Almost a year ago now the Chancellor, George Osborne, announced a series of tax changes affecting the buy-to-let market.
Firstly, from April 2017, mortgage interest tax relief for individual residential landlords will gradually be restricted from 40% to the basic rate of income tax, which is currently 20%.
He also announced that the traditional Wear and Tear allowance was to be replaced with a new system which requires landlords to deduct the costs they actually incur on replacing furnishings in rental properties.
The changes to the way landlords can claim mortgage interest tax relief are likely to affect higher rate tax payers as they will no longer be able to offset the full cost of doing business against their income.
In light of these announcements, there have been calls from many corners of the industry for landlords to incorporate.
What is incorporation?
Incorporation is the act of forming a limited company – in a landlord's case to transfer personal ownership of their property portfolio.
Companies will not be affected by the restriction of mortgage interest tax relief and are only required to pay corporation tax – currently 20% and due to fall to 18%.
It is for these tax benefits that landlords have been encouraged to incorporate their property portfolios.
The main disadvantages of incorporation are that more tax will be due if income is drawn from the company and that stamp duty and capital gains tax charges will apply when transferring properties from personal ownership to a limited company.
According to a survey by the National Landlords Association;
- four in ten landlords are either seriously considering incorporation or will be looking into the option in the coming months.
- only 31% of landlords it surveyed have absolutely no intention of moving their portfolio to a limited company, and that 29% remain undecided.
On top of this, Mortgages For Business recently claimed that limited company applications accounted for 43% of its new buy-to-let activity in January – up from 38% in December.
Last month, landlord tax expert Simon Blum offered his tax return advice. This time, considering that many landlords are clearly weighing up the pros and cons of whether to form a limited company, he explains how a tax return could change in the event of incorporation…
Is there a minimum number of properties needed for incorporation?
SB: No, one is sufficient. Providing the activities the landlord undertakes meets the ‘business’ threshold, incorporation is possible. This requires a reasonable amount of ‘hands on’ activities.
What do you mean by 'hands on activities'?
SB: Whilst a certain element of activity can be left to a letting agent, if the landlord leaves absolutely everything to the agent, changes should be made before incorporation is considered.
How does a tax return change if a landlord incorporates?
SB: Fundamentally. A company pays corporation tax and completes a corporation tax return, rather than an income tax return. A company will also need to produce formal statutory accounts and submit them to Companies House. The rental income will no longer appear on the landlord’s tax return.
When and how often does a company have to pay corporation tax?
SB: A company pays its corporation tax once, nine months after the year end on the calculated profits of the year. This is not the same as income tax, where tax is paid on January 31 and July 31, and based on estimated profits with a further top-up of tax underpaid on January 31 (although these rules may change shortly).
Is corporation tax calculated in the same way as income tax?
SB: The fundamentals of calculating the tax due are practically identical to when the properties are held in personal ownership. Corporation tax is to reduce to 17% in a few years and capital gains made by the company are charged at the same rate.
Do those who incorporate have to pay tax on profits they extract from the company?
SB: Yes, personal tax remains payable on any profits extracted from the company, but unlike personal income tax, there is far more flexibility available in extracting these profits in the most tax efficient manner possible.
Do you have any other important points to note about corporation tax return?
SB: The landlord must make sure they have personal funds to pay the final income tax liability, even after incorporation. Otherwise the landlord will need to extract the funds from the company, which may come at a tax cost.
*Simon Blum is a Senior Tax Consultant at OneE Group, an independent tax advisory firm and recognised supplier of the National Landlords Association.