There have been a number of changes in the tax environment over the last few years aimed at discouraging private ownership of second or investment properties.
The changes include the introduction of the higher rates of SDLT (an extra 3%) and the changes to the loan interest relief, which effectively increases the income tax liability of individual landlords. The first applies to individuals and companies alike, but the second of these changes makes corporate ownership of a property investment portfolio an interesting prospect.
There are however issues to consider both on the initial incorporation and in respect of the company itself:
CGT - Incorporating the portfolio
The transfer to the FIC would constitute a disposal for the purposes of Capital Gains Tax (“CGT”), which should be at market value. If what we are transferring is investment property it is unlikely that principal private residence relief will apply, especially if more than one property is being transferred.
Incorporation Relief may be available, but only if the property portfolio constitutes a business in the first instance, and there is case law on this. Incorporation Relief has the effect of wholly or partly deferring gains on the transfer, ‘rolling’ the gain over into the base cost of the shares in the company. It should be noted that all the assets of the business (except cash) need to move, so retaining investment properties may be a problem.
A single rental property, where the landlord takes a passive role won’t be sufficient to qualify as a business for the purposes of the relief. Larger portfolios have a better chance of qualifying, but there is still a need for active management, where the owner carries on activities such as dealing with tenant issues and filling vacant properties. It is likely that at least 20 hours of activity per week, in managing the portfolio will be needed, and other work and income streams will need to be considered.
This is usually one of the main issues, as it can be very difficult to establish whether there is an actual business, or simply the ownership of an investment.
The transfer of the portfolio can be further complicated if the properties are charged, and owners will need to be careful in respect of how this is dealt with.
Stamp Duty Land Tax (“SDLT”)
The transfer of the properties to a FIC will be a land transaction for the purposes of SDLT, on which SDLT will likely be payable. As the owner of the portfolio and FIC are likely to be connected, the transfer will be deemed to be at market value, regardless of whether the FIC gives consideration. In addition, where the portfolio is made up of residential property, the FIC will pay the additional 3% rate of SDLT.
The SDLT partnership regime may rescue a portfolio transfer, where the portfolio is owned and operated by two or more individuals. Once again, the FIC is likely to be connected to the owners, and so the partnership rules for SDLT may operate to reduce the SDLT to nil. However, there needs to be a genuine partnership arrangement and not mere co-ownership. Again, we will be looking at the activity of the partners in respect of the portfolio, as well as how that business is run and administered.
In addition, there are anti-avoidance rules, preventing the utilisation of a partnership as means of avoiding an SDLT bill on incorporation. These rules should always be considered.
Generally speaking, transferring property to a family partnership and then within three years incorporating that partnership by creating an FIC, will result in an SDLT bill.
Careful consideration will need to be given in respect of whether the partnership regime applies, what relief may be available (such as Multiple Dwellings Relief), whether all the properties being acquired are residential in nature and whether the highest rates of SDLT apply. Even if SDLT is chargeable, it may still be worth considering if the long-term tax benefits outweigh the short-term tax costs.
Some of the disadvantages of FICs for property portfolios affect all FICs, such as the loss of some privacy, for instance, because accounts will need to be filed at Companies House. Of course, there are also other administrative requirements and likely costs, associated with owning a company.
Incorporating will also mean the owners will need to consider the Annual Tax on Enveloped Dwellings, which affects companies owning residential property worth more than £500,000. Reliefs are available, such as where the property is let, but they need to be claimed.
Depending on the nature of the portfolio, such as where it includes commercial property, VAT registration may be required on incorporation. New bank accounts and as above, it may be necessary to deal with existing borrowing. Tenancies will also need to be addressed, as well as insurances.
Despite what the above might suggest, there are also a number of potential positives to incorporation including:
- Wealth can be accumulated and if kept within the company will (currently) be taxed at the lower rates of Corporation Tax. Even after planned increases, there may still be a net benefit. In respect of this point, FICs are generally aimed at wealth generation and preservation, so if all income is to be taken out, the FIC may not be the best model.
- Finance costs can be deducted, but again, the level of benefit should be considered as part of the decision to incorporate.
- Salaries can be paid for the management of the portfolio.
- The FIC also provides the opportunity to create income streams for other members of the family, including via discretionary trusts for younger members, in a tax-efficient way.
- FICs also provide certain asset protection benefits, in particular, on divorce.
- Depending on how the FIC is set up, there can be significant Inheritance Tax (“IHT”) benefits, as the valuation of an interest in the company can be significantly different to the valuation of a direct interest in the underlying property.
- Different classes of shares can also be issued, allowing owners to pass on the growth of a portfolio to the next generation, again providing an IHT benefit.
There are therefore a number of benefits, but the incorporation of a property portfolio and creation of an FIC should be given careful consideration. All the tax and practical implications, both in the immediate and long-term, should be analysed as part of the decision-making process.