Introduction
There has been some commentary on social media over the last week around whether a particular variant of property incorporation is ‘the worst tax avoidance scheme of all time?”
So, is it?
Now, I think I could win this argument quickly. I would simply point to NT Advisers Working Wheels scheme.
But that would be the easy option.
Over the course of this article, I’d like to consider the analysis and whether it is, in my opinion, fair.
As a preliminary note, I have no allegiance to either of the providers discussed in the commentary. I won’t name them or the person conducting the analysis (though you probably know already!)
However, I have advised landlords over the course of my career and have advised on many incorporations of property businesses.
So, what’s the chatter about?
What is an incorporation?
In a nutshell, incorporation is the transfer of the assets of an unincorporated business (sole trader or partnership) to a company.
Here, we are talking about the transfer to, usually, a new company in exchange for shares.
At the basic level, if one transfers the assets of the business to a company then:
(1) it is a disposal at market value for CGT purposes; and
(2) there is a market value consideration for SDLT purposes
The first is often ameliorated by incorporation relief and the latter, often more problematic, might be eased where there is a transfer from partnership
So, first of all, let’s look at incorporation relief.
Incorporation relief – CGT
The first point, unlike most reliefs, incorporation relief does not require a trade, but merely a business.
It is worth stating that case law is clear that, where the activity of property investment constitutes a business, then incorporation relief is available. It is also worth stating that case law shows this is not necessarily a high hurdle to clamber over.
The effect of incorporation relief is that the properties can be transferred without an immediate CGT charge.
However, the historic gain does not magically disappear into the ether, instead, the historic gain is deducted from the base cost of the company shares.
So, effectively, CGT becomes payable if and when the shares are disposed of.
One major trip hazard which I don’t think was referenced is where the gains on the portfolio exceed the equity (for example in a long held, but highly geared portfolio). To the extent the gain exceeds the equity, then an immediate CGT charge will arise.
Partnerships and SDLT
When it comes to whether a partnership exists or not, then this will be determined on the specific facts of the case.
This is a point discussed in the analysis.
In the absence of any partnership agreement to the contrary, I would suggest that there is a likely presumption that a married couple that jointly hold property are not in partnership.
So, I guess I agree with the commentator here.
On the other hand, I would suggest that those who are not married and hold let property together then there is perhaps a presumption of a partnership. Of course, this is better where the position is supported by a partnership agreement.
But why do we care about whether there is a partnership?
Well, in another glorious example of our labyrinthine tax system, transfers into and out of partnerships are treated more benignly for SDLT purposes.
Generally, where a sole trader transfers property to his or her own company, then there will be chargeable consideration for SDLT purposes equal to market value. The relevant % being applied to this.
However, where transferring from a partnership owned 50/50 by two landlords to a company owned the same manner, it is unlikely that there will be any chargeable consideration, if there is no change in income sharing rights.
So, where there is a partnership, and interests will remain the same post-transfer then there should not be any SDLT.
I would be concerned if the following plan is being marketed (and I make it deliberately extreme):
- Wake up on a Mon as a sole trader;
- Form a partnership on Weds; and
- Operate through a Limited Company in time to go down the pub on the Friday
This would be very much in the wheelhouse of DOTAS / GAAR and potentially s75A for SDLT purposes.
That said, I don’t think there is any suggestion that this is happening in the cases discussed.
One of the follow up articles I have seen suggests that, in the absence of a partnership, then SDLT is likely to be paid at a rate of up to 15% plus 2% if non-resident.
There is a general charge of 15% for companies acquiring higher value interests in residential property. However, in the context of landlords, this is unlikely as commercially let (and not to a connected person) properties obtain relief from this charge (as they do with ATED).
Rather oddly, where there are more than 6 properties being transferred, the properties are transmogrified into non-residential property and the lower rates of SDLT apply anyway,
Alternatively, one might also benefit from multiple dwellings relief.
Is this a tax avoidance scheme?
First of all, is what I have set out above, a tax avoidance scheme?
Let’s break it down.
I think (hope) it is in uncontroversial to say that incorporating a business, even if it saves you some tax, is not tax avoidance.
I don’t think this has anything to do with limited liability as proffered in the article. There is simply no “tax advantage” as defined in the legislation here. The legal, economic and real-world effects are all singing from the same hymn sheet.
It seems that HMRC agrees with this as can be seen from Part B of the GAAR Guidance where it indicates that the choice of business structure is outside the scope of GAAR (though it is accepted that GAAR is aimed at abusive planning).
The question is whether the bells and whistles added by the providers turn this into something worse.
The bells and whistles
There appears to be a bell and a whistle bolted onto the basic incorporation planning as follows:
- The insertion of a bare trust such that legal title of the properties remains with transferor; and
- The shareholders of the company choose to give away shares which have a right to future growth in the business
It looks like the relevant adviser has given them names – Substantial Incorporation Company (SIC) and Smart Company.
Let me look at SIC first.
Firstly, there is nothing particularly novel here. This structure has been around, I would wager, for a decade or so.
The idea here is that, because the properties are mortgaged, they cannot be refinanced (or the new terms would not be attractive) so the legal title is left in the name of the individual and the beneficial title is transferred (essentially the economic benefits of ownership)
As such, we are left with a bare trust or nominee arrangement. The transferor holds legal title as trustee for the company (the beneficiary).
The analysis raises points about whether this invalidates the mortgage. This must depend on the particular terms of the mortgage on a case-by-case basis. I would happily defer to an expert on this – it’s simply not my bag.
However, there are comments on the tax position that I am sure are not correct.
Incorporation relief requires one to transfer all of the assets of the business as a going concern. It is possible to leave the cash outside. Liabilities, if they are transferred, do not count as consideration so do not spoil the analysis. However, as confirmed by HMRC in their Manuals, there is no need to transfer the liabilities to satisfy this requirement either.
One of the arguments is, if I understand it properly, that, by leaving the legal ownership behind, the transfer of the assets is not being made in full. Something of ‘value’ is left behind.
But I do not think this can be correct.
TCGA1992, s60(1) – assuming the agreement meets the terms of the provision properly – acts to treat whatever is owned by the bare trustee under these circumstances as being vested in the bare beneficiary.
So, in this case, the property is treated as vested in the Company.
As this is for all purposes of TCGA then it must also apply for securing incorporation relief.
As I have said above, there is no requirement for the liabilities of the business to be transferred either for the transfer to be complete,
Does the addition of the bare trust make this a tax avoidance scheme?
In my view, no.
Let’s consider why the bare trust being bolted on.
Surely it is to facilitate an incorporation that could not otherwise take place, or could not take place on acceptable terms, without the bare trust?
This, in my view, does not contribute to the tax advantage as far as I can see. Any tax saving comes from the incorporation.
As such, there is no requirement to look at the various hallmarks.
So, we’ve dealt with the bells… what about the whistles?
The Smart Company aka freezer / growth shares
We now have to deal with something called a Smart Company.
As far as I can see, the Smart Company looks to be of pretty average intelligence. By that, I mean it is pretty run of the mill as far as tax planning goes.
It is simply a company which has issued some growth shares. Like so many trading companies and family investment companies over the years.
All of the private client teams of large law and accountancy firms will be packaging these up as FICs and selling them to their clients.
Of course, it is correct to say that the gift of these shares will have both CGT and IHT implications.
However, whether this is a practical issue will wholly depend on valuation of the shares.
This will depend on the rights attached to shares. But typically they participate in future growth only (no voting rights etc) and, further, this is only where growth exceeds a hurdle.
It is certainly conceivable they have a relatively low value to the assets of the company.
A gift of the shares by, say, the parents, will be a potentially exempt transfer. It will be a disposal for CGT purposes. This will be important as the shares will have a low base cost – remember my point above about the historic gain attaching itself to the base cost of the shares.
If they are transferred to trust, then there will be an immediate IHT charge of 20% to the extent that the value of the shares exceeds the nil rate band (£325k).
It might be possible to get holdover relief for CGT purposes on transfer to a trust – thought this will depend on it not being settlor interested (and not resident overseas).
Does the Smart Company make this tax avoidance?
If, in itself, an investment company which issues growth shares is tax avoidance, there are many large law firms and accountancy firms with a problem.
That said, I can see how a very complex and artificial set of articles could create some issues.
Again, I see no suggestion that is the case here.
Considered together, is it all tax avoidance?
Again, I don’t think so.
If I were to try and disclose an incorporation, followed by an issue of growth shares I cannot see how HMRC would be prepared to give me a Scheme Reference Number.
I do not think that, notwithstanding the legal advice around mortgages, that this would be different where some or all of the properties were subject to a deed of bare trust. Any tax advantage, if there is one, does not come from the bare trust.
Conclusion
As stated above, it will surely be a case-by-case basis as to whether the incorporation causes mortgage issues, problems for tenants and insurance. This is not my area of expertise, in any event.
As such, anyone contemplating such a move should get advice from a property lawyer.
The CGT position will depend whether there is a business for the purposes of TCGA 1992, s162 and, importantly, whether the gain exceeds the equity in the portfolio (as I say, a point sometimes missed).
SDLT will depend firstly on whether there is a partnership and, if not, whether there are 6 or more properties being transferred or whether multiple dwellings relief is available.
A quick shift through the gears where a taxpayer moves from sole trader to corporate entity via a partnership in short time would be problematic.
Is this the worst tax avoidance scheme of all time?
No.
Is it a tax avoidance scheme at all?
No.
If you have any queries about this article, landlord or property tax, then please get in touch.