A common question asked by potential buy-to-let landlords now that individual landlords are beginning to lose tax relief.
There are various tax and administration elements to consider before setting up a limited company to purchase a buy-to-let property which are outlined below.
Note that this article only covers the tax implications of a UK resident individual or UK resident company purchasing UK residential property.
Apart from certain exemptions, SDLT is due on the purchase or transfer of property and the rate of SDLT has increased substantially over the past few years. From 1 April 2016, a higher rate applies broadly to purchases of additional residential property by individuals, and to purchases of residential property by companies and trusts (other than bare trusts and interest in possession trusts). This is demonstrated in the table below. In addition, there is a special ‘super rate’ of 15% SDLT where properties worth more than £500k are purchased by a company. However, this does not apply where the property is used in a lettings business.
If a company owns a UK residential property valued at more than £500,000, it will be subject to an annual ATED charge and an ATED return needs to be submitted to HM Revenue & Customs (‘HMRC’) by 30 April if the property is within the scope of ATED on 1 April or within 30 days of acquisition if the property comes within the scope of ATED after 1 April. For a newly built property, within 90 days of the earliest of the date between when the property becomes a dwelling for council tax purposes or when it is first occupied.
With regards to landlords who own property via a limited company, they should be able to claim relief from the ATED charge on the basis that the property will be let to a third party on a commercial basis and isn’t, at any time, occupied (or available for occupation) by anyone connected with the owner. The relief is not automatic and must be claimed by submitting a ‘relief declaration return’ using the ATED online service.
If no exemption from ATED applies, then the following ATED charges will payable depending on the value of the property for the 2018/19 tax year:
If a taxpayer owns a property in their individual name, rather than through a limited company, they will be subject to income tax at their marginal rate (i.e. up to 45%) on any net rental profits. Everyone who is UK resident and receives under £100,000 of gross income annually is entitled to a tax free personal allowance and therefore, a landlord with no other income sources could receive £11,850 net rental profits tax free (2018/19 tax year).
From 6 April 2017 onwards, there has been a change in how net rental profits are calculated with regards to mortgage interest. It was previously the case that the full amount of mortgage interest would be deducted from gross rental income, effectively giving higher/additional rate taxpayers relief at 40% or 45%. However, the new rules mean that relief on mortgage interest will not be included in the calculation when calculating net rental profits and an adjustment will take place so that relief will be restricted to the basic rate of tax, i.e. only 20% of the finance cost will be deductible.
Basic rate taxpayers may think they are unaffected by this change, however, they could find that they are a higher rate taxpayer, once the finance costs are disallowed in their rental accounts and will not know whether the adjustment will take them into the higher tax rate without going over a series of steps in order to work out the effect of the change.
The change will be phased in gradually from April 2017 as follows:
On the other hand, companies are subject to corporation tax on net rental profits, currently 19% and will be 17% for the year starting 1 April 2020. Companies are not entitled to a tax free allowance and therefore, all net profits are taxable. There are no finance restrictions for companies which means that all mortgage interest or finance costs are fully deductible from gross profits. The profits in the company need to be extracted and can be paid out as dividends to individual shareholders. The current individual dividend allowance has been reduced from £5,000 to £2,000 for the 2018/19 tax year. Dividends received in excess of this amount will be taxed at 7.5%, 32.5% or 38.1% depending on the individuals other income. Any income received from the company needs to be declared on a taxpayers personal tax return.
With regards to calculating net profits, all expenses incurred must be ‘wholly and exclusively’ in connection with the rental business. In addition, any costs that are considered as ‘capital improvements’ will not be deductible from rental income and will instead be added to the base cost of the property.
If an individual wishes to purchase a buy-to-let property through a limited company, firstly, they will need to set up the company and register it. It is often the case that people choose to purchase ‘off the shelf’ companies which are already pre-registered at Companies House but have never traded and are ready to be used immediately. However, this is an extra cost that must be factored in.
When the company is up and running, it is necessary to produce a full set of company accounts to be submitted to Companies House, pay any corporation tax due and submit a company tax return as per the deadlines detailed below:
When declaring dividends in order to extract profits from the company, care must be taken to ensure there are sufficient profit reserves before doing so and dividend vouchers will need to be produced. Board meetings also need to take place.
As mentioned above, any dividends from the company need to be declared on a personal Self-Assessment tax return and it is necessary to register with HMRC for Self-Assessment if not already completing annual tax returns. In addition, winding up the company is also a legal process requiring additional administration and expenses.
As an individual landlord, there is also a requirement to be registered for Self-Assessment by 5 October following the tax year end when rental income was first received. For example, if someone purchased a property in June 2018 and started receiving rental income in July 2018, they would need to register for Self-Assessment by 5 October 2019. The first tax return would be due to be submitted by 31 January 2020. If a landlord is already in Self-Assessment, they will need to report their share of rental property income and expenditure on the UK land and property pages.
The cash basis will be the default method for calculating rental profits and losses for individuals unless the landlord opts out, or the gross annual rents exceed £150,000, in which case the accruals basis must be used. The cash basis is not available to companies and therefore, company accounts must be prepared on an accruals basis.
A company within the scope of ATED will be subject to ATED-related Capital Gains Tax (‘CGT’) at 28% on gains realised on disposal by reference to the April 2013 market value or acquisition cost if later. A company which qualifies for an ATED relief (i.e. commercially let to a third party) should also qualify for relief from ATED-related CGT.
A UK resident company is currently subject to corporation tax at 19% on gains realised on the disposal of residential property and Private Residence Relief (‘PRR’) is not available to companies. Also, companies do not have a tax free annual exempt amount and therefore, all gains are chargeable to corporation tax. Indexation allowance is a relief available to companies on the disposal of a property; however, indexation allowance is only available up until 31 December 2017. Properties purchased by a company on or after 1 January 2018 and sold at a later date will therefore not be entitled to receive indexation allowance as a relief. The usual incidental costs of acquisition and disposal are available to offset against any gain, as well as stamp duty paid and enhancement expenditure; i.e. any capital improvements made to the property.
Furthermore, not only is the company subject on corporation tax on the disposal of the property, but distribution of the post-tax retained profits in the company will then be subject to either income tax or capital gains tax, depending on how the funds are distributed.
Individuals are subject to CGT on gains realised on the disposal of residential property that has not been their main home and this will be the difference between the proceeds on sale and the purchase price. Stamp duty paid on purchase can be factored into the calculation, as well as enhancement expenditure and incidental disposal and acquisition costs. Individuals have an ‘Annual Exempt’ tax free amount which is currently £11,700 for the 2018/19 tax year (this is in addition to the personal allowance for income tax). Any gain in excess of the annual exemption will be taxed at either 18% or 28% depending on whether they are a basic rate or higher rate taxpayer, once their other income has been taken into account.
Individuals selling their only or main residence should qualify for PRR so that the gain is not chargeable to CGT. A married couple can only have one residence which qualifies for PRR. If an individual or married couple has occupied a property at any time as their only or main residence, they may be able to claim PRR on the proportion of the gain relating to the actual occupation of the property. There is also a ‘last 18 months’ rule where if the property has been a main residence at any time, the last 18 months of ownership also qualifies for PRR, whether or not the property was actually occupied by the owner(s). Lettings relief is another valuable relief available to individuals who have lived in the property as their only or main residence at some point. Other reliefs may be available to reduce the capital gain depending on circumstances.
Landlords who already hold a buy-to-let property or properties in their personal name may think about incorporating into a limited company. There are several points to consider before doing so and individuals should always take independent advice if they would like to pursue this option.
Firstly, in most incorporations (and especially for those that intend to utilise CGT incorporation relief) the company “pays” the transferor for the business by way of an issue of new share capital. The transfer of the business into a company, would, prima facie, be a transfer for tax purposes at market value with a resulting capital gain on the transferor if the property had increased in value since its original purchase. However, there is ‘Incorporation Relief’ which operates by rolling the gain in the properties at the time of transfer into the base cost of the shares. Therefore, the gain is brought back into charge if and when the shares are disposed of.
Incorporation Relief applies where:
“… a person who is not a company transfers to a company a business as a going concern, together with the whole assets of the business, or together with the whole of those assets other than cash, and the business is so transferred wholly or partly in exchange for shares issued by the company to the person transferring the business.” (TCGA 1992 s162(1)).
The requirement for there to be a “business” gives rise to what is often a point of contention between the taxpayer and HMRC. The word “business” is not defined by statute and therefore has its normal meaning. HMRC accept that in some cases a property investment business can indeed qualify for incorporation relief. Taxpayers and their advisers should carefully examine the level of activity in the existing business to determine whether it is likely to qualify for Incorporation Relief. Equally, it may be more beneficial to disapply incorporation relief in order to claim the individual’s annual exempt amount, depending on the circumstances.
SDLT is payable on the market value of the properties transferred to the company and the SDLT charge will be as per the table at 1) unless more than 6 properties are being transferred, in which case, the transaction may be taxed at the commercial rates of SDLT which can represent a large saving. A 15% SDLT rate, ATED and ATED CGT will be applicable on any of the properties transferred worth in excess of £500,000 which is inhabited or intended to be inhabited by an individual connected to the company or its shareholders.
Landlords will also need to obtain a mortgage in the name of the company and care must be taken as there may be early repayment charges on the existing mortgage. Actually obtaining the mortgage for the company may be slightly complicated and mortgage companies may request that the shareholder of the company provides a personal guarantee to the mortgage provider.
It is well known that mortgage costs and interest rates are usually higher on limited company buy-to-let mortgages which are likely to outweigh some of the tax advantages gained by owning the property via a limited company.
Typically, it is thought that only buy-to-let landlords with at least 4 rental properties are in a better position overall owning their properties via a limited company, whereas landlords with 1-4 properties would be in a very similar position owning as an individual investor. The added complications and administration of running a limited company would mean that owning as an individual investor would be the most favoured option.
In addition, whilst corporate structure might offer some tax benefits now, the rules can be changed at the whim of the chancellor.
Ultimately, everyone’s personal tax position is different, so it’s worth getting independent advice before making a decision on how to purchase a buy-to-let property. Our in house tax specialists can help with this and our residential conveyancing team can deal with the legal aspects of purchasing a property. If you would like to go ahead with setting up a limited company, we also have team who offer business starter packs including company incorporation, guidance notes and advice on start up.
Download our Residential Property Tax brochure.
For more information please contact Jenna Fyfe – Tax Manager or Caroline Lavis – Senior Associate.