Landlords double tax bills by taking poor adviceby
A tax planning scheme for landlords promoted by Property118 has been shown to double the tax payable and could lead to mortgage default.
Dan Neidle of Tax Policy Associates has dubbed a tax planning scheme for landlords: “the worst tax avoidance scheme ever”, as using it would double the tax payable and lead to mortgage default.
He talks to Rebecca Cave about the tax planning scheme promoted to landlords by Property118, in conjunction with Cotswold Barristers, and how it is doomed to fail.
What is the problem the tax scheme trying to solve?
Landlords who hold residential properties (not holiday lets) in their own names can claim only 20% tax credit on the finance costs connected with those properties. This can make letting a mortgaged residential property unviable.
If the landlord incorporates their property business the company can claim corporation tax relief for the finance costs, but the process of incorporation will trigger bills for capital gains tax (CGT) and stamp duty land tax (SDLT).
The lender also needs to agree to move the existing mortgage to the new company, which is not normally granted. The company generally has to take out a fresh mortgage on the let property, which is likely to be much more expensive than the original buy-to-let mortgage.
How does the Property118 plan suggest these problems can be avoided?
The landlord sets up a new company and transfers the let property to it in return for shares in the company. However, the sale is not completed so legal title to the property remains with the individual who continues to be the registered owner on the Land Registry.
Does this trigger a CGT bill for this individual?
Property118 asserts that the individual can claim incorporation relief, which defers the gain arising on the transfer of the property and rolls it into the value of the shares. In my view, it is unlikely that the conditions for incorporation relief would be met as property letting is very rarely regarded as a “business” for CGT purposes.
Because a property-holding trust has been inserted between the individual and the company (see below), the exchange of company shares for the whole of the property business hasn’t happened. This means the conditions for incorporation relief aren’t met.
How does the individual avoid the restriction on tax relief for finance costs?
Here’s the clever/stupid part. A trust is set up to hold the property with the individual as the trustee and the company as the beneficiary. The mortgage company is not told about this trust.
The mortgage remains in the name of the individual who carries on making the mortgage payments. But the individual no longer has a property business, which has been transferred to the company, so the individual doesn’t qualify for the 20% tax credit on those finance costs.
The company agrees to indemnify the individual for the mortgage costs, and claims tax relief for those indemnity payments.
Whether the company qualifies for that tax relief is debatable. It doesn’t have a loan relationship as it has not borrowed money to use in the property business, so it can’t get a corporation tax deduction for the indemnity payments under the loan relationship rules.
For the company to get a deduction for the indemnity under the general rules for a property business, would require the indemnity to be recognised in the company’s accounts as a liability relating to the property income, and not as further consideration for the capital cost of acquiring the property.
In the worst-case scenario, the company pays out the indemnity and gets no tax relief, and the individual receives the indemnity and is taxed on it. The individual also loses his tax credit on the mortgage payment.
The total tax paid by the company and individual doubles.
Does the hidden trust structure breach the mortgage agreement?
It is likely that it does, as the lender has not provided consent for the transfer of the property to the trust. UK Finance, the trade association for mortgage lenders, commented: “Transferring ownership of a property into a trust without informing your lender and seeking their consent would most likely be a breach of a mortgage’s terms and conditions.”
How is the liability to SDLT avoided?
This depends on there being a related couple (such as husband and wife) who have run the property business together as a partnership, and thus the partnership rules in FA 2003, Sch 15 apply to reduce the SDLT to zero. This is very difficult to prove, as the case: SC Properties & R Cooke vs HMRC shows.
Would the company be liable to the Annual Tax on Enveloped Dwellings as well?
Where the value of an individual residential property is £500,000 or more when it is transferred to the company (or trust), the Annual Tax on Enveloped Dwellings (ATED) will apply. The company would then be required to make an annual ATED return or ATED relief claim. The penalties for late filing of an ATED return or ATED relief claim, can be up to £1,600 per year.
Should this scheme be declared under the disclosure of tax avoidance scheme rules?
I believe the scheme does meet at least two of the hallmarks under the disclosure of tax avoidance scheme (DOTAS) rules because the sole purpose of the scheme is to avoid tax, and the provider is charging a premium fee for the scheme (over £40,000). Failure to register a scheme under DOTAS can result in a fine of up to £1m.
What should landlords do if they have taken up this scheme to avoid tax?
Any landlord who has taken up this scheme promoted by Property118 should seek tax advice from a tax specialist who is a member of a regulated body such as The Chartered Institute of Taxation, The Association of Taxation Technicians, The Institute of Chartered Accountants in England and Wales or The Institute of Chartered Accountants of Scotland. It would also be prudent to seek advice from a solicitor with experience in mortgages and property finance, in view of the potential for mortgage default.