Do limited companies provide the perfect solution for higher-rate taxpayers and what issues should landlords take into consideration?
The Chancellor’s announcement in the July Budget that he intends to reduce the tax relief available to wealthier landlords to 20 per cent from April 2020 has set a number of hares running.
In response, some investors are considering purchasing and even switching ownership of existing rental properties via limited companies. But do limited companies provide the perfect solution for higher-rate taxpayers and what issues do landlords need to take into consideration?
Owning property within a limited company is not a new idea and limited company status simply provides investors with a different tax wrapper. It is not dissimilar in conceptual terms to an Isa being a tax-efficient wrapper for savings.
Of course, limited company status does not offer a tax-free haven but it does mean that, from a tax perspective, landlords can continue treating mortgage interest payments as an expense, while paying corporation tax on profits at a rate of 20 per cent (or 18 per cent from 2020). However, if profits are to be withdrawn from the business as dividends, the amount of tax due on those dividends needs to be taken into consideration.
Investors can buy and hold property either as individuals or via a limited company. As individuals, property can be held in a sole name or in the name of a spouse or civil partner. Some higher-rate taxpayers will undoubtedly consider transferring property into a spouse’s name.
The other option is to hold property within a limited company: either an existing trading business or a special-purpose vehicle set up to own investment property.
Many business owners invest surplus company cash in rental property rather than holding cash in low-yielding business savings accounts. There is nothing wrong with using an existing trading company for this purpose, provided it does not inadvertently change the nature of the business from a trading to an investment company.
Alternatively, one can set up an SPV specifically for the purpose of owning rental properties. The benefit of an SPV is that it effectively ring-fences the asset and some lenders will lend only to SPVs, as the table confirms.
Some would say lending to a trading company is less risky than lending to an individual as the lender can make a charge over the business’s assets. However, there is really little difference between the two. Lenders will ultimately focus on the directors and shareholders rather than the company itself.
They will seek personal guarantees and debentures in the form of a fixed and floating charge over the assets owned by the company and, in the event of needing to take possession, will focus on recovering the outstanding debt from the directors of the business.
The good news is that, although only a handful of lenders offer mortgages via limited companies and SPVs, a growing number plan to launch into this sector.
In the coming months, some landlords will decide to move existing properties into a limited company structure. Technically, they will be transferring an asset from one legal entity to another. As such, the transaction will be classed as a purchase and they will need to consider issues such as stamp duty and capital gains tax.
What is more, because the transaction is a purchase, lenders may ask for a deposit to be paid from the limited company’s cash reserves, which could be an issue for the owner. It would be far preferable, from the perspective of the deposit, if the transaction were treated in the same way as a remortgage, which would mean the deposit would not have to deplete the business owner’s cash reserves.
The change to landlord tax relief will cause a lot of head-scratching and there is no one-size-fits-all solution. The answer will depend on your client’s circumstances.