Is Incorporation Legal Tax Planning or Tax Avoidance? | A Judicial Perspective

The following quotes reflect an evolving judicial attitude towards tax planning in the 21st century, with increasing emphasis on the need for commercial substance in tax planning arrangements and a clearer demarcation between legitimate planning and avoidance.

Lord Steyn in Inland Revenue Commissioners v Fitzwilliam [1993] STC 502:

“Tax planning is acceptable, provided the taxpayer does not frustrate the will of Parliament as reflected in the legislation.”

This highlights the court’s stance that taxpayers may engage in tax planning as long as it respects the intended effect of tax statutes.

Lord Nolan in Inland Revenue Commissioners v Willoughby [1997] 1 WLR 1071:

“Tax avoidance, in the sense of a course of action designed to conflict with or defeat the evident intention of Parliament, is a cardinal sin in fiscal matters. But tax mitigation is not tax avoidance; it is legitimate.”

Lord Nolan draws a clear distinction between legitimate tax mitigation and abusive tax avoidance.

Lord Templeman in Inland Revenue Commissioners v McGuckian [1997] 1 WLR 991:

“Fiscal nullity arises when there is a preordained series of transactions into which there are inserted steps that have no commercial purpose other than tax avoidance.”

This case advanced the Ramsay principle, focusing on distinguishing genuine commercial transactions from those created solely for tax avoidance. However, it did not dismiss legitimate tax planning.

Lord Hoffman in MacNiven v Westmoreland Investments Ltd [2001] UKHL 6 (referencing the Ramsay principle):

“There is no judicial anti-avoidance doctrine which overrides the application of the statute.”

This quote demonstrates the House of Lords’ interpretation that tax planning is permissible as long as it complies with statutory requirements, although it must be distinguished from artificial tax avoidance schemes.

Lord Walker in Barclays Mercantile Business Finance Ltd v Mawson [2004] UKHL 51:

“The hallmark of legitimate tax planning is that the taxpayer is merely taking advantage of a fiscally attractive option which Parliament has provided. On the other hand, tax avoidance typically involves taking steps that have no commercial purpose other than to secure a tax advantage.”

This quote from Lord Walker supports legitimate tax planning while reinforcing the line between acceptable planning and abusive avoidance.

Lord Walker in Astrovale Holdings Ltd v Revenue and Customs Commissioners [2005] STC 543:

“There is no objection to tax planning, so long as it is carried out in a way that does not defeat the purpose of the legislation or rely on artificial or contrived arrangements.”

Once again, Lord Walker distinguishes between legitimate tax planning and schemes that lack substance or commercial reality.

Lord Hope in Revenue and Customs Commissioners v Tower MCashback LLP 1 [2011] UKSC 19:

“The fact that a transaction is designed to give rise to a tax advantage does not of itself mean that it constitutes unacceptable tax avoidance. What matters is whether the transaction is one that Parliament intended to encourage.”

Lord Hope here reiterates that tax planning is permissible if it aligns with Parliament’s intent, highlighting the difference between legal tax mitigation and avoidance.

Lord Neuberger in Pitt v Holt [2013] UKSC 26:

“The courts must be astute not to allow tax mitigation measures which fall outside the bounds of what Parliament intended, but at the same time, they must not penalise taxpayers for taking advantage of reliefs and allowances which Parliament has specifically made available.”

Lord Neuberger emphasises that while taxpayers are entitled to use reliefs and allowances, they should not step beyond what the law allows.

Lord Carnwath in R (on the application of Prudential plc) v Special Commissioner of Income Tax [2013] UKSC 1:

“There is nothing wrong in taxpayers seeking to minimise their liabilities, but the line must be drawn where avoidance schemes distort the reality of transactions to achieve unintended tax results.”

This statement underscores that tax planning is lawful, but schemes that distort or misrepresent transactions will not be upheld.

Lord Reed in HMRC v Murray Group Holdings Ltd [2015] UKSC 58 (concerning the Rangers FC Employee Benefit Trust scheme):

“Where an arrangement is contrived and artificial, having no genuine commercial purpose, it is likely to fall outside the boundaries of acceptable tax planning.”

This highlights a shift in judicial thinking towards a more critical approach to artificial tax schemes, particularly those that lack substantive commercial purposes.

Lord Hodge in UBS AG v HMRC [2016] UKSC 13:

“The test is whether the transactions, viewed realistically, serve any purpose other than to reduce the taxpayer’s liability to tax.”

Lord Hodge advocates for a realistic assessment of transactions, suggesting that tax planning with no purpose beyond reducing tax liabilities will be subject to scrutiny.

Why Incorporation Is Not Caught by DOTAS

• • Absence of DOTAS Hallmarks:

Hallmarks Definition: DOTAS specifies certain “hallmarks” or features that are indicative of tax avoidance schemes, such as confidentiality clauses, premium fees, or complex financial products designed primarily for tax benefits.

Incorporation Lacks Hallmarks: The process of incorporating a business does not involve these hallmarks. It is transparent, routinely registered with Companies House, and lacks the secrecy or complexity associated with schemes that DOTAS targets.

• No Artificial Steps for Tax Advantage:

Genuine Economic Activity: Incorporation reflects a genuine change in the legal structure of a business, not an artificial arrangement inserted solely to gain a tax advantage.

Economic Substance Over Form: Tax authorities look at the substance of transactions. Since incorporation involves real changes in how a business operates and is governed, it has substantial economic substance beyond any tax implications.

• HMRC Guidance and Legislative Intent:

Explicit Exclusions: HMRC provides guidance on what constitutes a notifiable scheme under DOTAS. Ordinary business transactions, like incorporation, are not listed as requiring disclosure.

Furthermore, whilst not specifically referencing DOTAS, GAAR Part D guidance under D 2.2.1 gives examples of “Intended legislative choice” that should not be considered as aggressive or abusive and states:

“deciding to incorporate a business or to sell shares rather than assets (in both cases so as to pay less tax or Stamp Duty Land Tax)”.

D 2.2.2 goes on to say:

“This category might also include reorganising a trust or corporate structure in a straightforward way to fit in with a new tax regime.”

Transferring an unincorporated property rental business into a corporate structure aligns with both “reorganisation” and fitting in with “a new tax regime” brought about by S24.

Even where “some element of artificiality” exists in arrangements, D 2.5.2 makes the distinction that acceptable non-abusive arrangements:

“… includes cases where what otherwise could have been regarded as standard tax planning is carried out with steps that are more abnormal or contrived than those normally seen”.

Policy Focus: The legislative intent behind DOTAS is to capture aggressive tax planning strategies that exploit loopholes, not to burden standard business practices with additional reporting requirements.

• Compliance with Existing Tax Laws:

Adherence to Regulations: Businesses that incorporate comply with existing tax laws and regulations, paying taxes as required under the new corporate structure.

No Evasion or Avoidance: Since there is no evasion or avoidance of tax obligations – merely a change in how taxes are assessed and paid – incorporation does not trigger DOTAS provisions.

• Standard Commercial Practice:

Legitimate Business Activity: Incorporation is a common and legitimate method for structuring a business. Companies are incorporated for various commercial reasons, such as:

• Limiting liability – to ring fence personal wealth away from business risk and to encourage the next generation to take responsibility of the business without putting themselves at unacceptable risk.

Office of Tax Simplification (OTS) Property Income Review 2022

Pages 36 to 39 of the OTS Property Income Review dated 25th October 2022 provide further insights into the rationale behind landlord incorporation. The report highlights both the advantages and challenges of incorporation, focusing primarily on tax considerations.

• Perceived Benefits of Incorporation:

Corporation Tax vs. Income Tax: The review explains that incorporating a property business allows landlords to pay Corporation Tax at 19% (the main rate of Corporation Tax at the time, which has since increased to 25%), rather than the higher Income Tax rates applied to individuals, which can be as high as 45%. This lower tax rate incentivises landlords to retain profits within the company for reinvestment, as described on page 36.

Interest Deductibility: Page 37 notes that companies generally face fewer restrictions on the deductibility of interest compared to individual landlords. This is particularly important for landlords with significant borrowing, as incorporation allows for full tax relief on finance costs, which is limited for individuals under current Income Tax rules.

• • Commercial Drivers for Incorporation:

Limited Liability: The OTS outlines that one of the commercial benefits of incorporation is limited liability protection. This is especially appealing for landlords seeking to reduce personal financial risk while managing large property portfolios. This point is discussed on page 37.

Succession Planning: On page 38, the review highlights that incorporation can facilitate succession planning by making it easier to transfer property businesses to future generations. Incorporation provides greater flexibility for landlords looking to pass on assets while minimising tax liabilities.

Control over Profit Extraction: Another benefit of incorporation, discussed on page 38, is the ability for company directors to control how and when profits are drawn from the business. This provides landlords with more flexibility in managing personal tax liabilities, particularly in relation to dividend payments.

• Challenges and Disincentives:

Increased Administrative Responsibilities: While incorporation offers tax and commercial advantages, the report points out on page 39 that it also introduces new administrative burdens, such as compliance with Companies House requirements and regular filings. This adds complexity to running the business.

Double Taxation on Dividends: The review also discusses the potential for double taxation, as profits are taxed at the corporate level and then again when distributed as dividends. This may discourage some landlords from incorporating, despite the benefits.

• In summary, the OTS Property Income Review 2022 emphasises that while incorporation can provide significant tax advantages, particularly with regard to lower tax rates and full interest deductibility, it also comes with increased administrative responsibilities and the risk of double taxation on dividends. The review suggests that incorporation is most attractive to larger property businesses where the benefits outweigh the additional complexities.

Property118 incorporation models – Rebuttal of Tax Avoidance Allegations

Property118 categorically rejects the DOTAS characterisation of our tax planning structures, specifically the Substantial Incorporation Structure (SIS) and Capital Account Restructure (CAR). These strategies’ are a commercial necessity rather than any tax avoidance intent.

Legal Foundation: Gordon vs IRC and the Transfer of Beneficial Interest

To clarify, the Substantial Incorporation Structure (SIS) is fully compliant with UK tax law, as evidenced by long-standing legal precedents. Notably, the case of Gordon vs IRC [1991] STC 174 provides crucial insights into the transfer of beneficial interest and the application of Incorporation Relief under Section 162 of the Taxation of Chargeable Gains Act (TCGA) 1992.

In this case, the court ruled that the transfer of beneficial interest in property can form part of a legitimate business transaction without triggering immediate Capital Gains Tax (CGT) liabilities, provided that the entire business is transferred to a company in exchange for shares. This decision supports the incorporation relief principle, which defers CGT until the eventual disposal of the shares, rather than at the point of transfer.

Property118 applies the same principle in its SIS framework, where the beneficial ownership of properties is transferred into a company, deferring CGT under Section 162 TCGA. This is fully in line with UK tax law, as SIS focuses on legitimate business restructuring, allowing landlords to continue their operations under a more commercially viable structure without triggering immediate tax liabilities.

Commercial Drivers for SIS in Landlord Incorporations

It is crucial to emphasise that the primary motivation behind SIS is not tax optimisation but the commercial benefits it provides to landlords. SIS helps landlords to overcome significant financial and operational challenges as they seek to incorporate their property businesses.

Main Reasons Landlords Incorporate

1. Business Continuity and Legacy Planning

By incorporating their property businesses into a corporate structure, landlords can create a more durable framework that allows for the seamless continuation of their business operations. Incorporation provides landlords with the ability to:

• Ensure Business Longevity: By transitioning from personal ownership to a corporate entity, landlords create a stable legal structure that can outlive their personal involvement, ensuring the property business can continue operating without disruption.
• Facilitate Succession Planning: Incorporation allows for easier transfer of ownership to heirs or other stakeholders, whether gradually or in one transaction. A corporate structure provides clarity and efficiency in managing inheritance and succession, avoiding the complexities and tax inefficiencies that may arise from passing down individual properties.
• Simplify Estate Management: With incorporation, landlords can set up shareholding structures that reflect their long-term intentions, allowing different family members or business partners to take on roles within the company. This makes it easier to plan for the next generation without burdening the estate with fragmented property ownership.

2. Navigating Section 24 Finance Restrictions

Many landlords have been affected by the Section 24 restrictions, which limit the deductibility of finance costs (such as mortgage interest) from rental income. By incorporating their business through SIS, landlords can navigate these restrictions, as corporate entities are not subject to the same rules. This helps to alleviate the cash flow pressures many landlords face under the new tax regime, enabling them to maintain profitability while meeting their financing obligations.

3. Overcoming Financing Challenges

One of the major hurdles landlords face during incorporation is dealing with existing financing arrangements. Many lenders are unwilling to novate (transfer) existing mortgages when properties are being transferred from personal to corporate ownership. This reluctance is often due to perceived risks or because the lender’s policies don’t accommodate such restructures. However, Substantial Incorporation Structure (SIS) provides a solution by allowing landlords to defer the immediate need for refinancing, thus avoiding the costs and hassle of renegotiating financing at the point of incorporation.

SIS focuses first on the transfer of beneficial ownership while retaining the legal ownership in the landlord’s name. This ensures that the lender’s security over the property remains intact under Sections 85-87 and Section 114 of the Law of Property Act (LPA) 1925. By keeping the legal title in the original owner’s name during the incorporation process, the lender’s legal charge on the property is unaffected, meaning they retain full security against the borrower’s mortgage obligations.

This structure offers several key advantages:

• No Immediate Need to Refinance: Landlords can defer refinancing to a time that is more commercially suitable, avoiding penalties, fees, or rushed negotiations that might arise from trying to novate mortgages during incorporation.
• Legal Protection for Lenders: The LPA 1925 ensures that the lender’s security interest remains fully protected during this phase. Since the legal title to the property remains with the original borrower (the landlord), the lender’s charge continues to be valid. There is no need for lenders to consent to a transfer of the beneficial interest, as their security remains tied to the legal ownership, which does not change during the incorporation process.
• Flexibility in Lender Engagement: The structure allows landlords to engage with lenders at a later stage when the corporate entity is better established, improving their chances of securing favourable terms. This can help landlords avoid early repayment charges or fees that could result from refinancing prematurely.
• Minimising Disruption: Incorporating a property business is already a complex process, and adding the requirement to refinance all existing loans simultaneously can create unnecessary operational burdens. By deferring this need, SIS allows landlords to focus on smoothly transitioning their business to corporate ownership before addressing refinancing.

In summary, SIS enables landlords to postpone refinancing, reducing the immediate pressure of lender engagement while ensuring that the lender’s security remains fully intact under LPA 1925. This not only minimises the disruption to the business but also allows landlords to secure better refinancing terms once the corporate entity is firmly established.

ESC D32 Risk Mitigation

SIS is designed to mitigate the risks identified in Simon’s Taxes at B9:114 …

“The incorporation of a buy-to-let property business may involve refinancing the existing mortgages which could possibly prevent HMRC applying ESC D32. If the company does not assume the same liabilities of the transferor, but instead raises finance of its own, which is passed to the transferor to settle its debts related to the properties being transferred, there is considerable risk that HMRC might choose not to apply its concession.”

The above expert guidance from Simon’s Taxes is clearly derived from HMRC’s explanation of ESC D32 in CG65745, in particular the words “indemnity” and “taken over”.

SIS is designed to protect landlords, not to circumvent tax obligations.

Substance Over Form: Legal and Commercial Realities

In evaluating the SIS, it is important to apply the well-established legal principle of substance over form. This principle, supported by UK tax law, dictates that the true nature and purpose of a transaction should be assessed based on its substance, not its legal form.

The substance of the SIS transaction is clear: it allows landlords to transfer beneficial ownership of their properties to a company in a way that avoids immediate refinancing burdens. The commercial reality is that landlords need flexibility, and SIS provides a practical, commercially driven solution to that problem.

The substance of SIS is consistent with the commercial purpose of incorporation. The SIS structure is designed to assist landlords in navigating complex financial and legal challenges, particularly those related to financing, rather than being a tax-driven mechanism.

Addressing Misunderstandings and Defending Our Clients

It is essential to address mischaracterisation of SIS as a tax avoidance mechanism. Any positive tax outcomes arising from incorporation, such as the potential for Capital Gains Tax deferral, are merely incidental to the main commercial drivers of SIS. Incorporation Relief under Section 162 TCGA is a statutory relief intended to support the incorporation of businesses—our clients simply utilise the relief as intended by Parliament, in line with the Gordon vs IRC decision.

Compliance with DOTAS Requirements

The crux of our rebuttal is that avoiding refinancing and the potential for tax advantages associated with incorporation appear to have been conflated in the assessment of SIS. The decision to incorporate a property business and claim any associated reliefs (such as those under TCGA 1992, s. 162) is a statutory right, available to taxpayers who meet the relevant criteria. By contrast, SIS is a specific strategy designed to overcome financing challenges faced by landlords at the point of incorporation, particularly where mortgage lenders are unable or unwilling to agree to novation. Given that SIS has no impact on tax outcomes whatsoever the DOTAS hallmarks cannot possibly be applied to the structure.

HMRC’s Adoption of Dan Neidle’s Critique

We believe that Dan Neidle’s public critique has directly influenced HMRC’s current stance towards SIS and CAR. This is evident in the issuance of Scheme Reference Numbers (SRNs) under the Disclosure of Tax Avoidance Schemes (DOTAS) regulations for these structures. Despite nine years of compliance checks and Closure Notices issued by HMRC without any further tax due, the sudden change in HMRC’s approach reflects a misunderstanding of the commercial drivers behind SIS and CAR. These structures were designed to overcome real-world financial obstacles faced by landlords, particularly in refinancing their portfolios.

To summarise

In response to these misconceptions, we have been in regular communication with HMRC to clarify the legitimate commercial purposes behind SIS and CAR. Furthermore, Property118 is fully prepared to defend our clients’ interests before the First-Tier Tribunal (FTT), where we will present detailed evidence demonstrating the commercial legitimacy of these strategies, supported by clear legal precedents, such as Gordon vs IRC.

Our clients’ compliance with HMRC’s guidance and the broader commercial realities faced by landlords will be central to our argument. This ongoing dialogue and legal defence are part of our commitment to ensuring that our clients’ interests are robustly protected against unfounded allegations.

Help Us Fight Back

If you think HMRC is overreaching and want to help us stand up for landlords, please consider supporting the Property118 Action Group. With your help, we can push back against these unfair actions and defend the rights of landlords everywhere.

Visit our JustGiving page to donate. Every contribution helps us fight back and hold HMRC accountable. Together, we can make a real difference.

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