The implementation of section 24 of the Finance Act 2015, which has now fully taken effect, has had a significant impact on landlords. As landlords explore ways they can manage ongoing tax challenges, there has also been a surge in tax-saving schemes like the “Less Tax for Landlords” hybrid partnership scheme and similar solutions proposed by certain advisors. These schemes offer landlords the promise of lower tax bills and are often peddled as being suitable for all and easy to achieve.
However, the adage still applies: if it sounds too good to be true, it often is.
The legislation currently restricts the tax relief individuals can claim on property finance costs and can increase a landlord’s tax burden even when they have not turned a profit. These rules only apply to individuals and it’s understandable why landlords would consider different business structures as a means of mitigating the impact.
But before rushing to reorganise, it’s important to note that any transaction that has tax avoidance as one of its main motives is unlikely to work.
HM Revenue & Customs (HMRC) has warned that tax avoidance schemes are completely illegal and can lead to severe penalties. With that in mind, landlords should carefully consider all available options before committing to contrived structures.
For landlords concerned about the impact of Section 24, here are some key considerations to help inform any decision to restructure while staying on the right side of the law.
The commercial rationale
UK tax law contains a raft of anti-avoidance measures which target any transaction that has tax avoidance as one of its main purposes. Any restructuring that is undertaken purely to mitigate the impact of section 24 is therefore likely to be caught.
This doesn’t mean that restructuring is not possible, but any new business structure should provide a clear commercial benefit. The properly executed transfer of a letting business to a limited company, often referred to as an incorporation, can provide the benefit of limitation of liability for the landlord, allowing business risks to be separated from personal assets.
An incorporation offers a clear commercial benefit that certain other structures do not.
However, incorporating doesn’t always result in tax savings and can result in increased finance costs. In some cases, an incorporation can trigger Capital Gains Tax (CGT) and Stamp Duty Land Tax (SDLT) liabilities, so the commercial benefit must be weighed against the potential cost.
The way you operate your portfolio matters
When thinking about whether to incorporate a property rental business, the way landlords operate their portfolio is a critical factor. To claim relief from CGT, case law and HMRC guidance require that landlords’ activities must go beyond the mere letting of property -- Landlords must demonstrate that they spend at least 20 hours a week actively managing the business.
Landlords with larger portfolios or multiple tenancies typically find it easier to meet this requirement. But even those with larger portfolios may face challenges if they are also juggling a full-time job or delegating all work to letting agents.
Claiming relief from SDLT is even more of a challenge. In this case, relief is only available if the above CGT requirements are met, and the portfolio is run in partnership with someone else. Being in partnership means more than the simple joint ownership of property, and the relationship between the partners and their activities will be assessed.
Meeting the requirements for relief from both CGT and SDLT is not a given, so failure to accurately assess whether the conditions are met can lead to large tax liabilities.
Transitioning existing mortgages
Most landlords will have financed a part of their property portfolio with a residential or buy-to-let mortgage. Incorporation requires a change in ownership of the properties from the landlord to the company and any mortgage providers will need to be notified of this change in ownership.
Unfortunately, most lenders will usually treat the incorporation as an early termination of the existing mortgage and require refinancing to a company mortgage. This often leads to early redemption charges and increased interest rates.
In these circumstances, landlords are often tempted to take out new company mortgages with new lenders who offer better rates, but here lies the catch -- To meet the requirements for claiming relief from CGT, the liabilities of the rental business must transfer to the company.
Taking out a new liability to settle the old one on incorporation is not a transfer and can cause the CGT relief to be restricted. Landlords will need to discuss their financing arrangements to assess whether their existing debts can be transferred, typically by way of formal novation.
Prioritise thorough due diligence
Landlords should never proceed to incorporate without taking thorough advice. Even if the conditions for claiming relief from initial CGT and SDLT charges are met, it shouldn’t be assumed that ongoing tax liabilities will be lower.
It is crucial to bear in mind that corporate interest rates are usually higher, particularly if landlords are currently on fixed-interest mortgages and any tax benefits gained from incorporation should be carefully weighed against potential increases in interest charges and other costs associated with running a company. In some cases, the higher costs mitigate any tax savings and landlords end up financially worse off.
Balancing risk and returns in your property portfolio
The demands of managing a portfolio have evolved rapidly over the past decade and landlords are grappling with the challenges of striking the right balance between risk and returns. For some, selling appears to be the most sensible course of action. For others, portfolio expansion might offer a solution.
In the latter case, incorporation could prove to be the right strategic move to reduce personal risk while gaining control over revenue and flexibility in the future.
Regardless of the long-term goal, incorporating a property rental business purely for tax reasons should never be the go-to solution. Optimising a property portfolio for returns also doesn’t always hinge on a corporate structure. Every landlord’s circumstance is unique, and each case should be assessed by a trusted tax professional on a case-by-case basis.