Beating tax changes by incorporating - experts advise landlords
Property tax and legal experts have challenged landlords who are considering whether to incorporate their BTL portfolios, to mitigate harsh tax changes, to educate themselves.
Investor Ranjan Bhattaccharya met with Mark Alexander, founder of Property 118.com, and Mark Smith, a barrister with Cotswold Chambers, to explore some of the solutions and explain the key concepts which underpin the process.
The discussion was filmed just before the April 26 Baker Street Property Meet, where some 360 people from all over the UK come to talk about the ‘hot topic’ of property tax.
Mr Alexander, a landlord since 1989, started BTL mortgage brokers Money Centre from his bedroom, and by 2008 it was 38th on the Sunday Times profit track 100.
Along with Mr Smith, he successfully challenged the West Bromwich building society when it raised the margin on tracker rate mortgages by 2 per cent above base, and in the process helped 6,700 affected landlords recover £27m.
The duo are now advising landlords considering incorporation, via Property 118.com, with a series of podcast seminars and other materials which take a ‘multidisciplinary approach’ to the tax relief problem facing many landlords.
Mr Bhattaccharya said: “A lot of landlords are talking about incorporating their BTL portfolio - putting them in a limited company.
“One of the big barriers is that you have got to refinance everything – legal costs, valuation costs, solicitor fees. Then of course you may lose some fantastic mortgage rate products.”
He asked his guests to talk about the ‘holy grail’ where “you don’t have to refinance but you can incorporate.”
Mr Alexander warned there is no ‘one size fits all solution’ and incorporation is ‘probably one of the ten solutions that comes up’.
“If you’re transferring a property to a third party like a company than you’re triggering capital gains costs,” he said.
“Legislation enables you to exchange your equity for shares and offset the value of the shares created against your capital gain – so that can wash out the capital gain.”
He said this was ‘great for landlords that have been in the business for a long time and have accumulated a lot of capital gain because it effectively re-sets the clock’.
Mr Smith said: “Because it is a disposal of a major interest in property it does trigger SDLT (Stamp Duty Land Tax) but there is an exemption for people who are trading in partnership.”
However, he emphasized that ‘it’s important that this is properly established – and that people are aware of what a partnership amounts to.’
“If you’re not in a partnership and try to incorporate,” he said, “the SDLT hit, by and large, will make it prohibitively expensive.”
Mr Bhattaccharya pointed out that people get confused because they hear about section 162 and the stamp duty exemption for partnership. “They use the words scheme and ask is this avoidance?” he said. “But this is like opening an ISA account.”
Mr Armstrong said: “It can be complicated which is why we recommend people get clearance – it’s not compulsory – but it gives you certainty. “You’re effectively saying to HMRC: ‘This is what i am planning to do, this is my understanding of the law.’
“Is my understanding correct? And if they say ‘yes’ there can be no comeback.”
To qualify as free from paying immediate stamp duty and immediate SDLT, he said a clearance letter to HMRC will describe the business and ‘explain why we are not curating an investment – and in fact running a business.’
Property 118 is now registered with HMRC as a tax consultant and ‘can help people to get that clearance and get that ultimate peace of mind’, he added. More information about the qualifying criteria is available in a download pack from the website.
Other landlords are reluctant to refinance because they stand to ‘lose some cracking mortgages rates I’ve have got from seven or eight years back’ said Mr Bhattaccharya.
He asked: “How is it possible that I don’t have to refinance?”
Mr Armstrong explained the difference between legal ownership and beneficial interest, using the example of someone buying shares.
“You get a share certificate which says the nominee is the bank or the stockbroker who bought the shares for you.
“Technically they are legal owner, the piece of paper that you have got confirms that you are the beneficial owner. HMRC only taxes the beneficial owner.
“So if you make dividends on your shares you pay dividend tax.
“It’s an established principle. People think that beneficial interest transferring (BIT) is something new -- it isn’t, it’s been around since the Christian crusades so people could protect their assets when they went to fight.
“Taxation principles are very well established. The beneficial owner is the person that pays the tax on the dividend income and whatever else.
“Beneficial ownership is transferred all the time – every single conveyancing solicitor in the land will recommend that if the bank of mum and dad is financing kids’ properties for example, have a beneficial trust that says you own this much of the property.
“It’s perfectly legal. With a property we have the legal ownership, the bit that’s registered with HM Land Registry that says the legal owner is this person.
“If 100 per cent of the beneficial ownership is transferred, that meets section 162, you have to transfer 100 per cent of the business – that’s very important.
“The next question is – do lenders like it? In a lot of cases I can be honest and say no they absolutely hate it. Because in a lot of cases they have written these loans pre-credit crunch at very, very tight margins. They have had to re finance, they have been caught short. They are making much smaller profits on those mortgages than they wanted to and ideally they would like you to pay them off.
“The key question is can they stop you? And that is a very important part of the due diligence process which Mark Smith does.”
Mr Bhattaccharya pointed out that a lot of ‘mortgage contracts are just a couple of pages but if there’s nothing to say that you can or can’t do something, presumably, by definition it means you can.’
Mr Smith said: “Because the mortgage is linked to the legal ownership, and the taxation comes from the beneficial ownership, to separate the two is really what gives this strategy its power for residential landlords.
“Taxation following beneficial interest is the fundamental aspect of this – it has been enshrined in the law for centuries and is completely unarguable. “But on the flip-side, the lender’s security is lodged at the land registry against the legal title. And if there is any default on the mortgage, then it’s the legal owner they come after, which by and large will be the partners who have incorporated their business.
“The lender is not interested in or affected by the fact that the beneficial interest has been moved elsewhere because their powers under the legal title overreach any kind of trust or onward sale of the beneficial interest and they will recoup everything back for their own benefit in enforcing the mortgage.”
Mr Armstrong pointed out that a lot of mortgage brokers out there ‘really don’t like the idea of this, they want to do the remortgage business!’
“They have said things like – ‘This is mortgage fraud. If you don’t declare it to the mortgage lender you’re breaking the rules.’”
But he said his case against the West Bromwich has ‘proven all that wrong.’
“A mortgage lender can only call in a loan if you are in default,” he said.
“And if they haven’t got something in their terms and conditions that precludes the transfer of beneficial interest you can’t possibly be in default.”
From an HMRC perspective beneficial interest is not a problem because they have given clearance already for people incorporating and using a BIT structure, added Mr Bhattaccharya.
Mr Smith said: “Without being big headed, the clever part about this – because the revenue tax beneficial interest rather than legal interest we are taking that approach which they use to over reach and pierce arrangements which would otherwise prevent tax being paid. We use that to our benefit.”
Mr Bhattaccharya urged people who own any BTL property to take the time and get their heads around these concepts.
“The worst thing I hear people say is I am leaving it all to my accountant,” he said. “No! No! No!
“You have got to educate yourself, and understand what the problem means to you and you have got to start educating yourself about the solutions that will work for you and your business. And then start getting the proper advice and putting the pieces together.
“It’s up to you to figure stuff out how you solve it.”
To see the podcast, or access the downloadable pack addressing the information discussed, please visit: https://www.property118.com/landlord-incorporation-explained-video-interview-ranjan-bhattacharya/98856/