As a landlord of residential property the rules limit tax relief for interest and other finance costs you incur for your rental business. Is there a legitimate way to get around this?
Company v personal ownership
In 2017 the rules were changed to limit the tax relief landlords get for finance costs they incur in connection with letting residential property. However, the rules don’t apply to properties let by companies. As a result, corporate ownership of buy-to-lets is now more popular but it’s not necessarily the most tax-efficient option.
Tax rates
While the corporation tax (CT) rate, currently between 19% and 25%, is around half the higher (40%) and additional (45%) income tax rates, there are usually other tax charges when you take the income out of your company. These can mean that letting a company-owned property isn’t tax efficient.
Example 1. Daniel is a higher rate taxpayer. He owns a rental business and a company, Acom Ltd. His income from Acom alone takes him into the higher rate tax bracket. This means Daniel pays £400 in tax for every £1,000 of profit from his rental business, leaving him with £600. By comparison, if Acom owned the property it would pay as little as £190 tax. The trouble is when Daniel takes the remaining £810 as a dividend he’ll pay 33.75% tax on it. That leaves only £537, making him £63 worse off. However, if Daniel was a basic rate taxpayer the picture is different.
Example 2. If the profit from the rental business was accumulated in Acom until Daniel retired, when he expects to be a basic rate taxpayer, he can extract the income as dividends at a lower tax cost. At the current tax rates he would be taxed at 8.75% if his taxable income is within the basic rate band. On £1,000 of dividends the total tax for him and his company would be £261, leaving Daniel £739 (£1,000 less 19% CT = £810, less 8.75% income tax = £739).
Trap. If Daniel owned the property personally he could transfer it to his company to take advantage of the tax-saving plan shown in Example 2. However, this potentially comes with other tax costs such as stamp duty land tax and capital gains tax. These might nullify some or all of the tax savings.
Rental income shifting
An alternative is for Daniel to keep personal ownership but assign his right to the rental income to a company in which he owns the shares. The bad news is that this type of arrangement is caught by anti-avoidance rules. They say that where the transferor retains ownership of the property, directly or indirectly, they remain taxable on any income derived from it. So, neither transferring the property nor the income from it is likely to achieve a tax-efficient outcome.
Tip. An alternative way to shift at least some profit (and thus the tax bill) to a company is for it to manage the property for you in return for a fee. This fee is tax deductible for you. As a higher rate taxpayer you therefore save 40% tax on the income on which the company pays 19%. The arrangement must be genuine and on commercial terms. A fee of 15% on gross rents is typical. You can accumulate the shifted profit in the company and so save tax as illustrated in Example 2.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.