Landlords have been significantly impacted by the implementation of Section 24 of the Finance Act 2015 and this has prompted a search for effective ways to mitigate the increased tax burden that many landlords now face. As landlords navigate ongoing tax challenges, there has been an increase in tax-saving schemes, such as the “Less Tax for Landlords” hybrid partnership scheme and similar solutions suggested by advisors. While these schemes claim to offer reduced tax bills and easy implementation, caution is advised, and as the saying goes: if it seems too good to be true, it probably is.
Currently, legislation limits the amount of tax relief that can be claimed on property finance costs, which can result in landlords having to pay more taxes even if they haven’t made a profit. These regulations only apply to individuals, which is why some landlords may consider different business structures to minimise the impact.
However, it’s crucial to note that any transaction aimed purely at tax avoidance is unlikely to be successful. HMRC has warned that tax avoidance schemes are against the law and can result in severe penalties. Therefore, it is advisable for landlords to thoroughly evaluate all possible alternatives and avoid selecting contrived structures.
Navigating Section 24 concerns
With the impact of Section 24 in mind, landlords contemplating restructuring should carefully assess the implications. Here are some key considerations to guide decisions:
The commercial rationale
Tax laws in the UK include measures targeting transactions primarily driven by tax avoidance motives. Any restructuring solely aimed at mitigating the impact of Section 24 is likely to face scrutiny. Despite this, a suitably executed transfer of a letting business to a limited company, known as an incorporation, can offer a commercial benefit, providing limitation of liability and separating business risks from personal assets. However, potential drawbacks, such as increased finance costs, Capital Gains Tax (CGT), and Stamp Duty Land Tax (SDLT) liabilities must be weighed against the benefits.
An operational approach matters
The way in which landlords operate their property portfolios is crucial in determining whether tax charges will arise on an incorporation. To claim CGT relief, HMRC guidance stipulates that landlords must actively manage the business for at least 20 hours a week, which can be challenging for those juggling other responsibilities.
SDLT relief is harder to achieve, requiring the above CGT conditions to be met and the portfolio to be run in partnership with someone else. Partnership entails more than mere co-ownership of assets as the relationships between partners and the way they conduct business together will be evaluated.
Meeting both CGT and SDLT relief requirements is not guaranteed, necessitating careful assessment to avoid substantial tax liabilities.
Transitioning existing mortgages: A complex move
Typically, landlords secure financing for a segment of their property portfolio through residential or buy-to-let mortgages. The process of incorporation necessitates a shift in property ownership from the landlord to the company, requiring notification to mortgage providers about this alteration in ownership.
Unfortunately, most lenders view incorporation as an early termination of the current mortgage, which then requires refinancing to a company mortgage. This often results in early redemption charges and higher interest rates. Subsequently, landlords may be enticed to acquire new company mortgages from different lenders offering better rates.
However, to qualify for CGT relief, the liabilities of the rental business must transfer to the company. Acquiring a new liability to settle the previous one during incorporation does not qualify as a transfer and can limit the CGT relief. Landlords must evaluate their financing arrangements to determine if their existing debts can be transferred, usually through formal novation.
Prioritising due diligence
Thorough due diligence is paramount before incorporating a property rental business. Even if initial CGT and SDLT relief conditions are met, ongoing tax liabilities may not necessarily be lower. Corporate interest rates are typically higher than rates available to individuals so, any tax advantages gained from incorporation should be carefully assessed against increased interest charges as well as other expenses related to running a company. In certain situations, the increased expenses may outweigh any tax savings, resulting in landlords being worse off financially.
Balancing risk and returns
In a rapidly evolving property landscape, landlords face the challenge of balancing risk and returns. Incorporation may be a strategic move for those seeking to reduce personal risk, but it is not the right answer for everyone. It should not be a default solution solely for tax reasons. Each landlord’s unique circumstances should be assessed by a trusted tax professional on a case-by-case basis to determine the most suitable approach for optimising returns in their property portfolio.