Lee Sharpe considers what the personal tax freeze and the Corporation Tax hike mean, for people who are considering incorporating their residential property businesses (or not).
Introduction
The Chancellor delivered his latest Budget on 3 March 2021. He framed the Speech in terms of being “unpopular but honest”, in that he made it quite clear that many taxpayers were going to be caught on an individual basis by “fiscal drag” as personal incomes (hopefully) rise over the years to 2025/26 due to wage inflation, etc., while the main tax bands remain frozen at 2021/22 levels.
This article will consider one of the key features of the Budget, being the (re)introduction of a higher main rate of Corporation Tax of 25%, for profits deemed to arise from 1 April 2023. This has been somewhat tempered by the (re)introduction of a “Small Profits Rate” that will retain the current rate of 19% for the first £50,000 of taxable profits where it is primarily a trading or property business company (otherwise, it will be 25% at any level of profits). How will this change affect landlords who are already suffering the imposition of an effective surtax on their residential mortgage interest costs?
Note also:
- There will be a higher Marginal Rate (26.5%) for chargeable profits between £50,000 and £250,000, to “catch up” so that the company will have effectively paid 25% tax on all profits up to £250,000
- The £50,000 and £250,000 thresholds will be split amongst groups, and
- “Associated company” rules will be re-introduced to prevent avoidance by fragmenting a business amongst several companies
- The rules may not be exactly the same as the previous regime
- Taxation of personal dividend income has not been changed back to the old regime, despite its having become much more expensive since 6 April 2017, supposedly to help to offset the cost to the government of reducing Corporation Tax rates
Should I run my residential lettings business through a company?
The Chancellor has frozen bands and committed not to raise the rates of Income Tax, etc., in this parliament, so we might predict with reasonable accuracy / certainty what will be the impact on landlords in running their residential lettings business through a company, compared to running them personally. We have taken a rental business whose residential mortgage costs are 50% of its net profit after interest costs, etc., (e.g., its economic profit is £10,000, and £5,000 interest was paid to get to £10,000 net income; its economic profit is £40,000, and £20,000 interest was paid to get to that £40,000 of net income, etc.) We have charted below the net personal income after Income Tax on those rental profits run through an unincorporated business, versus the net personal income when the same business is run through a company, pays a salary of £9,000, and the remainder after Corporation Tax is distributed as dividends to the owner.
The dashed line shows the 2022/23 results, reflecting the current regime but 100% “Basic Rate restriction” of any dwelling-related loan costs subject to Income Tax and before the new higher Corporation Tax rates apply from 1 April 2023. The solid line is for 2023/24, i.e., after the higher rates of Corporation Tax have started to apply. The dotted line shows what the comparison would be in 2016/17, after the more punitive regime for dividend income had started, but before any restriction to residential letting finance costs had started – a kind of “baseline”. We assume no other income or allowances; the table further below sets out the figures in more detail.
Results and Conclusion
2016/17 serves to remind us why there was little appetite for incorporating residential property portfolios – at least from an Income Tax perspective – before the restriction for residential letting finance costs commenced in April 2017. (While the calculations do include finance costs for the sake of consistency, they make no difference to the outcome). The effective cost of incorporation broadly hovers around “reasonably tolerable” until profits rise beyond £100,000, whereupon they soon take a turn for the worse (the ‘kink’ around £120,000 reflects that the high cost of losing one’s tax-free Personal Allowance takes effect more ‘slowly’ in a company).
2022/23 broadly reverses the trend, once the post-tax profits paid out by the company are sufficient to put the owner/director into Higher Rates of tax, but only because the effective tax cost of running relatively substantial mortgages personally makes companies comparably much more attractive. Where mortgage interest, etc., is relatively low, the chart would more closely resemble 2016/17 – incorporation could result in a net annual tax cost.
2023/24 soon splits from 2022/23 once pre-salary profits exceed £60,000, and net taxable profits after the £9,000 salary hit the point at which the higher rates of Corporation Tax start to apply from April 2023, so the company then has a smaller post-tax pool from which to pay dividends to the owner/director.
Nevertheless, the effective tax cost of the finance costs restriction is so punitive in the example scenario, that running the residential portfolio is still beneficial in terms of annual profits taxation, even though Corporation Tax has risen significantly. Even so, the net benefit will diminish (and could become a cost) if the mortgage costs are lower.
While this broad review may provide a measure of reassurance to some residential property landlords with relatively highly-geared portfolios, it should not be taken to mean that incorporation is always better. In particular, the high thresholds for incorporating (and disincorporating) a property-rich business still need to be considered, and tailored advice is highly recommended.
