Should I transfer my properties into a company?First Published: December 2012 | Available in: Property Articles Your Property Network
Most landlords start their portfolio in their own personal name, perhaps along with a spouse or business partner. In time, as a typical portfolio moves from initial losses to substantial profits – and tax bills! – many landlords look at using a company to mitigate income tax, as companies pay tax at 20% up to £300k of profits. This article looks at whether it makes tax sense to transfer property into a company to save tax.
Why would you transfer your properties into a company?
The main reason that landlords look at transferring property into a company is if there are substantial rental profits being taxed at 40% or more – since a small company only pays tax at 20%.
Clearly, if there are no rental profits (i.e. tax losses are generated), or if the investor’s tax rate is 20%, there would be little tax motivation to make the transfer. Even those investors that are paying 40% income tax need to consider whether the costs and ‘hassle factor’ of running a company are worth the tax saving. As a rule, there should be at least £5,000 of rental profits being taxed at 40% before a company should be considered.
Using a company is more about saving income tax rather than capital gains tax – the net rate of CGT payable for many investors is lower than for companies.
When is a business not a business?
Landlords face a major problem when transferring rental property into a company – capital gains tax.
When any ‘trading’ (i.e. non-rental) business is transferred into a company, this transfer is deemed to be a ‘disposal at market value’ for tax purposes, and so a capital gain arises. However, for a trading business, there is a tax relief called ‘incorporation relief’ which means the tax can be deferred until the new shares in the new company are sold.
Unfortunately, a ‘property rental business’ is not deemed to be a ‘true’ business by HMRC. This means that CGT arises on the transfer of properties into a company.
How can a property portfolio not be a business?
The exact definition of a ‘business’ is not defined in law, so tax tribunals have to consider each case on its merits. A recent case was Ramsay vs HMRC (2012), in which a landlord transferred a block of 10 flats into a company – this is the most relevant recent case for landlords considering transferring property into a company.
HMRC investigated the transfer and disagreed that the property rental activity qualified for incorporation relief.
The ‘First-Tier Tribunal’ considered whether the letting and administration of the properties could be considered a ‘business’ or whether it was the passive receipt of rent (hence incorporation relief not allowed).
What was the tax tribunal result?
‘Ramsay’ and her husband were full-time landlords, spending 20+ hours per week managing all aspects of the portfolio, including maintenance, and check-ins / outs. HMRC also accepted that renting property was the Ramsays’ sole business activity for the entire period.
The Tribunal found that the Ramsays’ property management activities were ‘normal and incidental to the owning of investment property’, and the case was dismissed. However there were a few pointers from the case that mean a future case may succeed.
What can landlords learn from this case?
Several pointers came out of this particular tax tribunal case:
- It is more likely that a larger portfolio – rather than a small one – will be treated as a business
- It is more likely that properties that are not within the same block would be treated more favourably (in Ramsay’s case, the 10 flats were carved out of a single freehold unit)
- Anything that makes a rental business ‘look’ more like a ‘true’ business would help: having a website, business cards, an office to work from, a brand name etc.
- Realistically, landlords would need to be providing ‘services’ to tenants such as cleaning / laundry services – not just the normal repair works etc. This is the most challenging hurdle for most landlords to jump.
HMRC do operate a ‘clearance service’ for borderline cases, where it’s possible to present a case to HMRC for review, before the transfer of properties into a company. Although this is not binding, it at least means that an individual’s position can be checked before taking action.
What are the other options available?
Realistically, it’s quite rare for a landlord to have any chance of a residential portfolio qualifying as a business for CGT purposes. This means that other options to avoid 40% income tax on rental profits must be considered:
1. Start as you mean to go on – use a company from the start
This will mean fewer lenders to choose from, lower LTVs are possible, and higher mortgage rates and fees may be payable. But for investors who have plenty of cash, introducing funds into a company as a director’s loan can mean that as profits arise, these are only subject to 20% Corporation Tax, and the post-tax funds are repaid to the director tax-free.
2. Check the ownership structure – and ‘get the numbers right’
Are there other alternatives to a company? Could using a spouse’s Personal Allowance and Basic Rate band be an option – or adult children or other family members? And, get the numbers right – are you sure you are claiming every expense, allowance, relief and claim possible – many landlords say they are, but we usually find they are not!
3. Use a lease or management company
Under the correct structure, your personally-held properties can be leased to a company, so that most of the profits accumulate within the company. Tenancies are between the tenant and the company, and your company provides a ‘guaranteed rent’ to you personally. This arrangement is an advanced tax-planning method and requires careful set-up, flawless banking arrangements, and rent / repairs / contracts set at commercial rates. Similarly, a management company can be used to enable some of the profits to be transferred to a company.
Sadly, HMRC don’t regard a residential property portfolio as a business, and so when transferring property into a company, a sizeable capital gain will usually arise (with no sale proceeds to pay the tax!). Although technically it might be possible to qualify for ‘incorporation relief’ on such a transfer, realistically for the vast majority of landlords, this isn’t viable.
However, it’s often the case, on closer inspection, that there are easier and cheaper options to avoid Higher Rate income tax on rental profits, and indeed using a lease or management company can achieve the objective without the need to transfer the portfolio into a company.
For those lucky landlords for whom maximising mortgage leverage isn’t a priority, using a company from the start is often the preference. As always, property investing is a game with big numbers, so take professional advice.