Buy-to-let investors are nowadays Public Enemy No 2. (Tax advisers are Public Enemy No 1.) They have had their 10% wear and tear allowance abolished, a 3% stamp duty land tax surcharge introduced on purchases, and face a severe restriction on the tax relief available for mortgage interest payments. How should they respond to this carnage?
With new purchases the answer may be to make these through a company. These will attract the new 3% SDLT surcharge but so will purchases by most individual landlords. However, the position is better for companies so far as other taxes are concerned.
The rental income of a company is currently subject to corporation tax at 20%, compared with income tax rates of up to 45% for an individual. Furthermore, the restriction on the tax relief for interest payments, to be gradually introduced for individuals from next April, will not apply to companies.
Just to remind you how severe this restriction is, tax relief will ultimately (from April 2020), only be available at 20% for interest payments, whereas rent will be taxed at up to 45%. So a higher rate taxpayer with £12,000 of rental income and £8,000 of interest payments will have net income of £4,000 and pay tax of £3,800 on it – a tax rate of 95%. (“There’s one for you, nineteen for me”.) A company in the same circumstances would pay tax of £800.
The top capital gains tax rate for individuals is still 28% for sales of residential properties. (It is 20% for most other gains.) Companies pay tax on capital gains at the corporation tax rate, currently 20%. Also, they can claim an indexation allowance by reference to the increase in the Retail Prices Index over their period of ownership of the property, so that their gain excludes any inflationary element. Even in these low inflationary times this allowance can mount up over the years and the effective rate on gains for companies is significantly lower for companies than individuals, even if the planned future reductions in the corporation tax rate never materialise.
Investors who wish to transfer existing buy-to-let portfolios into companies in order to obtain these benefits will have to take account of the capital gains tax and stamp duty land tax charges which could (though will not always) arise on the transfer.
The use of companies to hold buy-to-let properties is not without its tax problems. Extracting income and gains from the company will produce a further tax charge and this could result in higher taxes overall, particularly on the capital gain. Also, if the owner dies before selling the property there could be capital gains to pay which would not have arisen if the property had been held personally. However, avoiding the interest restriction may make the letting business viable and any extra tax on sale, or on death, may be considered a price worth paying.
To this mix must be added the uncertainty of changes in legislation. As noted elsewhere (/news-publications/latest-news/2016/tax-on-trading-in-and-developing-uk-land-buy-to-let-investors-beware/) changes made in the Finance Act 2016 might tax gains on buy-to-let properties as income. Additionally, two possible changes have been mentioned which could affect the mathematics of holding properties through companies.
First, there is a suggestion that the “close company apportionment” rules may be reintroduced. Abolished in 1989, these rules could tax shareholders on the profits of a company even though they had not been distributed. This could make rental profits effectively subject to both corporation tax and income tax as they are earned.
Secondly, there is a suggestion that the law may be “simplified” by taxing the owners of small companies as though the companies did not exist. (It is surprising how many of the Government’s “simplifications” lead to an increased tax charge.) This would destroy any advantage of holding the properties through companies, though it is far from clear whether either of these suggestions will be proceeded with.
And, of course, the Government could change the law in any other way imaginable. Which all goes to show that buy-to-let is a high risk business.