From April 2017 small buy-to-let investors will be hit by gradual tax changes which will reduce their profits and increase their tax bills.
From April next year HMRC will start phasing in changes which will eventually
see landlords pay tax on the entire rental income they generate from their properties. They will no longer be able to deduct the cost of mortgage interest against their rental income and instead, they will benefit from a tax credit equal to 20% of the interest cost. It will mean higher-rate and additional-rate taxpayers will pay considerably more tax - and in some cases even pay tax where they make no profit!
But landlords structured as companies are exempt, and will pay corporation tax on their profits. As a company, investors pay less tax on their rental income, and the removal of higher-rate interest relief does not apply. Companies currently pay a flat rate of 20%, which will drop to 19% in April 2017 and 18% by 2020
Incorporating a limited company,
though, is a far from simple process, and there are several pitfalls that need to be avoided along the way. Companies only work for certain types of investors, and people have to be aware of the implications further down the line.
How to get started
To get started, most landlords
will need to set up special purpose vehicle (SPV) in order to buy the property which can be done quite cheaply online. After that buying the buy-to-let property through a company is a similar process to buying it as an individual but be aware that the 3pc extra stamp duty levied on people buying second properties from April will also apply to people buying through a company.
If you’re already a buy-to-let owner, transferring property into a company has
its own tax implications. The property has to be sold at market value, which has capital gains tax implications as well as potential stamp duty costs when the property is bought through the company.
If the property has increased in value since it was bought, capital gains tax may be payable on the sale, though after a tax case in 2013 landlords may be exempt from this if they can
show that letting the property is a "business" as opposed to the property itself being an "investment". This will depend on the amount of work the landlord does on the property, including day-to-day maintenance and direct management of tenants. If they have another job or employ a letting agent to do the work, it’s likely to be categorised as an investment as opposed to a business.
For landlords
who do not meet the latter criteria it's probably a sign that incorporating is not worth it.
Getting a mortgage
Specialist lenders offer buy-to-let mortgages for companies, and it’s easier to get a mortgage with a special purpose vehicle, which only holds properties, than a trading
company, which can carry out other business. This is because special purpose vehicles are regarded as less complicated and easier to underwrite.
What happens next?
Once you’re incorporated, you have some responsibilities that you did not previously have as an individual buy-to-let
investor. Instead of simply doing a self-assessment tax return each year, companies have to complete an annual return, accounts and a corporation tax return, so a limited company may have to factor in the cost of an accountant.
Things to watch out for
Incorporating is really only
useful for higher and additional-rate taxpayers, as the changes to tax relief are only likely to affect them. It might also be relevant to basic rate taxpayers who, when the new rules come in, will have combined rental and other income over the £40,000 threshold for higher-rate tax.
It is also important to consider what the profits from buy-to-let will be used for. For example whether the money is
needed now as income or is to be used later as a pension.
Removing profits from a company as a dividend will get more expensive in April 2016 for most people as dividend tax rates change. Basic-rate taxpayers will have to pay 7.5% tax, higher-rate taxpayers will pay 32.5% and additional taxpayers will pay 38.1%. This represents an increase for all three bands. There will be £5,000 dividend tax relief, but any amount above that will be
taxed at these rates.
Therefore, incorporating is a better option if you’re planning to “roll up” your income, and leave it to accrue without withdrawing it, for example to use as a pension later.
However, when you do come to distribute the money “rolled-up”, you will face a double tax hit. Your
profits will have been taxed within the company, at 20%, and then when you take the money out you will have to pay tax at either your dividend rate or as capital gains tax, depending on how you extract the money.
It's important for investors to be aware of this if they are thinking of putting their buy-to-let portfolio into a company. If it's only a short-term plan you have got to remember that
those two levels of tax are payable. If it is long term or you are looking to grow, then a company could make more sense.
If you have a buy-to-let property and are thinking of incorporating please get in touch for an initial, no obligation chat.
Noel
Guilford
Noel Guilford is the principal of Guilford Accounting a small business accountancy practice specialising in advising owner-managed businesses on current accounting, finance, and tax matters. You can reach him via email at noel@guilfordaccounting.co.uk or by phone at 01244 660866. He is the author of the best selling book 'Figure it out - an entrepreneurs guide to understanding your business numbers' which you can obtain by visiting http://guilfordaccounting.co.uk/figureit out.