Since the introduction of The Finance Bill 2016, and Clause 24 in particular, there has been much interest in the idea of investing in BTL through a limited company. However, as we shall discuss, one size does not necessarily fit all and so switching to a company ownership of rental properties may not suit everybody due to their personal situation. Today, we consider no less than ten different scenarios where investing in a limited company may not be all that it is cracked up to be.
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Links to resources referenced in this week’s show: Northwood article referencing NLA survey & company ownership issues, YPN article referencing the 'Danger List', Judicial Review of Clause 24 the 'Tenant Tax'
Handy article and calculator that explains some of the impact of Clause 24 on us...PS don't forget to follow my Property Investment Insights page on Scoop.it whilst you are there!
Today’s must do’s
Think before you leap into investing through a limited company...is it the right size and fit for you and your personal circumstances?
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Transcription of the show
Hello and welcome to another edition of The Property Voice Podcast, my name is Richard Brown and as always it is a pleasure to have you join me again on the show today.
I realised that I have spoken and indeed written a couple of times about the forthcoming tax changes. One potential solution to these changes that has been widely shared, including by me on this podcast, is the idea of investing through a limited company. However, as we shall discuss, one size does not necessarily fit all and so switching to a company ownership of rental properties may not suit everybody due to their personal situation.
Today, we consider no less than ten different scenarios where investing in a limited company may not be all that it is cracked up to be.
Here we go then…
Ever since the introduction of The Finance Bill 2016, and Clause 24 in particular, there has been much interest in the idea of investing in BTL through a limited company. As a quick reminder, Clause 24, which has a few public nicknames now such as, The Alice in Wonderland Tax, The Turnover Tax and The Tenant Tax, essentially means that mortgage interest deduction for tax purpose is changing.
Right now, any BTL investor is able to fully offset their mortgage interest payments in full against their rental income to arrive at a net profit for tax purposes. This is consistent with normal and long accepted business practice for the butcher, baker and candlestick maker.
However, Clause 24 has changed the way this will work from tax year April 2017/18 for BTL investors using their personal name, be that as an individual or as a partnership.
From next April, the following changes will be coming into effect:
- Mortgage interest will no longer be allowed as a pre-tax rental income deduction at all – this is one reason why the change has been termed the Revenue or Turnover tax, as it means an essential business cost will not be allowed to be deducted before total revenue is calculated to establish your highest tax bracket. In short, this could push people into a higher tax bracket, including modest earning basic rate taxpayers, despite no other change in their circumstances at all.
- It will be replaced by a relief instead. The relief will be calculated and used as an offset against the final tax payable for the year. However, the relief will also be capped at the basic rate of tax, regardless of what tax bracket we actually fall under. Whilst, it will be phased in gradually over 4 years from next April, it will mean more tax to pay each year than is now the case.
- The tax is due, no matter what the net paper and cash profits of the rental business are. This essentially means that in some cases, some landlords will actually be making a post-tax and indeed a cash loss on their property business and yet will still have a tax bill to fund and pay out of their pocket…it could lead to negative cashflow in some cases.
So, this will have a significant impact and beyond the apparently small numbers predicted by the Government I have to say. One of the most talked about solutions is to incorporate the property investments into a limited company structure instead. A recent NLA survey placed the number of existing landlords considering this move at 40%, although less than 1% had actually done it at that time.
There is a simple explanation for this lower conversion rate into a limited company structure…it may not be worthwhile for everyone…or in other words, it’s not a one-size fits all solution.
I previously talked about what I like to call my Danger List of potentially affected property investors in a recent YPN article. I have since also recorded a short video explaining this, which will be linked in the show notes. Essentially, the Danger List is a set of potential circumstances when it would be worthwhile at least considering investing via a limited company. Although, this is not a clear-cut exercise as I shall now reveal.
Here are some of the situations when it may not always work out better to invest through a limited company:
- Basic rate taxpayers – this is when the property owner or owners are basic rate taxpayers, even after the Clause 24 changes. This maybe the case for lower rental income and / or combined rental and other sources of income property owners. Even in situations where a couple own a property and only one is a basic rate taxpayer, it may be possible to elect to share the rental income in unequal proportions in favour of the lower rate taxpayer to legitimately reduce the tax bill.
- Low leverage investors – if you have a low loan-to-value (LTV) or low mortgage balances, then the changes might not actually have such a dramatic impact even after the watering down of the relief.
- Investors needing the income – switching to a limited company certainly reduces the initial tax deduction. However, it does not eliminate the personal income tax altogether for higher rate taxpayers. Keep in mind, that even when using dividends to distribute profits that this has also changed and will be capped at £5,000 per year at the basic rate of tax going forward. Additional dividends will still attract an increased tax charge for higher rate taxpayers for example. Whilst this should still reduce the overall tax bill by allowing full interest relief within the company, when added together with some of the other changes listed here, it may not always work out best. For example, if we already have a reasonable amount of dividend income, some of this benefit will be lost.
- Intend to flip sooner rather than later – when we think of investing in property, we often think of two extremes…long-term BTL and short-term property trading or flips. In both cases, any rental income is subject to income tax. Whilst property trading profits are subject to income tax as well, the profits on any sale of a BTL are subject to capital gains tax instead, this could become relevant for some. For example, there is a middle ground situation where we may rent for even a short time, say 6-24 months, and then sell on. Here, the key difference is that any profit on sale would then subject to capital gains tax and not income tax. So, under certain conditions, if our total gain comprises more in terms of the capital gain than rental income, then the decision to incorporate can then become more marginal.
- Where we have accumulated tax losses – if we have been acquiring properties regularly and refurbishing them back into a decent condition, it is possible that whilst our monthly rental income is cashflow positive that our annual tax bill shows a loss position instead. This is due to large upfront costs being offset against the rental income profits. Over time these losses can add up to such an extent that it could take several years of profits, even under the new system, before a tax payment becomes due.
- When the property is already or can be converted into a furnished holiday let – a property that is let for short periods, typically of 30 days or less, can under some circumstances be classed as a furnished holiday let instead. The relevance of this is that furnished holiday lets and similar property rental businesses can still claim the full mortgage interest deduction as before. It sounds bizarre but it is true. So, the mushrooming of holiday lets, short-term rentals, and serviced accommodation are all effectively the same thing from a tax point of view and may receive different or in other words better tax treatment that a standard BTL.
- When one tax savings generates another tax bill instead – if we already own a property and then intend to transfer it into a limited company, it is recorded as an entirely new transaction just the same as any sale would be. The implication of this is that this will trigger two potential taxes to pay: stamp duty on the purchase and capital gains tax on the sale profits. These taxes need to be paid at the time of sale or transfer and cannot be deferred, so the cash needs to be available to fund the tax payments arising. This may have the effect of trapping some people, particularly those that may have refinanced their property well above the original purchase price.
- When the compliance and non-tax costs of incorporation don’t add up – in a similar way to the tax point made just now, there are other one-off and recurring costs that usually result from incorporation. These include finance and broker charges, early redemption mortgage penalties, conveyancing fees and annual company accounts or returns and so on.
- When the increased finance interest offsets the tax saving – once again, all is not as straightforward as it may seem, as company BTL mortgages are currently more expensive than the personal BTL equivalents more often than not. This can mean that we end up paying more in interest, which could offset some of the apparent tax saving from switching. Whilst the lending market is starting to wake up, there are far less company products available when compared to individual BTL ones.
- It’s not over yet – this is a reference to the fact that whilst the Finance Bill 2016 and Clause 24 is in fact already law, there is a legal challenge calling for judicial review under way. Essentially, this review claims that Clause 24 is anti-competitive and discriminatory, as it only targets a certain type of business owner, i.e. those that invest personally rather than through a company. The recent UK vote to leave the EU may actually end up scuppering this legal challenge now, as some of it is based on European Law. However, it still remains to be seen whether any new Prime Minister and potential Chancellor still see the need for this in the climate of Brexit where the need to stimulate investment into the UK is required.
Whilst many of this list of 10 different situations apply to existing property investors, some may also apply to new or would-be property investors too. So, it is worth considering all of these potential factors before making any firm decision and that is part of the reason why we have yet to see a massive uptake in investing through a limited company, despite the impending tax changes.
Things may yet change, as they often do. Equally, things may not change and so a review of your own situation every 6-12 months is a good idea in any event. So, there we have it then…another situation in property that brings about a level of complexity for us to consider.
As a parallel, It is often said that many of the large, monopolistic companies, such as the mobile phone operators and utility companies, adopt what is called ‘confusion marketing’. This is where the range of offers, price structures, bundles, contract lengths and termination provisions is so complicated that the average consumer just sticks with their current provider, as it’s the line of least resistance.
Similarly, perhaps, the Government, aided by the lenders, are bringing about a bit of confusion in BTL tax planning, with the possible result that we will either do nothing…and end up paying more tax, or alternatively, not bother to invest in property at all. It strikes me that we will see both of these potential outcomes over the coming years…yet, that need not be you and I dear listener. We can educate ourselves and take control of our property investing destiny can’t we? Sure we can – stick around and I will do my best to shed light onto the situation.
On that promise then, let’s leave this one here for now.
Please don’t forget to complete our survey will you? I have seen these trickling through each week, so thank you for those that have responded. The link is in the show notes, or you can email me firstname.lastname@example.org to receive a copy of the link that way instead.
Right now though, all that remains once for me to say, is thank you very much for joining me on the show today and until next time on The Property Voice Podcast…it’s ciao ciao!