Property incorporations have become a widely used form of tax planning since the phased restriction of mortgage interest relief began in 2017. These schemes typically involve transferring personally held residential investment properties into a company structure to take advantage of more favourable tax treatment, particularly around mortgage interest deductions.
While the planning can, on paper, rely on legitimate statutory reliefs, many of these schemes have been promoted by unregulated or unqualified providers who gloss over complex requirements and significant risks.
This article outlines the key pressure points and legal pitfalls associated with such incorporations, especially those involving partnerships or Limited Liability Partnership’s (LLPs) as intermediary steps and highlights the growing scrutiny from HMRC.
Marketing Concerns
The proposed planning appears to rely on statutory reliefs explicitly provided for in the legislation. However, like all reliefs, there are stringent conditions that need to be met. These conditions are often glossed over in the marketing of this planning by many providers, who are usually unqualified, and more concerned about their own profits than professional and ethical tax planning. Several ‘pressure points’ are not properly flagged, if at all, to customers considering this planning, and this article highlights what to look out for.
Partnership Requirements for SDLT Relief
There is a statutory relief from Stamp Duty Land Tax (SDLT) for transfers of property from a partnership to a company when the company is controlled by the members of the partnership (who also need to be connected with each other – such as parents and spouses). However, this relief specifically requires a transfer from a partnership.
The legal definition of a partnership is critical in this context. Two individuals jointly holding investment property does not inherently constitute a partnership for tax purposes as it simply represents a joint-investment. Some degree of activity is needed to transform a joint investment into a partnership, as a partnership in law must be a business operated in common (by two or more people) with a view to profit. If the property was owned by only one individual, the partnership route is not available at all.
The LLP Solution and Its Risks
Providers typically present a straightforward solution to this challenge. The first step, they advise, is to convert the existing ownership structure of the portfolio to an LLP (an LLP is specifically considered a partnership for the SDLT relief). Provided the capital profit-sharing ratios of the partners match the transferors’ ownership ratio, there is no capital gains tax. If currently only one individual owns the property, a spouse or child can be introduced as a co-member of the LLP. Introducing an adult child to establish the partnership will trigger a capital gains tax charge. However, some providers suggest allocating only a fractional interest in the property to the child in an attempt to minimise the liability. This approach is aggressive and is likely to be challenged by HMRC due to it lacking genuine commercial substance.
There is accepted relief for SDLT on transfers to a partnership, and it does not matter if the transferors are merely holding an investment property jointly. In this context, the LLP acts as a middleman in the process. It is also accepted that the transfer to an LLP, in and of itself, carries low tax risk if executed properly, and may offer commercial advantages such as limited liability. The tax risks arise at the subsequent incorporation stage.
Incorporation Relief and Capital Gains Tax
The next stage is transferring the property to the company. This will, in the absence of a relief, crystallise both capital gains tax (CGT) and SDLT. Turning to CGT first, there is relief on incorporation of a business (‘incorporation relief’). The providers advise that provided the property is ‘actively managed’ and not left in the hands of a letting agent, incorporation relief is available. The providers will be vague on the amount of activity required, and unless it is clearly substantial (more than 20 hours per week in HMRC’s eyes), a challenge from HMRC is inevitable.
For landlords engaged in full-time employment elsewhere, a legitimate question arises regarding their capacity to actively manage a property portfolio. Occasional responsive maintenance activities, such as addressing sporadic tenant inquiries regarding property repairs, would be deemed insufficient to establish the requisite level of active business management for tax relief purposes. Full diaries and timesheets should be prepared and retained to support the landlords in the inevitable HMRC challenge. In addition, the way the calculation works, if the liabilities of the business exceed the cost of the properties (for example if equity has been released) a CGT liability remains.
SDLT Anti-Avoidance Measures
As mentioned above, there is statutory SDLT relief on the transfer from a partnership to a company controlled by the transferors. But, the providers will also gloss over an important piece of anti-avoidance legislation (known as ‘s75A’) that states that if ‘steps’ are incorporated into any ‘single arrangement’ that reduce SDLT, those steps will be ignored. There does not need to be any tax avoidance motive. The insertion of an LLP is a clear step, and unless the taxpayer can show the transfer to the LLP and the subsequent transfer to the company was not one ‘arrangement’ (a very difficult challenge) and show that both steps are completely unconnected, there will be an unexpected SDLT liability.
Mortgage Implications
The providers will also gloss over the non-tax implications if the property is mortgaged. Some go as far as to suggest that the lender need not be told about the transfer, using ‘deeds of trust’ to prevent any changes in ownership being shown at the land registry. This may be contrary to the conditions of the mortgage and could have substantial implications for the borrower.
Additional Aggressive Planning
Some providers go even further. They suggest a loan can be created between the property business and the owner (i.e., the owner lends to the property business), and then on incorporation, this becomes a director’s loan account, to be drawn down tax-free. They achieve this through circular movement of money. HMRC will invariably argue that any loan incurred for tax avoidance purposes is not covered by their general concession allowing the transfer of a business loan from the individual to a company on incorporation to be tax-free.
Summary of Key Risks
So, in summary, the ‘pressure points’ with the planning are as follows:
Liquidation Planning: A Warning
Whilst on the subject of LLPs and based on the principles set out above, it is worth mentioning a very aggressive form of planning. The steps here are:
HMRC’s Position on Liquidation Planning
The way this planning is purported to work is that, once the LLP is placed into liquidation, it is treated as having forfeited its status as a transparent entity and is retrospectively regarded as having always been opaque. It follows that at step a, the LLP is considered to have purchased the properties at market value (without a retrospective tax charge). When the LLP transfers the properties to a limited company, as the uplift in value between stage a and b is minimal, there is, according to this argument, little or no capital gain.
Specific legislation has been introduced to prevent this planning, effective from 30 October 2024, but HMRC, in their anti-avoidance ‘Spotlight’, maintains that the arrangement was ineffective from the outset. Firstly, s75A (explained above) prevents any stamp duty land tax relief, as the existence of the LLP and the associated step is simply ignored for SDLT purposes. Secondly, regarding the capital gains tax avoidance, HMRC will presumably argue (although they don’t explicitly state) that the transaction is wholly artificial and caught by the general anti-abuse rule – as no one in real-life circumstances would transfer property to an LLP and shortly afterward liquidate it.
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