Capital Gains Tax and tax schemes - will they work?

Simon provides an update on the current Capital Gains Tax situation for landlords and asks whether tax schemes for landlords will actually be acceptable to HMRC and work to reduce the amount of tax due.

Way back in July I wrote about the impact of the changes in the Summer Budget relating to mortgage interest relief for BTL landlords. In the article I said that landlords should take tax advice but that there was no need for immediate action as the restrictions on charging interest in your tax calculation as a deductible expense would only start to be phased in during the 2017/18 tax year.

Well – with the recent Autumn Statement there is cause for immediate action if you are planning to incorporate your BTL business to avoid this impost.

If incorporation is not completed before 1st April 2016 there will be an additional Stamp Duty of 3% on the entire value of your portfolio when you do incorporate (unless you already own 15 residential properties in a limited company).

Capital Gains Tax rollover

The full article that I wrote back in July is available here. One of the key factors that I identified then was the potential impact of CGT at the point of incorporation and that if this is not to be incurred then it is necessary to be able to demonstrate that you are running a business – and not just an investment portfolio.

In the one test case to date, the taxpayer devoted 20 hours a week to various activities of collecting rents, and property and garden maintenance. As a consequence the property (a house split into 10 flats) was determined to be a business (eligible for incorporation relief) rather than an investment (ineligible for relief). This enabled the taxable gain to be “rolled over” into the cost of shares in the new company under what is called s.162 relief. With the proposals in the Autumn Statement there is increasing interest in s.162 relief as the urgency created by the new 3% stamp duty surcharge is forcing landlords to act quickly.

There is no definitive guidance available on the criteria that HMRC might use to determine whether a taxpayer should get s.162 relief, so the following are just my thoughts on some factors that might sway any decision:

Investment:

  • Owner has full time paid employment not associated with the property
  • Owner uses an agent to collect rents and manage the property

Business:

  • Owner selects tenants himself
  • Owner collects rents himself
  • Owner undertakes minor maintenance work himself
  • Owner employs staff to help manage the portfolio
  • Owner can demonstrate that most of his income comes from the property/properties

    Ultimately it would all depend on individual circumstances!

Capital Gains Tax payable

If you are not in a position to obtain s.162 relief then your Capital Gains Tax on incorporation will be based on the capital profit you make on the sale of the property. This is calculated as the difference between the cost of your property including:

  • Purchase price
  • Stamp Duty (SDLT) paid on purchase
  • Valuation and legal costs on purchase
  • Any capital improvements (but not like for like renewals or repairs) 

    and the net sales price – i.e. after deducting from the actual sales price
  • Estate Agents commission
  • Legal costs of sale
  • Any other costs incurred to facilitate the sale

NB: Financing costs are not an allowable deduction.

Net gains for the year (on all sales of assets including shares) are reduced by an annual exempt amount of £11,100 to arrive at the annual chargeable gain. This is taxed alongside normal income; if, when net chargeable gains are added to taxable income (after all allowable deductions), this does not exceed the higher rate threshold of £31,785 the gains are taxed at 18%; any excess is taxed at 28%.

CGT is currently reported to HMRC as part of the annual tax return in January following the end of the preceding tax year. However, in the Autumn Statement, from April 2019 there will be a requirement to make an “on account” payment to HMRC within 30 days of the disposal. Put simply, for most BTL investors, the vast majority of any significant gain (after deducting the annual exemption of £11,100) is likely to be taxed at the rate of 28%.

Tax Schemes

The massive amount of tax at risk for BTL landlords will cause many landlords to seek ways of mitigating this and doubtless there will be many advisers, with varying credentials, offering “schemes” to assist in this cause. Even landlords that meet the criteria for s.162 rollover relief are faced with SDLT on the sale of properties to the limited company as well as costs of refinancing existing mortgages into new mortgages taken out by the limited company.

The only exemption from SDLT that I am aware of that is relevant here relates to the incorporation of existing partnerships whereby the ownership of the partnership is replicated by ownership of the shares in the limited company into which the properties are sold. The beneficial effect of these provisions might tempt some sole traders to form family partnerships shortly before a proposed incorporation. However, where such arrangements are made, HMRC is likely to be successful in invoking the general SDLT anti-avoidance rules. This would enable HMRC to ignore the interposition of the partnership prior to the incorporation as a method of reducing the (normal) charge to SDLT.

I envisage that tax schemes will fall into two groups:

  • The first will be schemes designed to help individuals avoid CGT on incorporation where their property portfolio is not truly run as a business. I cannot see any way that a taxpayer can alter his/her status at this stage – either the portfolio has been run as a business – or it has been a passive investment. Simple – and virtually no room for manoeuvre.

  • The second will be schemes for landlords who could qualify for s.162 relief but who are faced with SDLT and refinancing costs. Such schemes could be relying on the “partnership” exemption referred to above to avoid SDLT and other arrangements to mitigate the need to re-finance.

It is a statement of the obvious that sale of a property to a limited company establishes a new owner and consequently a new mortgage will be required. So when considering the viability of any schemes, landlords need to be sure that lenders understand the new ownership structure fully and that they will continue to lend on the same (or similar) terms to those existing prior to implementation of the scheme.

With BTL firmly in the “cross-hairs” for the Chancellor and HMRC, it is certain that HMRC will be looking out for schemes that seek to extend the boundaries of what is permissible under existing legislation. HMRC has three extremely powerful “weapons” in its armoury:

  • Since August 2006, it has been necessary for any “scheme” with tax consequences to be registered with HMRC under the DOTAS (Disclosure Of Tax Avoidance Schemes) regime.
  • There is now a Generalised Anti Abuse Rule (“GAAR”) which is almost tantamount to HMRC having the power to overturn any “scheme” that it considers to be abusive.
  • Finally, since July 2014 HMRC has had the power to issue “Advance Payment Notices” requiring the taxpayer to settle any disputed taxation in advance of final liability being determined by the Courts. If ultimately the Courts find in favour of the taxpayer, any tax paid will be refunded (plus interest) – but this could take several years.

Inevitably this is a dramatically abbreviated summary of hundreds of pages of legislation – but the message I want to get across is to be extremely cautious of any schemes - and even if ultimately the scheme works you may have to fund the tax saved for many years whilst the validity of the scheme is tested in the Courts (and doubtless there will be Appeals by the losing party thus extending further the final determination).

Conclusion

Until the legislation is produced there will continue to be some uncertainty about how exactly the new SDLT surcharge will work. But for most investors the uncertainties are irrelevant as action is required NOW to ensure that you have time to complete any proposed restructuring prior to April 2016.

Please take professional tax advice - we are not taxation advisers and cannot give any advice relating to your specific circumstances.

Related links:

>> Buy to Let Tax Calculator

>> Buy to Let Stamp Duty Calculator

>> Top 10 Buy to Let Rates for Ltd Co's

>> Investing in buy to let: Trading Ltd Co's versus SPV Ltd Co's

 

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