UK property has been targeted by a number of government tax policies over recent years which has led to increases in the overall cost of ownership, especially in relation to residential portfolios. For example, 2017/18 saw the first of four incremental restrictions to finance costs (mainly mortgage interest) incurred by higher rate taxpayers in their property business, whereby 25% of such costs attract tax relief only at the 20% basic rate of income tax. 2018/19 will see 50% of finance costs restricted in this way. From 6 April 2021 onwards relief will only be obtained at the basic rate of income tax, meaning greater tax liabilities for higher rate taxpayers with highly geared property portfolios.
The effect in certain cases is that investors are looking at how to reduce the impact of tax policies that erode their net investment returns. One option may simply be to pass the increase on to tenants. Another option may be to consider incorporating – transferring their property business to a company in consideration for shares.
Corporate vs individual ownership
A limited company will pay corporation tax on property business profits at 19%, much lower than the higher rates of income tax (currently 40% and 45%). In addition, the interest cost restriction referred to above does not apply to companies.
Company owners have more control over their personal income tax liabilities, as they can decide when to pay themselves a dividend. If they do not require immediate cash in the form of dividends, they can keep relatively low-taxed profits within the company for further reinvestment.
Companies must pay the 3% higher rate of Stamp Duty Land Tax (SDLT) on all purchases of residential property. However, in the context of a property business, individuals are also subject to the higher rate of SDLT and will only pay the lower rates if replacing their main residence.
Tax implications of incorporating
The greatest tax costs faced by individual landlords may come in the form of SDLT and possibly capital gains tax (CGT). CGT is charged at a rate of 28% on any gains arising on transfer. SDLT is payable based on the market value of the interests being transferred. The rate of tax will depend upon the number of interests, as two or more can attract multiple dwellings relief, whilst six or more are regarded as non-residential and can be taxed at the lower rates applicable to commercial property.
It may be possible for partnerships transferring their business to a company to pay no SDLT at all.
CGT will not apply automatically and will depend on the nature of the business itself and the involvement of the owner(s). Where relief can be claimed, no CGT becomes payable.
Contact us for more information
If you think that the potential savings of incorporation may outweigh the costs or are not sure and wish to learn more about how to change the ownership structure of your residential property business, please contact our tax team on 0207 306 9100.
The information in this article is believed to be factually correct at the time of writing and publication, but is not intended to constitute advice. No liability is accepted for any loss howsoever arising as a result of the contents of this article. Specific advice should be sought before entering into, or refraining from entering into any transaction.