Mark McLaughlin points out that 6th April 2017 was a significant date for many buy-to-let landlords.
Landlords of residential properties have been the subject of considerable media attention in recent times. For example, an article was published in the Telegraph on 8 April 2017 with the heading ‘New buy-to-let tax: how it works and how to beat it’ (www.telegraph.co.uk/investing/buy-to-let/new-buy-to-let-tax-works-andhow-beat/).
And so it begins…
The ‘new tax’ referred to in the above article was not actually a new tax as such, but the introduction of a restriction in the deduction of finance costs (eg loan interest) related to residential property to the basic rate of income tax (ITTOIA 2005, ss 272A-272B, ss 274A-274C; see also ITA 2007, ss 399A-399B for property partnerships), following legislation included in Finance (No. 2) Act 2015 (as amended in Finance Act 2016).
This finance cost restriction commenced on 6 April 2017, with the effect that in calculating the profits of affected property businesses for the tax year 2017/18, a deduction of 75% of finance costs is allowed, with relief for the remaining 25% being restricted to the basic rate of income tax. The finance cost restriction increases to 50% for 2018/19 and to 25% in 2019/20, so that for 2020/21 and later years there is no deduction from profits for finance costs at all, and relief is only available at the basic rate.
The potential implications of the finance cost restriction should not be underestimated. Aside from potentially creating profits that have not been achieved in reality, the restriction could (for example) result in a basic rate taxpayer becoming a higher rate taxpayer (with a knock-on effect in terms of capital gains tax (CGT) rates); a clawback of child benefit; the loss of personal allowances; and a restriction in the pensions annual allowance. This is by no means an exhaustive list of possible adverse implications. Detailed commentary on the finance cost restriction is included in ‘Buy-to-Let Property Tax Handbook’ (Bloomsbury Professional) at Chapter 3.
The finance cost restriction does not apply to commercial property lettings businesses, furnished holiday lettings, or for companies. The latter exception for companies has resulted in many landlords considering the incorporation of their buy-to-let residential property businesses. However, the incorporation of such businesses involves various potential tax (and non-tax) implications.
For example, the transfer of properties to a company upon incorporation constitutes a disposal, which will normally be treated as made at market value for CGT purposes. It will often be important to consider whether the buy-to-let residential property activity constitutes a business, in determining whether incorporation relief (under TCGA 1992, s 162) is available.
Unfortunately, there is no statutory definition of a ‘business’ in the Taxes Acts. Many landlords (or their advisers) have submitted non-statutory clearance applications to HM Revenue and Customs (HMRC) with a view to obtaining advanced assurance that HMRC accepts the existence of a property business. However, there is anecdotal evidence of HMRC refusing to offer its view in some cases, on the basis that the proposed incorporation is tax driven, and is not for (non-tax) commercial reasons. If so, this is a worrying development, and is hopefully not HMRC’s official policy.
Another important consideration in many cases is stamp duty land tax (SDLT) in relation to property situated in England, Wales and Northern Ireland, and land and buildings transaction tax (LBTT) in relation to property situated in Scotland. SDLT and LBTT are generally charged on actual consideration in money or money’s worth. However, there is an important exception to this general rule when property is transferred to a connected company. In that case, the chargeable consideration is the greater of the market value of the property and the actual consideration given (FA 2003, s 53; LBTT(S)A 2013, s 22). SDLT or LBTT may be subject to different calculation rules where multiple residential properties are acquired, depending on whether deemed non-residential property treatment applies (ie where six or more dwellings are acquired as part of a single transaction), or if ‘multiple dwellings relief’ is successfully claimed.
The effect of the SDLT and LBTT rules for partnerships (FA 2003, Sch 15; LBTT(S)(A) 2013, Sch 17) can sometimes be (if property is transferred from a partnership to a new company, and each of the partners is an individual ‘connected’ to that new company) that no SDLT or LBTT charge arises. This potential ‘escape’ from those charges has prompted some sole proprietors to introduce one or more family members as partners prior to incorporating the rental property business, in the hope of achieving SDLT or LBTT savings through the operation of the partnership provisions. However, it may be expected that HMRC will look carefully at any attempt to exploit these provisions to avoid a market value charge. There is no official ‘safe’ period between the sole proprietor introducing a partner in the business and the incorporation of the business. Although the partnership rules contain no specific anti-avoidance rules which would impact such arrangements, it is possible that the SDLT general anti-avoidance provision (FA 2003, s 75A-75C) could be applied. LBTT is within the ambit of the Scottish general anti-abuse rule (RSTPA 2014, ss 62-72).
CGT and SDLT or LBTT are two important tax considerations in the incorporation of a buy-to-let residential property business, but there are various other potential tax issues to consider (eg loan interest relief). A chapter dedicated to incorporation is included in the ‘Buy-to-Let Property Tax Handbook’ (Chapter 13).
Aside from the restriction in the deduction for finance costs mentioned above, there are other potential problems associated with property finance.
For example, in the case of incorporations, relief under TCGA 1992, s 162 is very specific. All of the assets of the business (apart from cash) must be transferred to the company, and this must be done wholly or partly in exchange for shares. HMRC’s Extra-Statutory Concession (ESC) D32 provides that where liabilities are taken over by the company, HMRC will accept that such liabilities are not consideration for incorporation relief purposes. Furthermore, the relief is not precluded by the fact that some or all of the liabilities of the business are not taken over by the company.
However, care is needed to ensure that liabilities remain within the terms of Concession D32. For example, if the company raises finance and uses the funds to pay the proprietors for the business to enable existing borrowings to be repaid, this will constitute (non-share) consideration for the business, resulting in any s 162 relief being restricted.
Many proprietors will continue to operate their buy-to-let residential property rental business without incorporating, despite the finance cost restrictions. This may be because it is the preferred business vehicle, or because it is not practical or financially viable to incorporate. Landlords facing higher tax bills as a result of the relief restrictions will need to consider their options, such as the viability of remortgaging the properties to benefit from lower mortgage interest costs (where applicable), remortgaging their main residence to pay the mortgages on some of their buy-to-let properties, or simply increasing rents. Some landlords will no doubt consider selling their property portfolios, although in many cases the CGT implications of doing so will need careful consideration in advance. Buy-to-let mortgages are considered in Chapter 16 of ‘Buy-to-Let Property Tax Handbook’.
Interesting times ahead
Of course, the finance cost restriction is only of many tax issues for landlords to consider, and there are other changes for landlords and their advisers to grapple with. For example, legislation in Finance Bill 2017 generally requires unincorporated property businesses with receipts for the tax year not exceeding £150,000 to calculate profits on a cash basis from 2017/18, subject to an election to continue calculating profits under generally accepted accounting practice. Furthermore, from 6 April 2019 making tax digital is being extended to landlords with an annual turnover of £10,000 or more, with the result that most landlords will be subject to the requirement for quarterly reporting to HMRC. All in all, there are ‘interesting times’ ahead for property landlords.
Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a consultant to professional firms with Mark McLaughlin Associates Ltd (www.markmclaughlin.co.uk). Mark is also the Editor and a co-author of ‘Buy-to-Let Property Tax Handbook (http://www.bloomsburyprofessional.com/uk/buy-to-let-property-tax-handbook-9781784510541/ )’. He can be contacted via Twitter https://twitter.com/charteredtax and LinkedIn http://www.linkedin.com/pub/mark-mclaughlin/11/811/12