Since George Osbourne announced in his 2015 Budget of restrictions in mortgage interest relief, landlords have been racing to incorporate their property portfolios, which got the thumps up from the courts following the Ramsey Case (2013). The case itself provided the main guidance and test as to whether the landlord would qualify for Incorporation Relief. Several years forward, and whether the landlord would qualify for incorporation relief has become very subjective.
Why should landlords incorporate?
The main reason for incorporation should be tax, but the tax savings only materialise in properties with high mortgage debt and where the landlords have additional income from an employment or self employment, or where the landlords are not reliant on their property income.
The other main reason is incorporation seems to provide a gateway to get children or other members of the family involved in the family property business. It is common to have children on the payroll of incorporated property investment business as well as other members who often assist in an unpaid roles with property management.
Not so common, but equally important, is Estate Planning. With zero Business Property Relief on investment properties, often the case remains for setting up trusts, either growth trusts or exempt. The growth trusts are fairly easy to set up, whereby the assets are transferred to various alphabet or flower shares, with each class of share holding a certain share of the property investment company, at certain value, normally fixed at today’s market value, with any increase in value of the properties been reclassified into different class of shares.
An Exempt Trust on other hand is a more mechanical process, whereby you follow certain steps, and as long as these steps are followed in exact same order, then the proportion of shares transferred to the trust is exempt from CGT and IHT. The process is far more labourous and time consuming and will involve agreeing a share valuation with HMRC.
Why shouldn’t landlords incorporate?
If saving tax is the only reason to incorporate, then this reason alone is not sufficient. Tax is already very complicated.
Having an incorporated company means as landlord you will be required to set up a business bank account from where you will need to operate day to day income and expenses. You will need landlords and public liability insurance as well as buildings insurance. The reason why you need additional insurance is to protect the landlords from been sued by the tenants. All AST and license agreements will need to be in the name of the company. It is illegal for incorporated landlords to have agreements in their individual names and to continue to do so, and will make them liable under the terms of AST. This may prove too much for some landlords, and they would rather continue as before.
Landlords no longer own the properties, these would be owned by the shareholders of the company. In many cases this may be the same, but there is an important legal distinction. The shareholders need not be necessarily the company directors. Though it is recommended, very few incorporated landlords actually have a shareholders agreement, even though this is one of the necessities, and often the shareholders would rely on the company’s articles of association as they ‘get out of jail’ card.
The company is liable for its own corporation tax liability, which is different from Income tax, which the directors and shareholders would also become liable for depending on the funds withdrawn from the company business account. Any amounts drawn as salary will reduce the company’s profits chargeable to Corporation tax. But with national insurance increased by 1.25% to 13.25%, the tax savings that were identified on incorporation may have evaporated. It is still part of the plan of a future government to merge income tax and national insurance as recommended by Office of Tax Simplification. However many governments have come and gone since this was recommended in 2002, and no government thinks they will be able to sell this plan to the public. If this is put into action, then just as this could deter incorporation, also it could reduce overall tax burden.
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