From the 6th April the restriction in tax relief on mortgage interest for higher rate tax payers increases so buy to let owners will start to see the profitability of their properties start to decline. Essentially in the 2018-19 tax year 50% of mortgage interest will be allowed as it has previously been, but for the remaining 50% the relief will only be at the 20% basic rate of tax.
Since the changes were announced, landlords have been searching for solutions to ensure the profitability of their buy to lets with the hint of interest rate rises ahead.
One potential solution talked about is the possibility of forming a partnership with the properties and then incorporating the business to fall out of the tax relief restrictions, but this solution is only likely to be accepted in certain circumstances.
The reasoning behind this solution is that normally when you have been operating a business as a sole trader or partnership you are able to sell your trade into to a limited company. When you sell something personally, other than certain personal possessions it falls subject to capital gains tax, but if you do not receive proceeds for the sale, in that you exchange your business for shares in the company, the gain you would be taxed on is rolled into the shares and the tax would be paid on their eventual sale.
The key word is business and where properties are involved it can be more difficult to convince HMRC of this. To achieve the relief on putting properties into a company you in theory would need to demonstrate some history of trading as a business prior to incorporation and it would be likely that HMRC will expect to see the owners collecting the rents themselves and organising any repairs etc, rather than using a management company to do all of what would be classed as the trade. If the properties simply appear to be an investment you could not assume incorporation relief would be accepted by HMRC. They would also be likely to expect to see a sensible number of properties in this business.
Whether the relief would be challenged will be on a case by case basis, it could go through without problem or it could be rejected, leaving a big bill later if the property prices have gone up since they were purchased. The relief would be open to challenge for a number of years after.
If you wanted to be sure you could apply to HMRC for clearance of transaction but this can be costly and time consuming, also giving more chance for scrutiny. There is a case, Elizabeth Ramsey versus HMRC, which does suggest HMRC expect it to be robust property letting business with a proper amount of time each being spent in managing the properties, say 20 hours a week and such as cleaning services provided.
In a case where it is debatable whether the situation could constitute a business, it may be best to formulate a plan based around the properties individually. It has to also be remembered that a company will almost always cost more to administer which has to be balanced against any tax saving, although there is a benefit in that there is currently an additional £2,000 tax free dividend allowance and the tax rates for dividends are generally more beneficial than operating as a sole trader.
The other aspect of this tax planning is that to gain the stamp duty relief on incorporation the business must be demonstrably a partnership prior to the sale, not simply properties with two names on the deeds. Examples of evidence to support a partnership that may be considered is a partnership agreement, joint bank account, leases and agreements in the joint names etc. HMRC do have the potential to reject the partnership under SDLT anti avoidance measures and overturn any relief claimed.