Solving Financing Challenges at Incorporation: Insights from Simon’s Taxes and CIOT’s 2024 Concerns

When landlords incorporate their property businesses, managing existing mortgages and capital accounts can present significant financing challenges. Incorporation can offer commercial benefits such as business continuity, legacy planning opportunities, and access to better financing, but it must be approached with careful planning to avoid triggering adverse tax consequences.

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. Alongside this, the Chartered Institute of Taxation’s (CIOT) 2024 Budget representations raise critical concerns about the practicalities of incorporation, particularly around the interpretation of existing tax relief provisions. This article explores these issues in detail, focusing on how landlords can overcome financing obstacles without triggering tax avoidance concerns.

Financing Challenges in Incorporation

Incorporating a property business often involves transferring property ownership from individuals to a corporate entity, which can create difficulties with existing personal mortgages and liabilities. Many lenders may not agree to novate (transfer) personal mortgages to the newly formed company, requiring landlords to manage these liabilities carefully to ensure they don’t inadvertently trigger Capital Gains Tax (CGT) or Stamp Duty Land Tax (SDLT) liabilities.

Refinancing Risks and Expert Guidance

A primary risk during incorporation relates to how existing mortgages are handled. As Simon’s Taxes at B9:114 explains:

“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.”

This highlights the importance of ensuring that the new company assumes the liabilities directly, rather than the transferor raising new finance to settle those debts. If handled incorrectly, this could prevent HMRC from applying Extra-Statutory Concession (ESC) D32, a critical concession that allows the company’s assumption of liabilities to be disregarded as “consideration” for CGT purposes.

How ESC D32 and HMRC’s Guidance Help

ESC D32 allows for liabilities, such as mortgages, that are assumed by the newly incorporated company to be ignored for CGT purposes. This is crucial in ensuring that landlords do not incur an immediate CGT liability when transferring their properties to a company. Without this concession, the transfer of liabilities could be treated as additional consideration, creating a tax charge.

HMRC’s CG65745 explains:

“The transferor is not required to transfer business liabilities to the company but often does so. This is normally done in practice by the company giving the transferor an indemnity in respect of those liabilities.”

This suggests that liabilities taken over should not trigger CGT when the company assumes them via an indemnity, provided the transaction meets the requirements of incorporation relief under Section 162 of the Taxation of Chargeable Gains Act (TCGA) 1992. This concession is essential for landlords incorporating their property businesses, as it allows them to avoid the time and cost of refinancing all existing loans immediately, providing flexibility to refinance at a later date when commercial conditions are more favourable.

Managing the Capital Account: Avoiding Locked-In Capital

Incorporation also involves careful management of the capital account in the unincorporated business. Simon’s Taxes B9:112 advises:

“If there is a substantial capital account in the unincorporated business, the business owner(s) should be advised to draw this down before incorporation. Otherwise, that capital will be locked into the value of the shares.”

Failing to withdraw capital from the business before incorporation can result in it becoming locked into the value of the company’s shares, making it difficult to access without triggering further tax liabilities. To avoid this, landlords should draw down their capital before transferring assets into the company, ensuring they retain financial flexibility.

HMRC’s BIM45700 supports this approach:

“A proprietor of a business may withdraw the profits of the business and the capital they have introduced to the business, even though substitute funding then has to be provided by interest-bearing loans.”

This implies that landlords can extract capital before incorporation, even if the company subsequently assumes responsibility for the remaining liabilities, ensuring liquidity and avoiding capital being unnecessarily tied up in the company’s structure.

CIOT’s 2024 Concerns: Transferring Only Beneficial Interest During Incorporation and the Call for an Amnesty

In its 2024 Budget representations, the Chartered Institute of Taxation (CIOT) raised significant concerns regarding the transfer of beneficial interest during the incorporation of property businesses. CIOT is the leading professional body in the UK for tax advisers, known for its expertise in all aspects of taxation. With over 20,000 members, CIOT’s primary objective is to promote efficient tax systems through education, technical research, and representation to the UK government and HMRC. The Institute is widely respected for its authoritative voice in tax policy discussions, making its representations critical in shaping tax legislation and guidance.

The Challenge of Transferring Only Beneficial Interest

Many landlords prefer to transfer only the beneficial interest in their properties to a newly incorporated company, while retaining the legal title in their personal names. This approach is often driven by practical financing concerns, as mortgage lenders are frequently reluctant to novate existing loans to a company. Retaining legal title allows landlords to avoid refinancing costs and complications while still moving forward with the corporate structure by transferring beneficial ownership to the new company.

However, current HMRC guidance does not clearly specify whether this approach—transferring only the beneficial interest—meets the requirements for incorporation relief under Section 162. CIOT has highlighted this as a critical issue, stating that the lack of clarity creates uncertainty for landlords trying to navigate the incorporation process while managing mortgage-related challenges.

CIOT’s submission emphasised that clearer guidance is urgently needed from HMRC:

“There is a need for HMRC to provide clearer guidance on whether transferring only the beneficial interest in a property meets the requirements of Section 162 for incorporation relief.”

Without explicit confirmation, landlords face the risk of being denied incorporation relief if such transactions are viewed as incomplete transfers by HMRC. Allowing the transfer of beneficial interest to qualify for incorporation relief would enable landlords to avoid unnecessary refinancing costs and disruptions while still achieving the commercial benefits of incorporation.

CIOT’s Call for an Amnesty

In addition to calling for clearer guidance, CIOT also proposed an amnesty for landlords who have undertaken incorporations based on their understanding of Section 162 but may have failed to meet all the technical requirements due to unclear or evolving guidance. CIOT noted that many landlords have acted in good faith, following professional advice, and structured their incorporations in line with their commercial needs.

However, with increasing scrutiny from HMRC, there is a risk that these landlords could face significant retrospective tax liabilities. In response, CIOT called for an amnesty period during which landlords who have incorporated could rectify any technical discrepancies without facing punitive tax consequences.

CIOT argued that such an amnesty would encourage greater compliance and allow landlords to regularise their tax affairs without fear of severe penalties, creating a more supportive environment for landlords seeking to incorporate while managing real commercial challenges.

Avoiding Tax Avoidance Concerns

While incorporation offers many commercial advantages, it is essential to ensure that the structure is driven by genuine business needs and not purely to secure tax benefits. The courts have consistently emphasised the distinction between legitimate tax planning and tax avoidance. In Barclays Mercantile Business Finance Ltd v Mawson [2004], it was stated:

“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.”

Landlords can ensure their incorporation strategy is seen as legitimate by focusing on real business needs—such as managing financing challenges and business continuity—rather than structuring the transaction solely for tax purposes.

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