BREAKING: Taxation has become a topic of concern for landlords recently and has prompted many to consider the idea of incorporation – forming a limited company for their property business.
Since Mr Osborne introduced his new tax regime for landlords, where landlords’ ability to claim 100% tax relief on mortgage interest as an expense, it will be phased-out over a number of years. This will reduce the expense claim to a maximum of 20% (or the basic rate of income tax) of interest paid each year. The HMRC “sting in the tail” with this is that mortgage interest will no longer be treated as an expense; the 20% relief being mearly a tax credit against total tax liability. This will have the undesirable effect for many of pushing up their total income, when rental income is added, which may result in a higher tax band rating.
As incorporated businesses and commercial property landlords are exempt the new measures, an obvious solution might be to form a limited company, a tax shelter under which buy-to-let properties can be owned. However, this will not benefit many and could disadvantage some, and there are many issues involved. It is important to seek professional advice before making any changes.
Another important consideration for those keen on incorporation is the risk that HMRC might again change the rules. Known in the trade as regulatory risk, HMRC has a habit of “closing loopholes” when it becomes obvious that a large number of people are taking advantage of tax avoidance measures.
A clue to HMRC’s intentions comes from their exploration of what they term “look-through entity.”
In the March Budget it was announced that the Government is considering the introduction of a completely new system of small company taxation. They have asked the Office of Tax Simplification (OTS) to consider a possible completely new system of taxation for small businesses, including landlord businesses.
It is proposed that the new system, if introduced, would apply to what HMRC term “micro-entities”, those businesses with 9 or fewer employees, and this would tax shareholders directly on their company profits in proportion to their shareholdings as if the company was a partnership or LLP.
For example, if a couple each owned 50% of the share capital of New Landlord Trading Ltd, and the company made a profit of £100,000, there would be no corporation tax to pay but they would each be taxed on their £50,000 share whether or not that amount was distributed to them.
HMRC says this could “level the playing field” between the taxation treatment of a small limited company and an unincorporated business. The Government and OTS are also considering the introduction of protected asset status for unincorporated businesses to align the owners’ liability with that of limited company shareholders.
What is Look-Through Entity?
Look-through or flow-through entity is a legal entity where income “flows through” to investors or owners; that is, the income of the entity is treated as the income of the investors or owners. This structure can avoid dividend tax and double taxation because only owners or investors are taxed on the revenue. Technically, for tax purposes, flow-through entities are considered “non-entities” because they are not taxed; rather, taxation “flows-through” to another tax return.
Key questions for property investors: if look-through entity is introduced, would this be optional or compulsory on smaller company owners, and what of tax reliefs, such as interest on loans, only available to companies and not to sole traders or partnerships? Should these be available, as the expenditure is by a company? Or not because the entity is not being taxed as a company?
These are uncertainties anyone considering incorporation has to deal with. Seek advice from a qualified tax accountant before making any decisions.
BREAKING: HMRC to Review Small Limited Company Business Taxation https://t.co/C8aS1fFbmk
LandlordZONE (@LandlordZONE) October 5, 2016