Assigning Rents To A Company – Could It Work?

Malcolm Gunn looks at a possible strategy for rental property business owners. 

Can rents be assigned to a specially formed company so as to lower the overall tax charge by taking them out of the higher rate tax charge on the property owner? Various opposing opinions have been put forward on this idea, and my suggestion is that the plan can be made to work, although there are some complications.

If the properties are transferred outright to a company, this would be a disposal of them for capital gains tax (CGT) purposes, and in most circumstances HMRC would not regard it as the incorporation of a business so that there is no CGT holdover. In addition, stamp duty land tax (SDLT), and also in Scotland Land and Buildings Transaction Tax (LBTT), arises on the value of the properties. So that effectively rules out that arrangement for most practical purposes.

What you may consider doing is arranging for the rents to belong to a company whilst the property owner retains the ownership of the title. To do this the company must be given a lease by the owner of at least a length equal to the period of any shorthold letting which will be granted in respect of the property. After all, a company cannot give a greater interest in the property to a tenant than that which it holds itself. The lease to the company will not be a shorthold as they can only be granted to individuals. 

It is not necessary to charge any significant amount of rent under this tenancy agreement, since there is no rule in the tax provisions for property businesses that market rent must be charged. However, for SDLT purposes this will be a letting to a connected company and market value of the lease will be assessed for the purposes of that tax. But if the letting is for the duration of an onward short hold tenancy to a third party, then generally no liability would arise. 

The plan will be to renew the letting to the company periodically, and the renewal of the lease could be a linked transaction enabling the SDLT position to be revisited. However, HMRC state that if the first lease expires naturally and contains no right or compulsion by either party to renew and then was renewed entirely following new negotiations as would apply to a new tenant, then the leases are not linked.

The income tax legislation contains provisions relating to the transfers of income streams. Essentially, when one person transfers to another person the right to taxable receipts without transferring the asset from which the right arises, the legislation will charge income tax on the transferor. However, for this purpose it is stated that the grant of a lease is regarded as a transfer of the property, so that means this charge will not apply here.

We have also legislation relating to gifts of assets where the donor retains a right to participate in the income given away. That income is then taxed on the donor. This is referred to in the tax legislation as the settlement provisions, but as we all know the legislation is much wider than that. Although (contrary to HMRC manuals) there is no bona fide commercial exemption, the legislation does not apply to transactions where there is no gift element. Although there may be a gift element if one just looks at the letting to the company, taking into account the whole arrangement, so long as the property owner keeps entitlement to all the shares in the company, it is just the commercial structuring of the property business with no gift conferred overall. See also Chamberlain v CIR HL 1943, 25 TC, where it was held that the structure of a company cannot form part of a settlement; and Mills v CIR HL 1974, 49 TC 367, where it was not the income of a service company, for which she worked for a low salary, which was taxed on Miss Mills, but the dividends paid by the company to a trust for her benefit.

If there is a mortgage on the property, the rent charged to the company will need to cover at least the interest so as to give relief to the property owner. Of course, once the restrictions on tax relief start to bite in years to come, this area may become more problematic.

The final point is that that company will be a close company, and it must not therefore provide free benefits to its participators, or if it does, tax charges will arise on those benefits. So the shareholder must be particularly careful that the company does not pay for anything which is in the nature of an improvement of the property. This point might give some difficult issues to resolve if there is a replacement of a bathroom on a like-for-like basis, although the new being more elaborate and thus enhancing the value of the property. 

To summarise, I believe the plan can work, although there will be some pitfalls to avoid and of course it should be remembered that if the profits are drawn out of the company at some stage then pretty much all of the tax benefits will unravel.