landlords moves to company structures may be seen as a tax avoidance Ruse.

The Stamp Duty Land Tax cut will make landlords more likely to move their properties into a company structure. But the government could soon view residential landlords moves to company structures (incorporating) as a tax avoidance ruse.

The Covid19 event and media and government panic and the resulting massive economic damage that house arrest and two metres social distancing has caused will mean government will, more than ever, be looking at every possible avenue to raise taxes to pay for the debts incurred.

It also makes it all the more likely the government will come after landlords who have bought property in company structures and / or moved existing property into company structures to save tax. The government could enact laws or change the tax code, or both, to make residential landlords pay the same tax that they would have paid had they not moved to incorporate.

Landlords, Section 24 and Tax

Residential landlords, as we know, are often at the front of the queue to be milked for more tax.

So, over the years since George Osborne bought in the infamous Section 24 change, (which meant landlords could no longer deduct mortgage loan and other financing costs against income before declaring profits), landlords have increasingly opted to incorporate in order to buy and let property through company structures.

Some have been putting new property buys inside company structures as well as, in many cases, also transferring existing properties into company structures. (The government’s English Private Landlords Survey (2018) puts the percentage of landlords who rent as individuals at a still relatively high 94%, 4% are doing it as part of a company and 2% “other organisation”).

By doing this, they usually save a lot of tax.

Benefits of Company Structures

The company structure has many benefits: the biggie is that mortgage and other financing costs can still be deducted from rental income before taxable profit is assessed – thus cutting taxable profit, a huge benefit compared to where one owns property outside a company structure.  

Plus corporation tax, currently at 19%, is lower than even the basic income tax rate. Of course, where one is taking money out of the company, there are more taxes to pay: Dividends over £2,000 are taxed at 7.5% for basic rate taxpayers or 32.5% for higher rate taxpayers, but it still is the better deal for most people, especially those whose dividend take does not push them into the higher rate.

Some Downsides to Company Structures

Sure, it must be said there are some downsides to owning via a company.

A company does not get a capital gains tax allowance like individuals do, (but it does get some historic indexation allowances (which are not available outside a company structure)). Also, generally financing costs – both interest rates and the cost of arranging financing – are higher where a company structure is used.  

Whether it is right for you personally to buy and let properties through a company structure will depend on a lot of factors relevant to you. It will depend on how much rental income you make now and are expecting to make in the future, what other income you have and expect to have in future, the gross and net yields of your properties, how much borrowing you have, your long term goals, your expectations about your future income and your future likely tax rates.

There is much to consider and you ought to really sit down with a good accountant and independent financial advisor who understands property taxes and who deals with it on a regular basis. We also suggest you perhaps start by reading a good book to get you started – and gen up on some good articles on this. The likes of Stephen Faye and Carl Bayley are two good sources for content on tax. By doing your own reading you’ll be less confused when you come to meet an advisor – and ready to hit the ground running. There is a good summary tax chapter in my own book, “Successful Property Letting” – see the links below. Great to get you started.

But, to repeat, it’s fair to say, that once you’ve done your sums, for the majority of people who are residential landlords, it will turn out to be more tax efficient to buy and hold residential let property in a company structure right now.

The Future is a Scary Place

I said “right now” because there are some things that have always worried me about people rushing off to set up company structures.

I’m going to quote Carl Bayley from his excellent book, “The Big Landlords Tax Increase (5th Edn)”.

He says this on pages 117-8 …

Any tax benefit you hope to obtain by using a company could be taken away at the stroke of a pen. Just as George Osborne practically napalmed landlords before running off to his high paid job in the city, any future Chancellor could drop a similar tax bombshell on property company owners.

Well expressed Mr. Bayley. I liked that – especially the reference to Osborne’s highly paid career post-Chancellor – it is the kind of straight talking language I’m known for too. (#See also the note at the end of this piece on Mr. Osborne’s colourful brother).

Mr. Bayley discusses “the Orwellian sounding Office of Tax Simplification (OTS)” and their system of “looking through” taxation. He then says this..

A look through system, if made compulsory, would take away the tax benefits of using a company. Under it, instead of paying corporation tax, certain company owners would pay income tax and national insurance on all the profits of the business, just like sole traders and partnerships do.

Finally he adds this warning…

The government seems determined to narrow the gap between the tax paid by regular employees, the self-employed and company owners.

It is my view that the CoronaPanic, whether justified or not, will greatly enable to the government to narrow this gap between the self-employed, individuals and company owners in terms of taxes.

CoronaPanic has created a millions of newly unemployed, destroyed hundreds of thousands of businesses and imposed a massive government debt on future generations on a level not seen since the end of the Second World War.

This will have to be paid for in part by higher taxes.

Levelling Up Tax

And the fact is that it will be very easy to present some increased taxation as both a “levelling-up” exercise as well as being “fairer”.

The government can easily say that it’s only fair that residential landlords are taxed the same whether they have property within a company structure or not. And they could even go as far as to say that landlords only moved to company structures as a ruse to avoid the tax the government wanted them to legitimately pay.

I think it would be easy for them to do all this under the law – they could just make residential landlords who are within company structures a separate class for tax purposes and different to other businesses. (They have already done something similar with capital gains taxes (CGT) where residential landlords pay a specially high rate of CGT).

They can do whatever they like – after all, they are the government who recently told people they could not go out to exercise more than once a day and not visit sick relatives.

And it would not matter how much Cherie Booth QC is paid to contest the “fairness” in court, there is really no chance of winning against the state which, after all, sets the law. (It was for these reasons I never thought the legal action against Section 24 would succeed. However, I was confident that West Brom would be defeated over what they did – but that a very different sort of case).

Landlords Taxes – What Should You Do Now

So, if you can save more tax by setting up a company structure in which to buy property, then go ahead. Also, if it makes sense to transfer your current portfolio into a company structure, then do that too. There are many advisors around who will tell you (for a fee) if it is the right thing to do and there are people who will help you do it. For another fee, they or others, may manage the legal paperwork and all the correspondence with lenders etc.

But be aware of the fact that there is always a risk that the government could change the tax code and law to make you pay the same tax as you would have done had you not incorporated. I don’t expect they would be seeking retrospective taxes, but they could, in the worst case scenario.

The risks of them doing any of this, post the CoronaPanic devastation, has just ratcheted up.

Just be aware of that.

For all those risks, residential property investment to let makes plenty of sense. It still does! The numbers still stack up and where else can you get an average 4% net yield on your money with the potential for capital growth?

Taxation changes are just one more thing we have to live with. The threat of changes of all kinds, puts many people off – which is all great for all those people who “stay in the game” or who are joining it now, because there is less competition.

Carl Bayley’s View

I contacted Carl Bayley for a comment on tax threats. He said this:

Since the banking crisis of 2008/9, UK Governments of all political persuasions have been trying to tackle the deficit. For political reasons, they have tried to avoid ‘across the board’ tax increases and have opted instead for ‘stealth taxation’ measures, like freezing bands and allowances for many years; and measures targeted at particular segments of society, which they feel will not lose them too many votes: the various attacks on residential landlords being the prime example.

Moving forward, as a result of the Coronavirus crisis and the consequent massive increase in national debt, it seems probable that ‘all bets are off’ and across the board tax increases are highly likely. Election manifestos can now be torn up due to the exceptional nature of the circumstances we face.

Increases in dividend tax rates are very likely, especially as we are also likely to see an increase in the rate of Class 4 National Insurance for the self-employed and the Government will wish to maintain some sort of balance between the tax burden on self-employed sole traders and small private company owners.

The Corporation Tax rate may also increase. I would say modest increases of a few percentage points are very likely. Beyond that, the UK Government will watch what other countries are doing, as they will not wish to make the UK uncompetitive. This need to remain competitive is what generally keeps the Corporation Tax rate in check although a form of ‘regressive’ taxation with a higher Corporation Tax rate on, say, the first £250,000 of profit cannot be ruled out. This would not bother the multinationals and hence would not damage the UK’s competitive position internationally, but would raise extra tax on small incorporated businesses operating in the UK.

Will we will see more attacks specifically targeted at residential landlords operating through companies? There are some possibilities that I can foresee.

At present, a company owner can still claim qualifying loan interest on funds borrowed to invest in a small private company engaged in residential property letting. This could be blocked.

Incorporation relief (for CGT purposes) on the transfer of a residential property business into a company could be blocked; as could the ability to avoid SDLT on transfers of partnership property to a company where that property is residential.

I must add I would hate to see any of these measures, as the current situation, and especially the wretched ‘Section 24’ restrictions, is grossly unfair and an offence against the basic principles of business taxation. The idea that incorporating a property business should be viewed as ‘tax avoidance’ when, in fact, it is the Government that has behaved so badly in this matter makes me very angry!

Beyond these points, the question of whether any further attacks might occur really depends on whether the UK Government genuinely believes the terrible damage it is doing to the private rented sector is somehow justified, or unimportant, or whether their peculiar stance on the issue is all just political rhetoric. They somehow seem unable to understand that the modern private rented sector is a professional business sector providing a valuable service to the general public: a home!

You could manufacture weapons that kill people and get full interest relief, but provide them with a home and you do not!

If the Government genuinely cannot see that further attacks on the private rented sector will lead to a big increase in homelessness, bankruptcies, and many other problems, they could go further.

However, when it comes to corporate residential letting businesses, the Government seems to have a desire to favour large, institutional investors, in the mistaken belief that bigger somehow means better (ignoring the many lessons throughout history that tell us, quite emphatically, that this is not always the case!)

So, any further action they might take would probably be targeted at smaller, privately owned companies. This, I think, is where they have struggled to figure out how to target their attacks in the way they desire. But, if they can resolve that problem, they might consider:

  1. A Corporation Tax supplement on residential letting profits and capital gains, and/or
  2. Withdrawal of interest relief for Corporation Tax purposes on residential letting businesses

A final, horrifying, thought, is that the Government might even consider making residential letting subject to VAT.

As I said, ‘all bets are off’!

THANK YOU, CARL BAYLEY.

# PS. From Me: George Osborne’s brother, Adam, is a colourful character: https://www.macleans.ca/news/world/george-osbornes-brother-problem/

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