Is Ltd Company Better for Landlords?
Individuals letting residential properties face a number of challenges especially in their tax position in coming years following announcement by Chancellor in 2015 summer budget. The major one is where high earning individual landlords would not be able to deduct 100% mortgage interest against their rental income for the purpose of calculating their tax liability. High earning individual means individuals who are high rate and additional rate tax payers.
Please see our blog for details: Income Tax in View of Chancellor’s New Buy-to-Let Tax Proposal
Please note that this punishment is only for individual landlords. If a person is letting residential properties through a limited company, these rules would not affect his/her tax position. This is the reason that a number of tax advisors are recommending landlords to form a limited company for their future property investments. Some are even proposing that the individual landlords should form a limited company and sell their portfolio to this company. In our opinion, it is not that simple.
- Selling the property portfolio to limited company:
Forming a limited company and selling your property portfolio to that company seems simple solution to Chancellor’s attack on landlords but it involves much complexities such as:
- Capital gain tax: Portfolio will be transferred to the company on current market value and if the purchase price of properties is less than the market value (which will be the case in majority of the cases), it can result in substantial capital gain tax. There are some Capital Gain Tax Reliefs available such as The Enterprise Investment Scheme (EIS), Social Investment Tax Relief (SITR), Entrepreneur’s Relief, Business Asset Roll-over Relief and hold-over for gifts but most of them are not available for letting business because by HMRC definition, letting isn’t trading business. If the entire letting portfolio is transferred in one go in return of company shares, incorporation relief may be available to roll the gain into value of those shares (EM Ramsey Case). Every individual case is different and should be discussed with a qualified tax advisor.
One way is to sell one or two properties each year utilising the annual capital gain exemption (£11,100 for 2015/16). Where the portfolio is held in joint names, the annual exemption will be doubled. Again, every individual case will have to be planned separately with the help of a qualified tax advisor.
- Stamp duty: Where the properties are transferred to a company, that company will have to pay the stamp duty.
- If the properties are financed by mortgage, lender will raise some hurdles or may charge higher interest rate to the company. Early repayment penalty or transaction fee should be another issue in mind.
- Forming a company to buy future investment properties:
This is more sensible approach which can avoid all above listed problems but the tax benefit in some cases is negative. Please see the example where Mr A has an impressive portfolio:
| Limited Company | Individuals (from 2020/21) | |||
| Rental Income | 57,000.00 | Rental Income | 57,000.00 | |
| Less: Mortgage Interest | – 21,000.00 | Less: Mortgage Interest | – | |
| Less: Other Costs | – 2,000.00 | Less: Other Costs | – 2,000.00 | |
| Net rental Income | 34,000.00 | Net rental Income | 55,000.00 | |
| Other Income | – | Salary Income | 11,000.00 | |
| Total Income | 34,000.00 | Total Income | 66,000.00 | |
| Tax calculation: | Tax calculation: | |||
| – | on £11,000 (0%) | – | ||
| On £16,000 (20%) | 6,800.00 | On £32,000 (20%) | 6,400.00 | |
| On £23,000 (40%) | 9,200.00 | |||
| Less: 20% interest relief | – 4,200.00 | |||
| 6,800.00 | 11,400.00 | |||
In case of Limited Company, the salary of Mr A which is still £11,000 will offset against the annual tax free allowance. But the problem is accessing funds from company (dividends). As per new rules, any dividend in excess of £5,000 withdrawn from the company is taxable. If Mr A withdraws all his money from the company i.e. £34,000, the situation will be as follow:
| Individuals (from 2020/21) | |
| Dividend income | 34,000.00 |
| Salary Income | 11,000.00 |
| Total Income | 45,000.00 |
| Tax calculation: | |
| on Salary (0%) | – |
| On Dividend: | |
| On £5,000 (0%) | – |
| On £16,000 (7.5%) | 1,200.00 |
| On 13,000 (32.5%) | 4,225.00 |
| 5,425.00 | |
| Total Tax: | |
| Company | 6,800.00 |
| Individual | 5,425.00 |
| 12,225.00 | |
Suppose Mr A’s financial situation is bit different:
| Limited Company | Individuals (from 2020/21) | |||
| Rental Income | 37,000.00 | Rental Income | 37,000.00 | |
| Less: Mortgage Interest | – 13,320.00 | Less: Mortgage Interest | – | |
| Less: Other Costs | – 2,000.00 | Less: Other Costs | – 2,000.00 | |
| Net rental Income | 21,680.00 | Net rental Income | 35,000.00 | |
| Other Income | – | Salary Income | 11,000.00 | |
| Total Income | 21,680.00 | Total Income | 46,000.00 | |
| Tax calculation: | Tax calculation: | |||
| – | on £11,000 (0%) | – | ||
| On £16,000 (20%) | 4,336.00 | On £32,000 (20%) | 6,400.00 | |
| On £3,000 (40%) | 1,200.00 | |||
| Less: 20% interest relief | – 2,664.00 | |||
| 4,336.00 | 4,936.00 | |||
| Individuals (from 2020/21) | |
| Dividend income | 29,000.00 |
| Salary Income | 11,000.00 |
| Total Income | 40,000.00 |
| Tax calculation: | |
| on Salary (0%) | – |
| On Dividend: | |
| On £5,000 (0%) | – |
| On £16,000 (7.5%) | 1,200.00 |
| On 680 (32.5%) | 221.00 |
| 1,421.00 | |
| Total Tax: | |
| Company | 4,336.00 |
| Individual | 1,421.00 |
| 5,757.00 | |
It is therefore clear that forming a ltd company can save tax as compared to having rental income as an individual but when it comes to withdrawing money from the company, situation become more complex and unclear. Landlords who are usually re-invest their savings in properties (meaning no dividends involved as they don’t withdraw money from the company) can be better off if they form a company. Again every case is different.
It is, therefore, strongly advised that landlord should discuss with a qualified tax advisor thoroughly before making any decision.
Effect of the new tax rules on Trusts:
There is no mention of trusts in the proposals. However, as trustees are normally subject to income tax rules rather than corporation tax rules, it is expected that loan interest relief will also be limited to 20% in trust situations. As relevant property (broadly, discretionary) trusts pay tax on rental income at 45%, limiting relief on loan interest to 20% will significantly increase their tax bills.
Does Company Pay Stamp Duty?
The use of a company, whether based in the UK or offshore to purchase the property, is altogether more interesting and does offer potential benefits, but not on the initial purchase.
If a UK or offshore company is used to purchase a property, it will still pay SDLT on the purchase price at the same rate as an individual would if he/she purchased the property direct. There is no immediate SDLT saving on purchase.
An SDLT saving may arise however when the time comes to sell the property. Rather than selling the property it is possible to sell the shares in the company thus transferring ownership of the property. This means that the new purchaser (and any future purchaser of the shares) pays stamp duty at 0.5 per cent (provided it is a UK company) or no stamp duty (if an offshore company is used) on the purchase price of the shares rather than SDLT at 4 per cent or 5 per cent on the purchase price of the property. On a residential property valued at £2 million, subsequent purchasers could save £90,000 from purchasing the shares in a UK company as opposed to purchasing the property direct.
There are also benefits for the seller, as it may be possible to negotiate a higher purchase price for the shares so that the SDLT saving is basically split between the parties.
It should be noted however that using a company to purchase a residential property and the directors of that company then living in that property may in certain circumstances give rise to significant income tax charges which would likely outweigh any SDLT savings