7:00 AM, 28th October 2024, About 3 hours ago
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The trend of landlords incorporating their Buy-to-Let (BTL) portfolios into limited companies has become more prominent in recent years, spurred by changes to tax relief and the shifting regulatory environment. However, this shift can come with complications that many may not fully understand—especially when it comes to mortgage arrangements. This article aims to help the UK Private Rented Sector understand the risks and challenges associated with refinancing during incorporation. This risk is inadvertently triggering unexpected tax liabilities.
The Hidden Risk: Refinancing vs. Novation
One of the biggest challenges landlords face during incorporation is dealing with existing mortgage arrangements. Most lenders require landlords to refinance their mortgages when transferring properties into a company. This means that instead of simply transferring the mortgage over to the company—known as novation—landlords often have to close the old mortgage and take out a new one under their limited company. However, for landlords, refinancing at the point of incorporation can lead to tax complications, especially when it comes to Capital Gains Tax (CGT) and Incorporation Relief.
A key resource in navigating these challenges is Simon’s Taxes, a comprehensive tax reference guide published by LexisNexis and widely used by tax professionals. This authoritative text provides invaluable advice for managing tax implications and structuring incorporations in a commercially sound and compliant way. At B9:114, Simon’s Taxes states:
“The incorporation of a buy-to-let property business may involve refinancing the existing mortgages, which could possibly prevent HMRC from 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, there is considerable risk that HMRC might choose not to apply its concession.”
This means that if the existing mortgage liabilities are not taken over by the company directly—using an indemnity, for example—HMRC may decide not to apply the Extra-Statutory Concession (ESC D32). Without this concession, landlords could end up with an unwelcome CGT bill.
ESC D32 allows liabilities like mortgages, assumed by the company, to be ignored for CGT purposes. This is crucial for landlords incorporating their property businesses, as it means they don’t incur an immediate CGT liability just for transferring their properties to a company. However, mishandling the financing could result in HMRC refusing to apply this concession.
This essentially means that if a landlord refinances their properties when incorporating, rather than transferring the mortgage to the company (novation), they could lose out on Incorporation Relief under Section 162 of the Taxation of Chargeable Gains Act 1992 (TCGA). This relief is critical for deferring CGT when transferring a property business into a limited company, and losing it could lead to significant tax bills.
When the company takes over the existing mortgage (one example being novation), it is seen as assuming the same liability. In such cases, HMRC is more likely to grant Incorporation Relief and apply its ESC D32. However, novation is not widely offered by UK lenders, which forces many landlords into refinancing—a much riskier strategy when it comes to tax.
Paragon Bank, however, stands out as one of the few lenders that appear to have embraced novation, offering a smoother transition for landlords looking to incorporate. Their approach mitigates the risk of landlords falling foul of the tax rules outlined in Simon’s Taxes, and more lenders should consider this strategy to support landlords during incorporation.
Encouraging Lenders to Support Representations to HMRC
One of the options for landlords looking to incorporate their property portfolios is to transfer the beneficial interest of properties into a company while retaining legal title in their personal names. The company then provides an indemnity to the landlord for the mortgage liabilities to be taken over, i.e. to service and eventually repay the loans. This could be anything from a few days to years after the incorporation occurs, but always at the point of refinancing and at the latest by the end of the entire mortgage term. This is a private arrangement between the landlord and his company and does not affect the mortgage lender or their security. This approach can ensure smoother transitions for landlords and protect lenders’ interests without needing immediate refinancing or triggering potential tax complications. It also enables landlords to conclude the transfer of legal ownership and new financing arrangements at a more convenient and economical point in time.
The above is what HMRC guidance at CG6745 appears to regard as what “normally” should happen. However, recent challenges by HMRC appear to contradict their guidance manuals.
Legal Protection for Lenders Under the Law of Property Act (LPA) 1925
Mortgage lenders might feel uncertain about transactions involving beneficial interest transfers, but the Law of Property Act 1925 provides robust protection for their interests. Under the Act:
By supporting HMRC representations that recognise the validity of this arrangement, lenders can help simplify incorporation processes without sacrificing the security of their mortgage charges or inadvertently driving their borrowers to take unnecessary risks associated with arranging new lending at incorporation.
The Chartered Institute of Taxation (CIOT) and Property118 are actively working on representations to HMRC to acknowledge this structure as legitimate for tax purposes, particularly in relation to Incorporation Relief. It is also important to remember that taxation follows beneficial ownership.
We urge mortgage lenders to support these representations, which could open doors to more streamlined processes for both landlords and lenders, reducing tax risks and offering more flexibility.
Why Landlords Should Discuss This With Their Brokers
For many landlords, their broker is their first point of contact when considering incorporating their property portfolio. Unfortunately, if brokers are not fully aware of the risks of refinancing at incorporation, they could inadvertently guide their clients towards decisions that result in costly tax consequences.
If you are a landlord considering incorporation, make sure you raise these points with your mortgage broker. Ask them whether novation is possible with your lender and how it might impact your eligibility for Incorporation Relief.
How you can help
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