10:29 AM, 17th October 2024, About a month ago
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Introduction: This case study presents the commercial rationale behind the incorporation of a property rental business and provides a detailed comparison of the tax outcomes for both unincorporated and incorporated residential landlords. It explains how incorporation is driven by genuine business needs, such as full deduction of finance costs, risk management, and succession planning, and why this restructuring does not fall foul of the Disclosure of Tax Avoidance Schemes (DOTAS).
Profit Before Finance Costs
Taxable Profit: £175,000
Step 1: Loss of Personal Allowance
As the landlord’s income exceeds £125,140, they lose their entire personal allowance (£12,570). The landlord is taxed on the full £175,000.
Step 2: Income Tax Calculation
Total income tax before finance cost credit:
£7,540 (basic rate) + £34,856 (higher rate) + £22,437 (additional rate) = £64,833
Step 3: Finance Cost Tax Credit
Final Income Tax Liability
National Insurance
Conclusion for Unincorporated Landlord:
Profit Before Finance Costs
Taxable Profit: £175,000 – £50,000 = £125,000
Step 1: Salary and Corporation Tax Calculation
To withdraw all the profit in a tax-efficient manner, the landlord first receives a salary of £12,570, fully utilising their personal allowance.
Step 2: Dividend Payment and Tax
Step 3: National Insurance Contributions
Final Tax Breakdown for Incorporated Landlord
Conclusion for Incorporated Landlord:
Incorporation offers significant commercial advantages to the landlord beyond tax considerations. These include:
This incorporation clearly does not fall under the Disclosure of Tax Avoidance Schemes (DOTAS) because:
Initial Conclusion
This case demonstrates that the incorporation of a property rental business is driven by legitimate commercial reasons. The structure provides risk management, financial flexibility, and better alignment of finance cost deductions, with significant long-term benefits for the business. It does not fall foul of DOTAS because it reflects genuine business activities and is not designed to exploit tax avoidance schemes.
The tax savings in the incorporated structure arise from standard deductions and the ordinary use of salary and dividends, making the arrangement commercially justifiable and compliant with tax rules.
In summary:
Landlords transferring properties into a limited company may trigger a Capital Gains Tax (CGT) liability. This arises because the transfer is treated by HMRC as a sale at market value, potentially creating a taxable gain based on the property’s appreciation over time.
The CGT is calculated by taking the difference between the original purchase price of the property and its market value at the time of transfer, less any allowable costs or reliefs. Given the long-term appreciation of property values, CGT could represent a substantial cost for landlords who have held properties for many years.
Incorporation Relief under Section 162 of the Taxation of Chargeable Gains Act 1992 can help defer CGT when transferring a business, including a property rental business, into a limited company. This relief applies where the business, along with all its assets (including properties), is transferred to a company in exchange for shares.
Key Points of Incorporation Relief:
By using Incorporation Relief, landlords can avoid an immediate CGT liability, making the incorporation process more affordable in the short term and allowing for a smoother transition to a corporate structure.
The final major cost consideration for landlords incorporating their rental property business is Stamp Duty Land Tax (SDLT). As with CGT, transferring properties to a company is generally treated as a sale, triggering SDLT based on the current market value of the properties.
For residential properties, SDLT is calculated based on a tiered rate system, with additional surcharges for Buy-to-Let and second properties. The 3% surcharge on additional residential properties applies in most cases when properties are transferred to a company. These rates can significantly increase the cost of incorporation for landlords with large property portfolios.
If a landlord incorporates a portfolio of six or more residential properties, they may qualify for non-residential/commercial SDLT rates. The current rates (as of the most recent HMRC guidelines) are:
These rates can provide significant savings compared to the higher SDLT rates and surcharges applicable to residential property transactions, especially for larger portfolios.
Advantages of Using Commercial SDLT:
Landlords transferring properties from a partnership into a company may be able to claim relief from SDLT under Finance Act 2003, Schedule 15. This relief applies when a partnership transfers its business assets to a company in which the partners hold shares proportionate to their partnership interest. The relief allows the transfer to be exempt from SDLT, provided certain conditions are met.
This relief can be highly beneficial for landlords operating through a genuine partnership, as it eliminates the need to pay SDLT on the property transfer. However, HMRC scrutinises whether a partnership genuinely exists, making it essential to meet the legal criteria of a partnership for the relief to apply.
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The vast majority of readers will have lost interest at this point, but for our friends in the tax industry (lawyers, Accountants and CTA’s) we decided to keep going with further analysis. Our hope is that it will showcase our attention to detail in this highly specialised area of tax planning and that some people might even find our insights interesting and possibly even helpful.
We tweaked the scenario’s above, first to assume there are no finance costs and second to assume all profits from the businesses are re-invested. For ‘numbers people’, the outcomes are quite fascinating.
Since the landlord’s income exceeds £125,140, they lose their entire personal allowance (£12,570). The landlord is taxed on the full £175,000.
To withdraw all the profit in a tax-efficient manner, the landlord first receives a salary of £12,570, fully utilising their personal allowance.
Without finance costs, the incorporated landlord now has a higher overall tax liability compared to the unincorporated landlord, primarily due to the corporation tax and dividend tax, which are more pronounced in the absence of finance cost deductions.
However, incorporation may still make sense for landlords even in the absence of finance costs. While the immediate tax comparison shows that the incorporated landlord could pay more tax than the unincorporated landlord in this particular scenario, there are several commercial and strategic reasons why incorporation might still be beneficial:
One of the key advantages of incorporation is the separation of personal and business liabilities. By operating through a limited company, the landlord’s personal assets are generally protected from business risks, such as debts or legal actions. This is particularly important for landlords with a large property portfolio, where the exposure to financial risks may be greater. In contrast, unincorporated landlords have unlimited liability, meaning that personal assets are at risk if the business incurs significant liabilities.
Incorporation provides flexibility in terms of succession planning and transferring ownership. Shares in a company can be easily transferred to heirs or successors without triggering Capital Gains Tax (CGT) or Stamp Duty Land Tax (SDLT) on the properties themselves. This ensures that the business can continue seamlessly through generations, making it an attractive structure for landlords with long-term business interests.
Incorporated landlords have greater flexibility in managing profits and reinvesting them in the business. Instead of withdrawing all profits as personal income, a company can retain earnings and use them to fund future property acquisitions, maintenance, or other business activities. This can support business growth without incurring personal tax liabilities on profits that are reinvested.
Incorporation allows landlords to extract profits in a tax-efficient way by balancing salary and dividends. While dividends are subject to dividend tax, the ability to control how much income is withdrawn and when allows for better cash flow management. This can be particularly advantageous for landlords who want to minimise tax liabilities in a given year or reinvest profits.
Many lenders prefer dealing with limited companies, particularly in the Buy-to-Let sector. Incorporation could therefore improve access to financing or result in better borrowing terms for landlords. The corporate structure often provides a clearer picture of a business’s financial health, which lenders view favourably.
The tax treatment of property income and finance costs has been the subject of significant changes in recent years, with unincorporated landlords increasingly losing some of the tax advantages they previously enjoyed. Incorporating may provide more stability or flexibility in dealing with future changes to tax policy, as corporate tax rules tend to change less frequently than those for individuals.
Even without the benefit of finance cost deductions, incorporation can still offer significant commercial advantages beyond immediate tax savings. For landlords with larger portfolios, concerns about risk management, succession planning, business growth, and long-term strategic flexibility may outweigh the short-term tax liabilities.
The decision to incorporate should be based on long-term business goals rather than purely tax considerations. Incorporation remains a powerful tool for structuring a property business with future-proofing, risk management, and flexibility in mind. It’s also worth remembering that the tax environment is constantly evolving, and what might seem less beneficial today could become advantageous in the future.
The numbers in the previous scenario would not change, i.e.:
Since no salary or dividends are taken, the full £175,000 of profit remains in the company, and corporation tax is payable on this amount.
In this scenario, the incorporated landlord is in a far more advantageous position, as the business retains a significantly higher proportion of its profits for reinvestment.
Over time, this ability to retain more profits and reinvest them could lead to significant growth in the value of the business and the overall property portfolio. The incorporated structure may prove much more beneficial for landlords who are focused on long-term growth and reinvestment, particularly if they do not need immediate access to the profits for personal use.
For landlords who intend to reinvest all their profits back into the business, incorporation offers substantial advantages in terms of retained profits for future growth. The lower tax burden and flexibility around profit extraction provide an efficient platform for business expansion, even if there are no immediate personal tax savings from taking a salary or dividends. In reality, if the owners of the business have not utilised their nil rate bands for income tax it would make sense to do so by taking a small salary. This would reduce the corporation tax even further and, if the money is genuinely not required, the funds could be loaned back to the business in the form of Directors or Shareholder loans and subsequently be repaid without taxation consequences.
We have not mentioned financing in this article due to the significant confusion that has arisen since HMRC issued Scheme Reference Numbers (SRN’s) for the Substantial Incorporation Structure (SIS) and the Capital Account Restructure (CAR) and also followed that up with a Stop Notice for CAR. Property118 will not be promoting or assisting in the implementation of either of these structures unless/until HMRC removes the SRN’s and associated notices and DOTAS publications.
Property118 categorically rejects the DOTAS characterisation of the Substantial Incorporation Structure (SIS) and Capital Account Restructure (CAR). These strategies’ are a commercial necessity rather than any tax avoidance intent.
It is crucial to emphasise that the primary motivation behind SIS was never 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.
SIS was 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 was designed to protect landlords, not to circumvent tax obligations.
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 applied 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.
The Capital Account Restructure (CAR) was a commercial strategy designed to address liquidity and financing challenges that landlords face when incorporating their property businesses.
Here’s how CAR was intended to help to solve these commercial problems:
In evaluating the SIS and CAR, 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 CAR is equally consistent with the commercial purpose of incorporation. CAR is designed to assist landlords in navigating complex financial and legal challenges, particularly those related to financing, rather than being a tax-driven mechanism.
It is essential to address mischaracterisation of SIS and CAR as tax avoidance mechanisms. 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 and CAR. Incorporation Relief under Section 162 TCGA is a statutory relief intended to support the incorporation of businesses—our clients simply utilised the relief as intended by Parliament, in line with the Gordon vs IRC decision.
The crux of our rebuttal is that avoiding refinancing and the potential for tax advantages associated with incorporation appears to have been conflated in the assessment of SIS and CAR. 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 and CAR were specific strategies 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 neither SIS nor CAR had no impact on tax outcomes whatsoever the DOTAS hallmarks cannot possibly be applied to the structure.
In response to these misconceptions, we have been in regular communication with HMRC to clarify the legitimate commercial purposes behind SIS and CAR. Furthermore, if necessary, 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.
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.
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Just in case you’re still yearning for more, here’s some really boring legal stuff …
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.
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