Incorporation – What Is It and Should I?

As an association, we are often asked to find a speaker to talk about 'Incorporation' and whether it is a good thing or not. Over the years we have had various speakers selling their specific solution but never managed to get a good discussion on the subject, until this month, when PDPLA member Richard Hemingway shared his experience of the process.

Unfortunately, we were unable to film at this meeting and several members have asked if any notes are available so, hopefully, this article will help…. 

What's The Problem?

 The short answer is TAX! If you hold your properties in a company the tax burden can be much less than if you have all the properties in your own name (classed as a sole trader from a tax perspective)

Some of the specifics of the tax differences are:

• -S24: A sole trader pays tax on gross income even if a large proportion of that is mortgage interest, a company can count this interest as an expense to be deducted before tax due is calculated.
• -Capital Gains: A sole trader has to pay a tax of 28% on any rise in value of the property when he or she sells it, with a company there are options to defer the tax due far into the future
• -SDLT: Both sole traders and companies need to pay stamp duty, and one of the issues is that if you simply create a new company and then transfer your properties into it, you effectively create a new owner and thus fall due for stamp duty.
• -Inheritance Tax: Death and taxes – not too much you can do about either but a company structure gives many options to pass wealth on to future generations in a tax efficient manner. By comparison, a sole trader with a reasonably large portfolio will leave an estate upon which an Inheritance Tax charged at 40% currently, which means often the deceased heirs will have to sell half the portfolio (more depending on leveraging) just to pay the taxes
• -Legacy Planning: This goes hand in hand with inheritance tax. As a sole trader you can gift properties (or parts of properties) to others but when you do, you fall liable for Capital Gains Tax, you may also owe SDLT and once gifted, you have no say or control of that property anymore. A company structure gives many more options – you can pay dividends to a family member unable to manage their own finances for example or split and divide ownership and income however best suits your own situation.

So Why Doesn't Everyone Incorporate?

Again, the short answer s TAX!

If you move your properties from ownership in your own name to company ownership, this is seen legally (and from a tax perspective) as a sale / purchase transaction and as a result:

• -You as the selling owner will be deemed to have made a capital gain (equivalent to the difference in value of the property between the purchase price and its value now – less allowable expenses and the like), this could be substantial for established landlords.
• -Also, the 'sale' will be liable for stamp duty (SDLT)
• -And mortgages taken out in your own name against properties you own will need to be replaced with corporate mortgages taken out by your company – corporate mortgages tend to have a higher interest rate than personal ones and given the current bank rate, a new mortgage is likely to be more expensive than a pre-existing mortgage.

Incorporation Without Pain?

There are companies (typically employing barristers with a tax speciality) who purport to be able to move you from 'sole trader' to 'incorporated' without some or all of these costs.

As an Association we have to be clear that any scheme which legally reduces the taxes you need to pay is something we are keen to support – but the UK tax code is so complex, there is a constant game of tax specialists looking for 'loopholes' (interpretations of the rules that when applied, reduce the amount of tax an individual needs to pay) and HMRC / the Government making new rules to close perceived loopholes. As a result, what may be acceptable this year can be outlawed next and oddly, once outlawed HMRC appear able to apply retrospectively in many cases.

A number of the companies specialising in Incorporation assure customers that their liability insurance protects customers from any future HMRC clawback of previously non-taxed monies but the risk ultimately sits with the individual and any changes need to be carefully considered against the mess which is the UK tax system and the cavalier way in which it is constantly changed and updated. 

Richard's Example

Richard and his wife are both in full time employment and have built up their sizable property portfolio locally over the past 18 years. Some properties are in joint names, others just in Richards or his wife's name and yet more already in a company structure.

Apart from concerns about 'whether it is worth it anymore' with the ever increasing individual tax burden and ever tightening regulations, the sole trader model meant that it was almost impossible to react to changes tax effectively – for example if one of them decided to stop working, or to plan for the long term future in a way that would allow children to inherit without having to sell half of the portfolio to pay inheritance taxes and the like.

In their case, they chose an organisation which purported to be able to move all of their property into a company structure that met all of their needs. Ownership would be split between different share types with different values – so for example (not Richards specific example):

• -At setup, most of the company's value is held in A & B class shares, so if a couple have one class each, the company can decide which class to pay dividends to allowing the partners to ensure that monies taken out are done so tax efficiently
• -Other classes start with zero value (so can be gifted or transferred with capital gains liability) which can be shared around the family and dividends to them can, for example, reflect the amount of work that individual contributes to the company
• -And one final class of share was setup in trust and any capital growth from the day of incorporation would be held by that final class and thus reduce future capital gains because of its trust status (but obviously, with the high cost of establishing and maintaining a trust, only this specific aspect of the whole company is included for maximum benefit

In Richard's case, incorporation cost him in the region of £40,000 but has been accomplished in a way which allows him to retain his existing mortgages and thus not incur SDLT or CGT. Going forward he will benefit from full tax deductability of mortgage and finance costs, arrangement fees and other expenses.

An unanticipated benefit is that what has already been invested in the business effectively becomes a directors loan account (the amount the director loaned to the company) and can be repaid to the director tax free as and when funds are available within the company – so in Richard's case he was able to take the value of his original investment back from the company spread over a period of years without incurring any tax liability - click the graphic below to link to Richard's presentation from our May member meeting.

Should Everyone Incorporate?

Sadly, not everyone can and in some cases, it does not make sense to do so.

Firstly, you need to be able to prove that you are operating a business and not just trying to reduce the tax on an investment vehicle. If you can show that you spend at least 20 hours per week working for the business you should pass that hurdle and it does not matter whether you self-manage or use an agent, if you are able to show you are investing the time managing contractors and agents or working yourself.

Secondly, you need to be more than 1 person – if you are not a partnership, then it is not an option.

The final 'biggie' is whether your portfolio is big enough – if you are only paying a few thousand in tax per year and are looking to save a few hundred pounds each year,the payback and overhead of company accounting and audit will be prohibitive.

Where To Start?

There are a number of tax advisors offering support in this space – most start with a consultation that costs several hundred pounds at the end of which, you will have a good idea of the cost to you of proceeding and the potential benefits if you do so.

As a landlord Association we do not wish to promote one advisor ahead of another, but we can put you in touch with members who have gone this route and they can share details of who advised them and how it went.Do note, that if you are introduced to an advisor in this way, the member introducing you will get an 'introduction payment' of around £200 if you decide to proceed and incorporate.In the grand scheme of things, this is a trivial sum and not a consideration – but in the interests of transparency we need to be clear that the PDPLA gains nothing from these introductions but the member may do so.

If you decide to investigate this further, do let us know as the more we can help and guide each other, the more effective we are collectively as an Association.