corporation tax rates of 20% and falling, and continue to offset 100% of finance costs against income despite George Osborne’s tax changes for individual landlords being phased in from April 2017.
As an aside – an additional advantage to non-residents is that dividends are generally taxed in the Country of residence of the shareholders on a remittance basis. For example, UK Nationals resident in Malta can choose to take income in the form of dividends from their property rental business (UK Limited Company) and pay income tax at a rate of just 5% in Malta. You may wish to seek further guidance and Consultancy on this from Mark Alexander (Property118 founder) as he’s already doing it.
What if I am a sole trader?
Sole traders must pay SDLT on incorporation, which is often a major disincentive. However, there are a variety of cost effective ways to form a partnership with a spouse, another landlord or a family member without you needing to refinance or pay excessive amounts of stamp duty or CGT. For example, you could take on a partner who owns just a 1% stake in the beneficial interests of the business. Alternatively, a structure exists whereby your spouse could become a partner in the business without incurring any CGT or SDLT whatsoever. Cotswold Barristers has advised several clients on these transitional steps with a view to longer term planning. Once a partnership has been active for three or more years it is possible to claim SDLT relief on incorporation, even if the legal title of properties and mortgages are still owned by an individual. Conditions apply of course and the partnership split of beneficial interest in the business assets is a vital component to such planning.
“The Partnership Act 1890 (c. 39) is an Act of the Parliament of the United Kingdom which governs the rights and duties of people or corporate entities conducting business in partnership. A partnership is defined in the act as ‘the relation which subsists between persons carrying on a business in common with a view of profit. A partnership can arise through conduct, oral agreement, or a written contract known as a partnership agreement. The minimum membership is two and the maximum is unlimited since 2002. The provisions of the Partnership Act 1890 apply unless expressly or impliedly excluded by agreement of the partners.”
In other words, if you have joint mortgages or share beneficial ownership of a property rental business with one or more others you are in partnership.
What is a rental BUSINESS?
There are many commonly held opinions on this matter, most of which are myths for the reasons explained below.
Example question; does the fact that landlords may choose to outsource a lot of work to managing agents, engage a self-employed Personal Assistant to deal with post and book-keeping, have an accountant and maybe even live in abroad mean that they are in fact passive investors and not a rental business partnership at all?
Answer: of course not!
As an owner of a property rental business you remain accountable for over 180 pieces of legislation, regardless of whether you outsource. The ongoing running of your business is no less than that of directors of a company in terms of ongoing due diligence and continued professional development, all of which takes up a significant amount of time. We have listed below some of the regulations and procedures that all rental property business owners remain accountable for as follows:-
- Considering rent offers made by tenants sourced through agents
- Tenant selection decisions based on referencing organised through agents
- Checking to ensure that agents have organised the purchase of Rent Guarantee insurance on our behalf
- Organising re-quoting and/or renewal and of buildings, contents and landlords liability insurance
- Checking that tenants deposits are registered and that prescribed information has been correctly served by our agents
- Checking that prescribed information in respect of tenancy deposits is re-issued buy our agents when fixed term tenancies end and roll over to statutory periodic tenancies
- Checking that annual Gas Safety checks have been organised by agents and that certificates have been issued in a compliant and timely manner
- Checking that rents are paid as due by agents and that accountants are notified accordingly
- Liaising with agents and legal advisers over rent arrears and any other breaches of tenancy
- Liaising with insurers over claims
- Paying ground rents and service charges in a timely manner
- Considering accounts and minutes prepared by freehold management companies and liaising accordingly
- Liaising with agents over maintenance issues reported by tenants
- Sourcing/paying for items needing to be replaced
- Checking that EPC certificates are up to date
- Keeping up to date with selective licensing arrangements being introduced by various Councils
- Reviewing check in/out inventories produced by agents
- Dealing deposit refunds
- Dealing with ADR in respect of tenancy deposit disputes
- Reviewing market rents
- Continued professional development through reading news, forums, industry websites and attending expo’s and landlord meetings
- Liaising with accountants in respect of tax returns and other accounting matters
- Daily bank reconciliation
- Regular reviews of the mortgage market for optimal lending terms
The relevant case law relating to what constitutes a property ‘business’ is HMRC vs Ramsay. Much has been made of this by overly cautious accountants who assume that because HMRC accepted that Mrs Ramsay spent 20 hours a week managing her block of 10 flats this is some sort of benchmark. The matter is of course subjective because HMRC lost their case and Mrs Ramsay was indeed entitled to claim incorporation tax relief. No similar cases have occurred since. Naturally, the more properties involved in your rental property business, the safer it is to assume that incorporation relief is applicable in your case. Counsels opinion is always recommended on a case by case basis.
Cotswold Barristers have advised several property rental businesses on incorporation. We are also the architects of the ‘Beneficial Interest Company Trust’ which enables landlords to incorporate without the need to change the legal ownership of properties or to disturb existing mortgage arrangements.
What is a Beneficial Interest Company Trust?
This form of trust is not a legal entity such as a company. It is a paper declaration which describes the entity receiving the benefit of assets. You may wish to think of it in terms of being similar to a V5 certificate from DVLA confirming the registered keeper of a vehicle, which may or may not be the legal owner.
A beneficial interest company trust transfers 100% of the beneficial interest (income and capital gain) in the property rental business to a company. This involves no change of legal ownership so far as HM Land Registry is concerned. The consequence is that existing mortgages can remain in place without affecting the mortgage lenders rights.
The trust deed empowers the company to be able to call upon the legal owner(s) (settlor) of the trust to sell the property at any time and transfer 100% of the net sale proceeds to the company. In reality the persons controlling the company are the same as the legal owners of the properties, hence there should never be a conflict.
Due to the way the trust deed is structured, the legal owners of the property rental business now stand as bare trustees, i.e. they only hold the legal title in name but don’t own any share of the rental profits or capital gains. The settlor is still legally responsible for the mortgage arrangements, hence the question is raised; how does the settlor receive the money to pay the mortgage interest? Again, this is dealt with in the trust deed. Without affecting any of the legal rights of the mortgage company, the trust deed makes the company a party to the mortgage liability, and hence responsible for servicing the contracts. The structure allows the settlor of the trust (the legal owners/borrowers) to continue to make the mortgage payments and claim them back from the company.
The outcome is that the entirety of the business sits on the balance sheet of the company and all income and expenses associated with the property portfolio accrue to the beneficial interests company. HMRC have the right to treat payment of the mortgage as income arising to the settlor of the trust. However, the settlor of the trust (as bare trustees) would only be responsible for the flat 20% tax rate payable by trustees, hence a zero tax liability based on the ability to claim 20% tax relief on the mortgage interest.
Please note that a beneficial interest company trust is very different to a typical declaration of trust used by residential conveyancers to protect the interests of family members who contribute to a property transaction. Beware cheap imitations being offered by unregulated, uninsured and unqualified inspired amateurs, they are both plentiful and extremely dangerous.
Why should I use Cotswold Barristers?
Cotswold Barristers is fully insured to provide advice on these matters and is regulated by the Bar Standards Board to provide advice in England and Wales only.
We are authorised to advise on a Direct Public Access basis which means that you do not need to employ a Solicitor to instruct Counsel at Cotswold Barristers.
We work on a fixed fee basis, and in regards to the tax planning structures referred to on this web-page we provide clients with undertakings to defend any legal action from mortgage lenders and/or HMRC in respect of the advice we provide.
We only advise of tax matters in accordance with legislation. We do not construct “schemes” which could fall foul of legislation under DOTAS (Disclosure Of Tax Avoidance Schemes).
We are the Honorary Legal Counsel of Property118 Action Group. In June 2016 we won refunds of overcharged tracker mortgage interest from ‘The West Brom’ on behalf of a representative action group organised via Property118.com. It is believed to the the UK’s largest Direct Access representative action case to date.
Our service includes:-
Checking mortgage conditions to ensure that restructuring arrangements will not result in breach of contract.
Providing bespoke advice as necessary.
Producing all documentation.
Dealing with SDLT returns.
The cost of advice
Our fees range from £6,995 to £13,995 plus VAT depending on the number of properties within your property rental business. Accountants charge similar fees to deal with the various claims for tax relief. Therefore, typical inclusive costs are £14,000 to £28,000 plus VAT. Initial discussions to establish whether you qualify to be a client of Cotswold Barristers are not chargeable.
Who deals with the claims for the various forms of tax relief?
A panel of tax advisers, who have acted for other clients we have advised, is being put together by Property118. Introductions can be made if you feel your existing accountant is inexperienced in dealing with such complex restructuring matters. However, we are happy for you to instruct any appropriately qualified accountant of your choosing.