Practical aspects of property incorporation

When structuring a property investment business in a company mortgage, interest relief remains available in full and can be offset against business profits. On the contrary, only the basic rate tax relief is given to those that operate their business as a sole trader, providing greater benefit to a company structure.

Incorporation means 19% tax is payable rather than 40% for higher rate taxpayers, profits are available to be reinvested or built up within the company in a tax-efficient manner, and you can control the timing and extent of income tax liabilities on any income withdrawn from the company.

Why set up a partnership?

Business accounts can have a far simpler structure when operating as a partnership structure, each partner may attribute their profit share based on what is agreed per the partnership agreement. This makes things easier for self-assessment purposes.

An unregistered partnership does not have to file a corporation tax return, though it must be emphasised that precise bookkeeping and good accounting records should be practiced.

Company formation 

Buy to let landlords are faced with potentially significant tax barriers including capital gains tax (CGT) and stamp duty land tax (SDLT) upon incorporation. When incorporating, the transfer to the company is treated as taking place at market value. This can crystallise tax charges for both CGT and SDLT:

1. Capital gains may be crystallised and subject to CGT at up to 28% – provided capital gains have arisen
2. The company must pay SDLT with the higher rates for residential property

The tax charges can be a barrier to incorporation for many individuals.

Why Incorporate? 

Capital Gains Tax relief

It may be possible to mitigate any CGT liability by taking advantage of incorporation relief. Originally, the relief was generally thought not to apply to landlords, but this was clarified in the case of Ramsey.

Under incorporation relief, a CGT charge that would otherwise crystallise on the transfer of a business can be deferred.

Incorporation relief applies where ‘A person who is not a company transfers, to a company, a business as a going concern, together with the whole of the assets of the business… other than cash, and the business is so transferred wholly or partly for shares issues by the company to the person transferring the business’.

What is a business?

There is no definition of ‘business’ which means that one must make a judgement based on the facts of each case. However, the leading authority on the meaning of ‘business’ for the purposes of incorporation relief is the Upper Tribunal decision in Ramsey.

Distinguishing an active business and mere passive investment is based upon no definitive list of factors. Some factors to take into consideration are:

1. A serious undertaking earnestly pursued
2. An occupational function actively pursued with continuity
3. Has a certain measure of substance in terms of turnover
4. Is conducted in a regular manner and on sound recognised business principles
5. Are the kind which is commonly undertaken by those who seek to profit by them

Whilst we will not delve into the meaning and detail of each of the above factors, the ultimate test to consider is whether there is an active business viewed on the facts as a whole. It is helpful that the decision in Ramsey considered that the description of the work ‘business’ is a wide one.

Other indicators to factor, which are certainly not an exhaustive list, are:

• The number of investments held
• The amount of time spent operating the business each week
• The kind of investments held

Stamp Duty Land Tax relief

Multiple dwellings relief (MDR) and the company acquiring at least six properties would minimise the SDLT liability upon acquisition by the company. However, this would typically still crystallise a material SDLT liability. Special rules can apply to certain partnerships which mean that the SDLT liability is mitigated in full, but it must be noted that these rules are complicated and do not apply as a blanket approach.

Commercial/practical points

Lender’s consent

You should check the terms and conditions of the mortgages to determine whether consent from lenders is required before incorporation. 

Not all lenders would lend to a company and so new lending in respect of the company might have to be arranged in such circumstances, with the old mortgages paid off from new funding. In such cases, mortgage redemption penalties should also be taken into account.

Compliance / administration

Partnership

A partnership bank account should be used to operate the business;

The partnership should be registered with HMRC.

Company

Following incorporation:

• Annual accounts will need filing for the company;
• Depending on the size of the business, the accounts may need to be audited;
• A corporation tax return (CT600) will need filing;
• Other Companies House filings relating to company ownership will need to be made.

At ETC Tax, we have significant experience in advising clients on property incorporations and tax-efficient structuring of property portfolios. If you have any clients with property portfolios looking to structure their affairs in a tax-efficient manner, we would be delighted to hear from you. 

Please get in touch for specialist property tax advice.