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Guest post by Tony Gimple, Estate & Succession Planner with Planned Succession
The politics of restructuring tax relief for buy-to-let landlords with personally owned properties to one side (some one in five are likely to be affected), the removal of top and higher rate tax relief on the annual interest paid and other qualifying expenses for buy-to-let landlords by 2020 has thrown into relief the advantages of ‘corporate’ ownership.
In simple terms, in the 2015/16 tax year a top rate taxpayer would receive 45% tax relief on interest costs etc., but by April 2020 that will only be 20%, whereas companies can claim 100% of interest costs. Interest rates are still at historic lows, but for business planning purposes a rate increase in the not too distant future cannot be ruled out. All in all, investors and those with higher levels of debt in particular will see a significant increase in costs and drop in profits.
By way of example, take a top rate taxpayer owning a £2m investment property with a mortgage of £1.2 million. If the property was let part/fully furnished, profits are reduced by the wear & tear allowance, being 10% of the gross rents say. After April 2016, however, one can only deduct the actual costs of replacing furnishings in the tax year of replacement, meaning that as replacements are unlikely to take place each year, profits and tax will both rise; thus for personally owned investment property: -
| 2015/16 | 2016/17 | Tax Increase | |
| Income/rent | £80,000 | £80,000 | |
| Wear & tear | (£8,000) | n/a | |
| Less loan Interest (3%) | (£36,000) | n/a | |
| Taxable profit | £36,000 | £80,000 | |
| Tax at 45% | £16,200 | £36,000 | |
| Less interest at 20% | n/a | (£7,200) | |
| Total tax | £16,200 | £28,000 | £12,600 |
| Profit | £27,800 | £15,200 |
Post April 2016 and a sample 3% interest rate rise, looking between now and 2020 with combined interest rate rise, and impact of tax changes and rent increases at, say, 5% pa.
| Income/rent | £92,000 | ||
| Wear & tear | n/a | ||
| Taxable profit | £92,000 | ||
| Tax at 45% | £41,400 | ||
| Less interest at 20% | (£14,400) | ||
| Total tax | £27,000 | ||
| Profit | (£7,000) |
As you can imagine, the situation is very different for limited companies. By way of basics, a company is a separate legal entity and pays corporation tax on its net profits; currently 20%, but falling to 18% by 2020. On that fact alone, companies pay less tax than higher rate taxpayers. That said, from April 2016 a tax charge arises when shareholders extract profits by way of a dividend; individuals will have a tax free dividend allowance of £5,000, with the excess being taxed at either 7.5%, 32.5% or 38.1%, depending on the individual’s tax band.
Looking at the net post-tax position of a top rate tax payer compared with a shareholder who also pays tax at the top rate tells the real story of why limited company ownership is generally the best way to structure a property business. Using the same numbers as before and after all deductions and taxes, the personal owner is left with £15,200 cash in hand, whereas the shareholder has £24,239 cash in hand – that’s £9,039 more!
Bringing adult children with no other dividend income or other shareholders with no other income (spouses perhaps) into the business will enable those shareholders to receive a tax-free distribution equal to the dividend allowance, thus further improving the overall net position. Moreover, including family members makes for effective succession planning in the long term.
Capital gains tax (CGT) is another area where using companies is more beneficial; in that, an individual selling investment property will pay CGT at 28% if they are a higher rate taxpayer, whereas a company would doubly benefit due to the indexation allowance and the lower rate of corporation tax which falls to only 18% by 2020. That said, sale of individually owned company shares also is liable to CGT; with the gain calculated on the increase in value of the shares since ownership which, in some circumstances, could lead to a potential double tax charge.
The real elephant in the room is Inheritance Tax (IHT), as after all the other taxes paid during our lifetimes, anything above what is known at the nil-rate band (NRB) (£325,000 in the 2015/16 tax year) is taxed at 40% if left to anyone other than a spouse or civil partner. Thankfully though the IHT problem is solvable, albeit there are rarely any perfect solutions and all said and done it’s our children’s problem.
Stamp Duty is now also a consideration; in that from the 6th April 2016 the purchase of a second home or other property will incur an additional 3% charge, albeit it may well be that ‘corporations’ with fifteen or more residential properties could be exempt. The trouble is, imposing different tax rates for different asset classes held by businesses may not be as simple as it sounds, especially as it will likely impact on other legislation and lead to unintended consequences - more work for lawyers and accountants though!
Whilst making the change from personal to company ownership is a relatively simple mechanical process, any transfer will almost certainly lead to CGT (incorporation relief may be available for ‘actively managed’ property businesses), stamp duty (SDLT) (‘multi-dwelling averaging relief’ may be available, as will certain ‘partnership’-based transfers but this cannot be relied upon due to anti-avoidance measures), and legal fees; but the devil will be in the individual detail. Likewise, a company holding buy-to-let properties for 12-months or more must be structured as what is known as a ‘Special Purpose Vehicle’ (SPV) and will require a bespoke memorandum & articles of association and a shareholders’ agreement, which you are advised not to attempt yourself.
In summary, regardless of the changes proposed by the Chancellor, smart property investors have always used ‘corporate’ structures as they offer great flexibility, significant tax advantages and, on death, they generally can leave their shares without having to sell or transfer property, pay CGT or SDLT, albeit there will most likely be IHT to pay but that usually been sorted well in advance. That said, everyone’s circumstances are different; there is no ‘one’ right answer and, apart from the Wills, Lasting Powers of Attorney, correct personal ownership of property, and foundation IHT planning that everyone should have, there is no on-size fits all solution.
Lastly, whatever you do, don’t try to do it yourself – whether individually or company owned, running a successful property business is a team sport and your accountant, financial adviser (mortgage broker) and someone like us will all need to work together to get you the best result, albeit nothing’s cast in stone and the trick to staying on top of the game is to effect change whenever it’s needed.
This post is based on our understanding of current taxation, legislation and HM Revenue & Customs practice as at December 2015, all of which are liable to change without notice. The impact of taxation (and any tax reliefs) will depend upon your individual circumstances and you should not take action without first taking professional advice.
Tony Gimple, Estate & Succession Planner with Planned Succession
Richard Brown, The Property Voice's Insight
Following our podcast episode which featured Tony Gimple, which you can find here, there has been a LOT of interest in the subject of company incorporation and estate / tax planning I can tell you! It seems to be an idea whose time has come.
If you did not hear the podcast episodes, then Tony joined us in the middle of our Property Cycles series and in particular when we were discussing our Property Portfolio Development Cycle. I outlined how our portfolio development progresses through four clear stages, which I called the 4Es of Property Portfolio Development: Entry, Expand, Establish & Exit.
Tony quite rightly suggested that ideally, we should start with our exit in mind...it could make a huge difference, not least of which to our tax and inheritance position after all. However, he also spoke about it never being too late to start to make plans, so if you are already progressing along the 4Es, then fear not, it is not too late to review your position.
The latest raft of changes from the Summer Emergency Budget & Autumn Statement need not lead to a winter of discontent. Seek the right advice, have a flexible plan and set sail on the right course is the advice offered by both Tony and myself. Yes, there could be some costs in setting up a correct structure now, but these will be potentially dwarfed by some of the costs we may have to face sometime in the future if we do not plan correctly.
Listeners / readers of The Property Voice can receive two Fact Sheet Guides, one on setting up a company and the other on family investment companies from Tony Gimple. If you would like to receive these, along with a 10% discount from Tony's fees, then simply drop us an email: podcast@thepropertyvoice.net asking for an introduction and we shall make the necessary arrangements for you. Alternatively, just drop Tony an email tony.gimple@planned-succession.com quoting The Property Voice, to receive them directly.
As Stephen Covey says 'Begin with the end in mind'.