Can you use incorporation relief to move properties into a limited company without paying SDLT and CGT?
Have you heard about the latest craze of moving properties into a partnership to avoid CGT and SDLT? Our property accountants have helped many property investors incorporate their property business into a limited company. They have only done this where there is a clear benefit.
I have been up and down the country attending property networking meetings, listening to property educators. They 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 the properties are moved into an LLP. Finally, the properties are then moved into a Limited Company (LTD). With many variations in between.
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.
Budget 2015/6 updates mean property investors will pay more buy to let tax
In the 2015/6 budget updates George Osborne put in place a number of buy to let 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.
- 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.
If you wish to learn more about the budget changes see our article.
Many landlords have been contemplating moving their portfolios into a limited company 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 a property
- -£100,000 cost of property
- £100,000 taxable gain
Some time ago our property accountants wrote an article about incorporation relief referencing a specific case “Ramsay v HMRC (2013)”. HMRC insisted that a couple should pay CGT because they transferred their properties into a limited company.
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.”
SDLT where no charge arises when incorporating properties into a limited company
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 the market value of the property at the time of transfer. Our property accountants can help you with this matter.
SDLT mitigation through incorporation
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.
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 an organisation similar to that required in an ordinary commercial business. Merely holding property jointly does not constitute a partnership.
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.
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 a limited company and groups of other limited companies which are connected.
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 an 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.
HMRC clarifies “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) A partnership is a 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. If you are unsure about this then please book a call with our property accountants for you to gain clarity.
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 HMOs, 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 Schedule 15
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
FA03 Schedule 65
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 a 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.
Download your buy to let tax guide here, written by our property accountants
No SDLT charge when incorporating properties into a limited company
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 limited 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.
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 of less than seven years
You don’t have to pay SDLT or tell HMRC if you buy a new or assigned lease of fewer than seven years. This is as long as the chargeable consideration is less than the residential or non-residential SDLT threshold.
- any premium and the net present value of any rent in the case of a new lease;
- the consideration is given for the assignment or surrender of an existing lease.
Many investors prefer to lease the property to the company. The grant of a formal lease to the company may still create an 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 when moving properties into a limited company
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, the 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.”
The General Anti Abuse Rule (GAAR) introduced on 17 July 2013, when the Finance Act 2013 was passed, applies to SDLT. Our property accountants have spent a long time to understand this to make it easier for our clients to be kept informed.
Mortgage companies and their view of incorporation
A number of people are stating that you do not need to inform your mortgage companies when you look to use incorporation relief.
Mortgage products are not regulated by the Financial Conduct Authority (FCA). In any case mortgage lenders make more money if they lend to incorporated businesses as they deem it to be riskier. 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.
Some lawyers and accountants are suggesting that the banks will not do anything because you are paying the mortgage. Banks can make more money from other clients nowadays compared to you. This is especially the case where you have a mortgage of less than 4% interest. Do not give them a good reason to pull the mortgage out from under your feet.
How can our property accountants help you reduce your buy to let tax?
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