An article which appeared in the Daily Telegraph recently has certainly been making some waves in the tax world. It concerned what was described as ‘a controversial tax manoeuvre’ under which a property portfolio that was subject to mortgages could be transferred to a limited company without having to re-arrange all of the mortgage finance.
The reason for wanting to put your property portfolio into a limited company was simple: limited companies are not subject to the restriction on loan interest relief, which will start being phased in from 6 April 2017.
A lot of buy-to-let landlords who hold their property portfolio in individual names, but might not be able to convince their mortgage lenders that they should re-lend to a limited company, are obviously very interested in any way of achieving this tax benefit without the refinancing problem.
As the Telegraph article puts it, the ‘beneficial interest company trust’ claims to allow borrowers to move their properties into a company while retaining the legal title – removing the need to re-mortgage. Borrowers transfer solely the beneficial interest into the company, and keep the mortgage in their own names.
Financing and tax questions
The first question is whether this could be regarded as any kind of ‘mortgage fraud’. The legal firm who are promoting the arrangements think not. They are quoted as saying ‘we are suggesting that this arrangement does not affect the lender’s security because you’re not changing the legal interest. If the lender needed to enforce the loan, it would overreach any trust status, and the lender would still have to come after the individual’.
We don’t claim to be legal experts, but this certainly seems right. How an arrangement could be described as ‘fraud’ when you’re not actually damaging anyone’s interests in any way is difficult to recognise on the face of it.
More concerning to some readers will be the quoted comments of a representative from a well-known firm of accountants.
We have to say straight away that the author of this article has great respect for the firm of accountants, who generally seem very ‘switched on’ on tax matters. As the representative has been reported, though, what he says doesn’t seem to make sense.
He is quoted as saying that ‘the test is to do with why you’re incorporating’. Is there a commercial rationale, or is it a tax reason? He then goes on to refer, although the Telegraph article doesn’t make this explicit, to the ‘transfer of income streams’ legislation in the Income Tax Act 2007.
Transfer of income streams
To paraphrase this legislation, where the right to an income stream is transferred to another person without the asset from which that income derives being transferred as well, HMRC can charge tax on the consideration for the transfer of the income stream.
So, if A transfers an income stream valued at £1 million (based on future expected receipts) to B Limited for £1 million, the danger is that this ‘manoeuvre’, which is aimed to bring about the result that the income is taxed at the 20% corporation tax rate, could instead trigger an income tax charge in the year of transfer on the whole £1 million. A disastrous result, if true.
In the author’s view, though, anyone suggesting that the transfer of the beneficial interest in a property is within these anti-avoidance rules is talking rubbish. Historically, the legislation is aimed at complex tax avoidance schemes, sometimes involving partnerships and the right to income derived from the membership of a partnership. It certainly doesn’t seem to have been aimed at the position where you separate out the legal and beneficial ownership.
An example of the difference between legal and beneficial ownership is the situation where a share portfolio is held on your behalf at your bank. The actual shares, on the company share register, will be registered in the name of X bank nominees limited. However, the dividends received from the shares are paid straight to the ‘real’ owner, as are any proceeds on sale of the shares. The ‘real’ owner has the absolute right to decide what happens to the shares, whether they are sold or transferred to someone else. All of the attributes of ownership belong to the beneficial owner, except for the name stated on the ownership register.
The same applies to a bare trust of a property portfolio, held by one person on behalf of another.
Specifically, in this context, it is quite feasible for a property portfolio to be registered at the land registry in the name of Mr A, but for him to be holding that purely as nominee, or bare trustee (the terms are interchangeable for these purposes) for A Limited. It is A Limited which ‘really’ owns the properties, and which declares any income for tax purposes, or any capital gain on sale.
The key to the operation of these rather obscure new anti-avoidance rules is that the right to income from ownership of a property derives from the beneficial interest in that property, not from the legal interest. Like with the shares held at your bank, the dividends belong to the real, that is beneficial, owner, not to the legal owner, and are taxed directly on them.
So there is no separation, in the author’s view, between the income and the asset from which it is derived. The company owns both the asset (the beneficial interest) and the right to income.
The real issues
The accountancy firm’s spokesman is far nearer the mark, in the author’s view, on what is presented as a secondary objection, which is the problem of incurring stamp duty land tax (SDLT) (in England and Wales) when the beneficial interest is transferred to the limited company. Where a ‘partnership’ transfers a property portfolio it owns to a limited company that is connected, the SDLT rules provide that in many cases there is effectively no charge to SDLT.
Again, the accountant may have been misquoted here, but the problem may not be the one which the newspaper article states. This says that HMRC can withdraw this stamp duty ‘relief’ if it believes that the partnership has been established for the purposes of avoiding the stamp duty charge. What HMRC could more reasonably argue, in some cases, is that, as a matter of fact, there is no ‘partnership’ at all. Whether joint ownership of a property portfolio comprises a ‘partnership’ is a difficult question to determine, and this is where HMRC could validly mount an attack.
However, consideration could be given to introducing the portfolio first of all into a limited liability partnership (LLP). This is because an LLP is specifically deemed by the tax legislation to be a partnership.
Another issue, which the article doesn’t emphasise, is the capital gains tax charge (CGT). If your property portfolio is worth more than it cost, on the face of it any transfer to a company that you own would be treated as if it were a sale for the full market value of the portfolio, triggering a capital gain.
There is a relief from this CGT charge where you are incorporating a ‘business’, and the company issues shares in return for the business assets (TCGA 1992, s 162). However, you’re here again within the realms of the difficult interpretation of a fairly woolly English word: the word ‘business’. If the holding of a property portfolio for rent is not regarded as a ‘business’, this capital gains tax relief will not apply, and the full tax charge will crystallise.
- It is possible to transfer the beneficial or ‘real’ ownership of a property portfolio without changing the registered, or legal owner.
- You should consider whether your case for avoiding SDLT is watertight on the transfer of a portfolio, including by ensuring that the current arrangements are definitely a ‘partnership’ – perhaps by moving the portfolio initially into an LLP with a view, some time in the future, to possibly incorporating it into a limited company.
- If there is a substantial inherent capital gain in your portfolio, do bear in mind the risk of incurring capital gains tax (perhaps with no cash to pay it) on the transfer to the company. This could be more painful, in some people’s circumstances, than simply bearing the effects of the mortgage interest disallowance.
- As to whether it is permissible legally (without committing ‘fraud’) to transfer the beneficial interest, but not the legal interest to a company; take legal advice on this.
- Consider other ways of mitigating the tax effects of the new mortgage interest disallowance for buy-to-let property portfolios: could you make a charge from a company to reduce the profits? Could you make staged disposals of properties to reduce the borrowing? Or could you have the same effect by leaving the property portfolio in an LLP, perhaps, but introducing a company member?
This article was first printed in Property Tax Insider in January 2017.