Have you heard about the latest craze of moving properties into a partnership to avoid capital gains tax (CGT) and stamp duty land tax (SDLT)?
Have you heard how much it will cost? Does it all sound too good to be true or indeed confusing?
I have been up and down the country attending property networking meetings and listening to property educators talk about moving properties into partnerships to avoid CGT and SDLT. There has been a lot said about transfers of properties from individuals into a partnership, then into a LLP and then into a Limited Company (LTD), or multiple variations of this.
The recent spate of property transfer schemes to avoid taxes is very difficult to understand and could end up costing you a lot more than it seems, particularly if you find yourself in the firing line of HMRC.
First, let’s remind ourselves why people are thinking about doing this now.
Budget 2015/6 updates mean property investors will pay more tax
In the 2015/6 budget updates George Osborne put in place a number of tax changes:
- Changes to mortgage interest relief. The tax relief on mortgage interest will be set at 20% even though you might be a higher rate taxpayer. In essence, this means that mortgage interest costs of £6,000 will be reduced to £3,000 as an allowable cost to offset against your income.
- Removal of the 10% wear and tear allowance. If you have furnished properties then you were previously able to claim 10% of the net rent. This has now been removed. As such if your rental income for furnished properties was £40,000 then you would lose the £4,000 allowable costs for wear and tear.
Please note that I have written another article about the removal of the 10% wear and tear allowances and how you might take advantage of this change.
All of these changes mean that some people who are currently basic rate taxpayers may soon be considered to be higher rate taxpayers. Overall, a huge number of landlords will pay more tax on their property portfolio. To see how much the budget will affect you please feel free to download our budget announcement template here:
If you wish to learn more about the budget changes you can find more details in my previous article.
Because the changes in the budget apply only to individuals, not to limited companies, many landlords have been contemplating moving their portfolios into limited companies to alleviate some of the negative changes. However, the issue initially with the transfer of properties from one entity (person or company) to another is that you will need to:
- Pay CGT on the profits made
- Pay SDLT because it is a transfer of ownership
- Refinance the property as you cannot simply transfer the mortgage without the consent of the mortgage lender
CGT mitigation through incorporation
You will be liable for CGT based on the profit you have made when transferring the property into a limited company, regardless of the price paid by the company. Even if you gave the property to the company for £0 you will be deemed to have transferred the property at market value.
For example, Mr A transfers his property for £0 to his limited company
- £200,000 deemed market value of property
- -£100,000 cost of property
- £100,000 taxable gain
Some time ago I wrote an article about incorporation relief referencing a specific case “Ramsay v HMRC (2013)”, whereby HMRC insisted that a couple should pay CGT because they transferred their properties into a limited company.
In short, the Ramsays disagreed with the CGT liability and took HMRC to the Upper Tribunal, which overturned HMRC’s decision in regards to the CGT liability. As such the Ramsays did not have to pay CGT because the Upper Tribunal decided that their activities constituted a business as opposed to property investment. In reaching this decision, it considered the fact that they did the following:
- Met with tenants to discuss rental disputes and payments
- Checked utility meters and made payments to utility providers
- Carried out maintenance to unblock drains, fix garage doors and refurbish properties when tenants left
- Carried out work to ensure that they were compliant with fire regulations as required by Belfast City Council
- Carried out garden work and ongoing maintenance
- Cleaned communal areas and cleared rubbish
- Project managed the development of their property
Mrs Ramsay demonstrated that she and her husband spent at least 20 hours per week on their property and as such proved that they were in fact in business.
Judge Roger Berner said in the appeal hearing: “I am satisfied that the activity undertaken in respect of the property, again taken overall, was sufficient in nature and extent to amount to a business for the purpose of s162 TCGA. Although each of the activities could equally well have been undertaken by someone who was a mere property investor, where the degree of activity outweighs what might normally be expected to be carried out by a mere passive investor, even a diligent and conscientious one, that will in my judgment amount to a business. I find that was the case here. For the reasons I have given, I allow this appeal.”
So, what does this mean for you? If you can prove that you work with your properties on a daily basis (at least part-time) then you may be allowed to incorporate your property business without having to pay CGT.
SDLT where no charge arises
You can give property or land away or transfer ownership to another person or limited company. If there’s no ‘chargeable consideration’ you don’t have to pay SDLT or file a return. The chargeable consideration is a payment that can be cash or another type of payment, including:
- works or services
- release from a debt
- transfer of a debt, including the value of any outstanding mortgage
You don’t need to pay SDLT or tell HMRC about freehold land and property transactions with a total chargeable consideration of less than £40,000.
However if you sell a property to a connected party (wife / husband / kids) then SDLT will be based on market value of the property at the time of transfer.
SDLT mitigation through incorporation
There has been a lot said about SDLT mitigation if you put properties into a partnership and then into an LLP and then finally into a limited company. Again, I have heard of many variations to this as I am sure you have too.
In general, you need to pay SDLT if you buy land from another entity. This means typically that you will need to pay the normal scaled levels of SDLT plus the 3% SDLT surcharge if the property is a buy to let.
As such there has been a lot of talk about moving properties into a limited company or some other type of variation to mitigate SDLT altogether.
HMRC takes the view that a partnership is unlikely to exist where the taxpayer is one of a group of joint owners who merely let a property. On the other hand, there could be a partnership where the taxpayer is one of a group of joint owners who:
- let the jointly owned property, and
- provide significant additional services in return for payment.
Much depends on the amount of business activity involved. The existence of a partnership depends on a degree of organisation similar to that required in an ordinary commercial business. Merely holding property jointly does not constitute a partnership.
This is similar to the Ramsay case, which suggested that owners need to carry out additional services other than simply renting out the property (see above for the list of activities that the Upper Tribunal deemed to be a business activity).
Various court cases have established the principle that income derived from property in UK land is very unlikely to be trading income except for hotel or guesthouse activity, where the whole income from guests is usually chargeable as trading income. The mere fact that the taxpayer spends a lot of time working in their letting business — perhaps even all their working time — does not convert rental income into trading income, whereas the provision of bed and breakfast, for example, is clearly trading.
Essentially the distinction lies between the hotelier (who is carrying on a trade) and the provider of furnished accommodation (who is not). An important difference is that in a hotel or similar the occupier of the room does not acquire any legal interest in the property.
SDLT for linked transactions
A connected person could be your relative, for example, your brother, sister, parent, grandparent, husband, wife or civil partner — or one of their relatives. If the buyer or seller is a business, a connected person would be a business partner and their relatives. It also includes companies and groups of companies which are connected to the business.
Transfers of interests in partnerships other than property investment partnerships are not generally chargeable to SDLT. If, for example, a person buys an interest in a farming partnership then there is a transfer of interest in the partnership. However, providing the farming partnership is not a property investment partnership and there has not previously been a transfer to the partnership falling within paragraph 10 of the Finance Act 2003, then the acquisition of the interest is not deemed to be a land transaction. As a result, no liability to SDLT arises, even though the partnership holds chargeable interests.
For me, this is a clear difference between genuine business partnerships whereby they are using the property as part of the business, and partnerships where property is the business. In the above example the property itself is not the driving force behind their income, rather their business activities reside within the property.
HMRC clarifies the point once more by saying: “In each case, a partnership will exist if and only if the entity carries on a ‘business’. Where an entity does not carry on a business there will not be a partnership for SDLT purposes and the partnership rules set out in this chapter will not apply: even if the parties are bound by a partnership deed.”
What is deemed to be a partnership?
The Partnership Act 1890 identifies a number of considerations when deciding that a business activity is indeed a partnership:
- (1) Partnership is the relation which subsists between persons carrying on a business in common with a view of profit.
- (2) But the relation between members of any company or association which is:
- (a)Registered as a company under the Companies Act 1862, or any other Act of Parliament for the time being in force and relating to the registration of joint stock companies, or
- (b) Formed or incorporated by or in pursuance of any other Act of Parliament or letters patent, or Royal Charter, or
- (c) A company engaged in working mines within and subject to the jurisdiction of the Stannaries:
is not a partnership within the meaning of this Act.
The Finance Act 2003 Schedule 15 method
There has also been a lot said recently about the transfers of property into a partnership without SDLT being charged within the Finance Act 2003 schedule 15.
HMRC describes a partnership, consisting of individuals G and H (each with a 50% interest), owns the freeholds of many houses in multiple occupation, letting them as a commercial undertaking. None of the properties were introduced by the partners or persons connected to them.
The partners spend a significant amount of time managing the tenants, collecting rents and undertaking repairs. The activity amounts to a business and the partnership is a property investment partnership.
G wishes to introduce his daughter J as a partner. He gives J half of his interest in the partnership, so J acquires a 25% interest in the profits.
This is a transfer of an interest in a property investment partnership, with no consideration given. Here, the properties were all purchased from parties unconnected with the partners. There is, therefore, no SDLT charge on this transfer.
FA03/Sch 15 excludes from SDLT:
- The transfer of an interest in land into a partnership
- The acquisition of an interest in a partnership
- The transfer of an interest in land out of a partnership
Such transactions were treated for the purposes of SDLT as if they were not land transactions.
References to the transfer of an interest in land include:
- The grant or creation of an interest in land
- The variation of an interest in land and
- The surrender or release of an interest in land
Such transactions are exempt from charge if the following conditions set out in FA03/S65 are met:
- The effective date of the transaction is not more than one year after the date of incorporation of the limited liability partnership.
- At the relevant time the transferor:
- is a partner in a partnership comprised of all the persons who are or are to be members of the limited liability partnership (and no one else), or
- the interest transferred as nominee or bare trustee for one or more of the partners in such a partnership.
- the proportions of the interest transferred to which the persons mentioned in two above are entitled immediately after the transfer are the same as those to which they were entitled at the relevant time, or
- none of the differences in those proportions has arisen as part of a scheme or arrangement of which the main purpose, or one of the main purposes, is avoidance of liability to any duty or tax.
No SDLT charge example
Here is an example of where there will be no SDLT charge:
A partnership of A and B has relevant partnership property including a commercial unit and various shareholdings in several companies. The commercial unit has a market value of £1.5 million subject to an outstanding mortgage debt of £500,000 and the shares have a market value of £180,000.
C joins the partnership paying £300,000 for a 25 per cent share.
HMRC states that the liability will be based on the consideration given less the excluded amount.
Firstly we need to establish the net market value of the chargeable interest:
- MV – SL
- MV = £1.5 million
- SL = £500,000
Net market value equals £1 million.
We now need to establish the appropriate proportion.
As C was not a partner before the transfer this will be equal to the partnership share he acquired, i.e., 25%.
The excluded amount is therefore:
25% x £1m = £250,000
To establish consideration for SDLT purposes we look at the consideration passing less the excluded amount:
£300,000 – £250,000 = £50,000.
This will be the consideration for SDLT purposes.
As the SDLT consideration is less than the 0% threshold, if a certificate of value at £125,000 is included in the instrument, the SDLT liability is nil. This doesn’t take into account the 3% SDLT surcharge implemented in 2016.
In reading the provisions of Sch 15 FA 2003 it is necessary to distinguish between the actual consideration given for the acquisition of a partnership interest and the “chargeable consideration”. This is because it is the “chargeable consideration” that determines the extent of the SDLT charge on the acquisition.
Assignment/lease properties to avoid SDLT
You don’t have to pay SDLT or tell HMRC if you buy a new or assigned lease of less than seven years, as long as the chargeable consideration is less than the residential or non-residential SDLT threshold.
Chargeable consideration includes:
- any premium and the net present value of any rent in the case of a new lease;
- the consideration given for the assignment or surrender of an existing lease.
To work out the net present value (based on the average rent over the life of the lease) you can use the stamp taxes online calculator.
Many investors often prefer to leave the property ‘outside’ the company in their personal ownership and lease the property to the company instead. The grant of a formal lease to the company may still create a SDLT liability. However, in many cases, it is possible to avoid SDLT altogether by granting the company a non-exclusive licence to occupy the property. This is because a (mere) licence is an exempt interest for SDLT purposes.
Although a licence does not give the occupier any legal protection, this should not be an issue since the ‘landlord’ owns the company. Care is required to ensure that the legal document is drafted correctly — if it grants an exclusive right of possession to the occupier, it will be treated as a lease (Street v Mountford HL  2 All ER 289).
Final SDLT consideration
An article by tax barrister Michael Thomas summed up the issues above quite nicely:
- “The SDLT treatment of partnerships is a very complicated and unsatisfactory area, which requires caution;
- HMRC takes some controversial views which have no basis in the current legislation (although many of these are favourable to taxpayers);
- Creating a partnership may result in an SDLT charge;
- SDLT is still a potential issue even though, as a matter of general law, land is held outside the partnership;
- There is considerable uncertainty as to the scope of many of the key concepts including ‘actual consideration’, ‘partnership property’ and the issue of when consideration is given for the transfer of an interest in a partnership; and
- Although welcome reforms are proposed from Royal Assent of the FA 2006, which will remove the charge on actual consideration and confine the charge on the transfer of an interest in a partnership to partnerships whose main activity is investing or dealing in land, many problems will remain.”
Finally, the partnerships regime contains anti-avoidance rules to prevent the regime being used for the purposes of saving SDLT. As a regime which prescribes very precise results and is less amenable to broad-brush interpretations, the partnerships regime is potentially a fertile ground for tax planning, and the anti-avoidance rules are certain to be scrutinised in order to see if there is a way around them.
The General Anti Abuse Rule (GAAR) introduced on 17 July 2013, when the Finance Act 2013 was passed, applies to SDLT.
My first question to you is this: “Do you wish to be the one that HMRC takes to court?” My second is: “How much money do you have for any court fees if you lose, never mind the cost of a specialist barrister who wins no matter if you lose?”
One major issue I have with the current workarounds being suggested is the fact that a number of people are stating that you do not need to inform your mortgage companies if you transfer your properties to a partnership/limited liability partnership/limited company.
Although this may be true, notice the word ‘may’, you need to remember that buy to let mortgage products are not regulated by the Financial Conduct Authority (FCA) albeit this looks to be changing. In any case the mortgage lenders make more money if they lend to incorporated businesses as they deem it to be more risky. As such the banks will lose out if you move the properties into a limited company without telling them. Do you think they will be impressed? The mortgage interest costs are typically higher if you have properties in an incorporated business. They will also be looking for some sort of administration fee to transfer the properties into a limited company.
Indeed, they may decide to do a financial evaluation on the property and you/the company to ensure that their mortgage is not at risk.
As you can see from the above that I am very concerned when I hear lawyers or accountants suggesting to their clients that they keep the incorporation quiet. Some lawyers and accountants are suggesting that the banks will not do anything because you are paying the mortgage.
Let’s put it this way. Banks can make more money from other clients nowadays compared to you if you have a great mortgage deal from the early 1990s of less than 4% interest. So do not give them good reason to pull the mortgage out from under your feet.
If, like me, you have integrity and you also wish to sleep at night, then I would suggest that you are open with your mortgage lenders. At the end of the day you need them more than they need you.
Next steps — understand how you structure your property business
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