The tax changes proposed during 2015, and due for implementation from April 2016 and 2017, with the withdrawal of mortgage interest relief down to the basic rate of income tax, on a sliding scale to 2020/21, have has major implications for landlords with large borrowings.
One possible strategy to be adopted by landlords in this position, and given the gradual implementation there is time to consider options carefully, is to consider sheltering property investments in company ownership.
Private ownership of rental property has historically been the more popular with landlords. A company will pay corporation tax on any gains, and the shareholders will also be liable to capital gains when the company is dissolved. The so called ‘double tax charge’ has dissuaded most landlords from using a company.
Nevertheless, with the proposed restriction of mortgage interest relief, and the £5,000 tax free dividend per shareholder, the company route warrants a fresh review.
Transfer of property with pregnant gains
The costs are likely to outweigh any benefits on the transfer of property already owned by the landlord into a company. Capital gains tax is payable on transfer. Where a buy-to-let activity constitutes a business it is possible to use ‘incorporation relief’ so that the gain is effectively delayed until the property is eventually sold. However, buy-to-let will probably only be a ‘business’ where there is a portfolio of properties and the landlord is not using a managing agent. Similarly, stamp duty will be payable on the transfer of property to company. Some exemption from stamp duty applies where property is held by a partnership which is trading and not merely letting property. A solicitor’s advice on stamp duty implications is advisable.
Income tax savings on company rental
Due to the stamp duty and capital gains tax implications it is unlikely to be beneficial to transfer an existing property to a company. However a company could be established to purchase a new property.
Interest can be deducted from company profits in full. This contrasts with an individual who will only obtain a reducer of 20% of mortgage interest (by the time the rules are fully effective in 2020/21.) However given that corporation tax is currently 20%, falling to 19% in 2017 and 18% in 2020, there is no more tax relief on mortgage interest than with property owned privately.
Any tax saving therefore hinges on the tax efficiency of extracting profits from the company. As explained previously, the first £5,000 of dividends extracted will be tax free from 6 April 2016. This represents a considerable saving for a higher rate taxpayer (taxed at 32.5% on dividends) and for an additional rate taxpayer (taxed at 38.1%.)
The £5,000 dividend allowance is per person, and therefore the potential for overall tax savings increase the greater the number of shareholders per company.
A basic rate taxpayer is not likely to lose out as a result of the proposed changes to the restriction of mortgage interest relief. Therefore, the arrangement would be in place to divert income that would otherwise be taxed on the higher income spouse, rather than to save tax for the basic rate taxpayer.
For instance a company can be set up with different classes of share, so that all dividends are payable to a lower earning shareholder. This contrasts with individual ownership. Rental profits of a privately owned property are taxed in proportion to company ownership. Special trust arrangements can be used to avoid this requirement, however the capital sharing ratio will determine the income sharing ratio for a married couple.
Any income received by children over £100 a year will be taxed on the parent. The rule applies to unmarried children under 18. The inclusion of children in a scheme will not result in any significant income tax saving.
There is a possibility of paying a salary to a spouse, where the taxable income of the shareholder is less than the personal allowance (of £10,600 for 2015/16.)
Annual Tax on Enveloped Dwellings
Annual Tax on Enveloped Dwellings or ATED does not apply to most landlords. If a person lets a property for a commercial rent to a tenant with whom the landlord is not connected, the landlord will be relieved from paying this annual charge.
For a residence worth £1 million or more and owned by a company or partnership there is an annual tax of £7,000. From 1 April 2016 there will a charge of £3,500 for properties worth between £500,000 and £1 million.
This is a possible drawback to owning property via a company. The charge, introduced on 1 April 2012, was mainly intentioned for individuals who are not domiciled in the UK and using a company as a way of avoiding UK inheritance tax.
Landlords eligible for relief from the ATED should review their compliance requirements.
On the purchase of existing property, where rents are modest (around £5,000 per year per shareholder) and significant capital gains are not expected, modest tax savings could be achieved using a company to buy a rental property. In most other cases, private ownership is likely to result in considerably lower exposure to capital gains on eventual disposal.
If there is no intention to sell the property, company ownership could also be a preferred route. There is no capital gains tax on transfer of a property as a result of death. Probate value will establish the new cost for calculating gains. One scenario could include, for instance, a property which produces income for a spouse during the landlord’s lifetime and which transfers to children on death.
The additional accounting costs of a company should be considered, especially given that companies producing (relatively modest) profits of £5,000 per shareholder are likely to be most tax efficient.
The cost and availability of a suitable mortgage should also be established. Although some lenders are proposing to offer competitive mortgages for company owned buy-to-lets, these loans are likely to require personal guarantees.
Tax rules change frequently and company ownership carries regulatory risks, i.e., the risk that the rules will be changed again, especially given the exposure to capital gains tax on ending the company arrangement.
For a more detailed analysis of tax implications of company ownership, please read the following review of company owned rental property below.
The link to a full report on this can be read here: