General Anti-Abuse Rule (GAAR) – what it is and why it’s important to property investorsFirst Published: May 2016 | Available in: Property Articles Your Property Network
Many property investors are facing an increasingly challenging tax regime, following the Finance Act 2015 – restricting residential mortgage interest relief – which has received Royal Assent. There is now an added incentive for property investors to become more ‘creative’ with their financial affairs – however it is important to stay on the right side of the law. This article explains what the UK’s General Anti-Abuse Rule (GAAR) is, how it affects property investors, and how to ensure compliance with it.
General Anti-Abuse Rule – never heard of it! What is it exactly and why does it matter to me?
The UK’s ‘General Anti-Abuse Rule’ – or ‘GAAR’ for short’ – is part of HMRC’s anti-tax abuse framework, and came into force in July 2013. The purpose of the GAAR is to stop taxpayers from obtaining tax benefits arising from ‘abusive’ tax arrangements.
Generally, the GAAR is an over-arching rule that take priority over other parts of UK tax law – essentially, the GAAR is a ‘test’ to be ‘passed’ by a taxpayer when undertaking transactions or arrangements. GAAR is therefore a deterrent measure designed to stop financial planning that has no genuine rationale other than to save tax.
The GAAR applies to all the major taxes that a landlord would encounter.
How do I know if my financial affairs fall foul of the GAAR?
Firstly, a ‘tax arrangement’ is almost anything that doesn’t HAVE to be done (so, unlike paying a mortgage, or insuring a property).
Examples of ‘tax arrangements’ for landlords include:
- A landlord also has a property management company, which charges a fee to manage his personally-held portfolio
- A landlord leases his properties to a company, which then leases the properties to the end-tenant
- A landlord pays a spouse to manage a property refurbishment
Secondly, we then need to review whether the tax arrangement is ‘abusive’ for the purposes of the GAAR. This essentially means that the arrangements:
- Must not appear to be ‘contrived’ or ‘abnormal’For example: a landlord pays their management company a property management fee of 50% of the gross rent received. Clearly, this would be an ‘abnormal’ rate to pay, since the market rate is usually in the 5-20% range.
- Must appear to be a reasonable course of actionFor example: it would be reasonable to pay an adult child a sensible refurbishment management fee, if the adult child lived in the same city as the property, whereas the landlord parent did not (assuming the adult child declares the income). In other words, in the particular circumstances, the ‘arrangement’ makes business sense.
- Must not be the type of arrangement that HMRC has previously not acceptedPrior to the introduction of the GAAR in July 2013, HMRC may have already ruled on a particular scenario being unacceptable, and so with GAAR in place such scenarios would obviously be unacceptable and so no further GAAR check is needed.
Note that the taxpayer’s opinion of whether their financial set-up is reasonable and on a commercial basis does not in itself mean that the GAAR test is passed i.e. HMRC take an objective view of the facts of the case. For example, this may include a review of bank statements to determine if the management fees claimed as an expense were actually paid over to the management company during the year (since it would be ‘abnormal’ if that didn’t happen).
The ‘Red Face’ test
Essentially, the GAAR exists to ensure that the tax system is not abused by taxpayers, who may otherwise engage in elaborate and absurd arrangements to obtain a tax advantage.
This means that property investors need to have a reasonable business reason to explain how their affairs are arranged – which, should they need to, could be explained, so that the person passes what I call the ‘red face’ test – in other words, would you feel comfortable explaining the business reasons why your financial and tax affairs are set up as they are?
Note – the UK tax system is one of ‘self-assessment’, and there is no ‘clearance’ procedure available for GAAR i.e. compliance with GAAR is assumed, along with compliance with all other aspects of tax law, when the taxpayer files a tax return.
However, unusually, the burden of proof that a taxpayer’s financial and tax arrangements falls foul of the GAAR rests with HMRC.
How can I avoid falling foul of the GAAR?
Generally, property investors are likely to be low-risk as a taxpayer group, since few investors have complex tax arrangements. However the following are some general pointers to bear in mind to assist with compliance with the GAAR:
- Ensure that there is a credible explanation for your overall tax set-up – for example, a private landlord may wish to present a corporate image to the wider world, and so may wish to use a company
- Ensure that payments to third parties are actually made, and at ‘normal’ times – for example, refurbishment management support should be invoiced and paid within normal commercial terms e.g. 30 days after the refurbishment is completed
- Comply with all other tax and business legislation e.g. companies employing family members as staff should have Employers Liability cover in place
- Ensure that commercial arrangements are in place – for example, a property management company manages other property than the landlord’s own, and charges a commercial rate to do so
- Don’t set up payment plans / commercial contracts / schemes / rental agreements etc that don’t operate on normal commercial terms, which would clearly be open to HMRC questioning – for example – charging absurd rates of interest on loans to family members, paying offshore companies for “services” which couldn’t possibly be provided by an offshore entity.
Draft legislation was part of the Finance Bill 2016, and which stated the penalty rate for an arrangement subject to the GAAR, but found to fall foul of GAAR, would be 60% of the avoided tax. Penalties could also reach 100% of the avoided tax. Clearly, this is a penalty regime that one does not want to fall foul of!
The General Anti-Abuse Rule (GAAR), introduced in July 2013, enables HMRC to challenge abusive tax arrangements which have no commercial basis and are purely about saving tax. However, there is a lot that property investors can do to ensure that they are compliant with this aspect of UK tax law, while still enjoying the benefits of an optimal financial and tax set up. As always, professional advice and support should be sought from a qualified tax accountant with specific deep experience of property investment scenarios.