As the number of tax planning opportunities available to contractors continues to dwindle, we look at the pros and cons of running buy-to-let investments via a corporate structure.
Thanks to Luke Somerset, a director from CMME for answering our questions.
In his final Budget, George Osborne made life more taxing for landlords. What measures did he put in place?
Previous budgets and autumn statements haven’t been kind to landlords. Within a 12-month period, existing and prospective landlords saw reforms to both their acquisition costs, through a 3% Stamp Duty levy imposed on non-primary residences which came into effect in April 2016, and now face a raft of measures to reduce the tax breaks enjoyed by landlords currently.
The latter is seen by many contractors as the more punitive of measures, cutting their profit and in some cases eradicating their rental profits altogether.
Mortgage interest relief – From April 2017, contractors will no longer be able to claim the entire mortgage interest payments associated with their buy to let as a tax-deductible expense if they fall into higher or additional rate tax brackets, and will be charged an additional 20% or 25% tax on their interest payments respectively – any profit made on letting the property thereafter will be subject to the contractors highest marginal rate of tax.
This change will be phased in over a 4 year period, however, the impact on profits for landlords will be immediate.
Wear and Tear Allowance – Prior to the start of the tax year, contractors could claim 10% of their annual rental income for “wear and tear”, rendering that portion of their rental income tax-free. In April 2016 that allowance was abolished and replaced with a “prove it” style system, which only takes account of the actual value of repair works carried out to the property during the financial period.
What this new measure doesn’t fully take account of is the depreciation of fixtures and fitting. For example, the loss in property value over time as your kitchen becomes dated.
Do these changes apply to both individual landlords, and corporate landlords?
Properties owned by a limited company are not affected by these changes and for many, it may appear that the previous chancellor left the door open for a mass migration of personally owned by to lets into a company structure. However, moving property into a corporate structure will inevitably incur some tax liability in the form of stamp duty, with the 3% levy dolloped on top, and Capital Gains tax should the property have increased in value. Both are calculated at the open market rate of the property.
Contractors should also consider a largely unknown tax which could scupper their plans – or at the very least, alter the corporate structure used to own a buy to let.
The Annual Tax on Enveloped Dwellings, or ATED, was originally introduced to make it less attractive to hold a high value property, worth in excess of £2m, in a limited company structure.
From April 2016, the £2m taxable value was reduced, putting any property worth over £500,000 firmly within the grasps of ATED. Properties falling inside this tax face an even higher rate of Stamp Duty, an annual tax levy and Capital Gains Tax on the disposal of the asset. Thankfully, there are exemptions, however it is crucial that your company is formed correctly to benefit from these.
A good accountant will navigate their way around the ATED rules with the help of a good specialist mortgage adviser.
Are you allowed to own and rent out property via your own limited company?
We receive numerous enquiries from contractors seeking to purchase via their contracting company as a means of investing retained income. However, this can impact, amongst other things, your entitlement to claim under the Flat Rate VAT Scheme and makes closing the company in the future all the more complicated, particularly if you don’t intend to sell your investment property. There’s also ATED to consider if using a company whose primary trade is not the letting of property.
A solution is to form a new limited company, which can be set up for the sole purpose of letting property and this new company can be formed as a subsidiary, or holding company, of the main contracting company allowing the deposit for the purchase to be transferred between companies without incurring a dividend tax liability.
Are there a lot of lenders willing to lend to companies, compared to individuals?
Increasingly lenders are switching onto limited company lending, with the volume of company based lending now double what it was this time last year.
However, they are far from mainstream. The lending policy hurdles, tax and legal implications are numerous.
What should I look out for when seeking a commercial mortgage, compared to a standard individual BTL?
A joined up approach to tax and mortgage planning is essential. Finding a broker with the relevant experience and skill is essential. They’ll pull the legal, accounting and mortgage piece together for you and ensure that every component part of your purchase progresses smoothly.
If you’d like to find out more, try our mortgage guide.