Lee Sharpe warns that landlords should not rush into incorporating their businesses without weighing up the ‘pros’ and ‘cons’.
It seems you cannot have a discussion involving landlords these days, without somebody mentioning incorporation. I have to admit to being partly responsible for this, with a fair few articles, etc., over the last couple of years. But incorporation is a complex issue and there are several factors to consider. Not all of them distil down to ‘simple mathematics’, or tax. A run-down of the main points you should consider is set out below.
Limited liability vs public accountability
A key protection for limited companies is that their owners’ (shareholders’) liabilities are limited to the wealth of the company, as reflected in the shares they hold.
If (say) a tenant successfully sued a non-corporate landlord for serious failings then, insurance aside, the landlord’s personal wealth would be at stake. If the same case were taken against a corporate landlord, however, then only the company’s wealth would be at risk and the shareholders’ personal wealth would basically be protected. This limited liability is particularly relevant where there is a substantial property development activity, since construction can be a hazardous occupation, both financially and otherwise.
However, there are rules to follow in exchange for that limited liability. A non-corporate business is generally required to disclose very little information about itself to the general public (although there are details on the Land Registry when it comes to property ownership). But the ‘quid pro quo’ for limited liability protection is that:
- details of a company’s owners (shareholders) and its officers (such as directors) must be publicly available through Companies House, and be updated as and when appropriate;
- the company must file its annual financial statements (in a standard format) with Companies House for public record (having said that, the amount of information that must be publicly disclosed for ‘small’ companies is quite modest – names, but not dates of birth or necessarily personal addresses; balance sheets but not profit statements); and
- the company directors are obliged to observe the requirements of the Companies Acts. This basically means more administration and more paperwork, minutes of formal meetings, etc. But sometimes it is more demanding. For example, if a company is in financial difficulties, then simply put, the directors are supposed to look after the company for the benefit of its creditors, not its owners – something which directors of even very large companies appear to ‘overlook’, if recent press reports are to be taken at face value.
It’s not yours anymore
Having been used to running one’s own business perhaps for decades, it is sometimes difficult to get to grips with the fact that, although you may own the company because you hold all of the shares, the properties, equipment, cash in the bank, etc., actually now belong to the company itself, as a legally separate entity.
This is particularly relevant for people who have grown used to running their personal expenses etc., through their business bank account – it is quite common, but if it is not managed carefully, problems can arise.
All that glitters…
It is easy to think that because corporation tax rates are so low (just 19% and set to fall to 17% by 2020/21) then large savings will be made. Individuals pay income tax at rates as high as 45%, and capital gains tax at up to 28%, so yes, companies can be much more efficient.
However, those post-tax profits still belong to the company, and shareholders and directors will generally have to pay income tax in order to get the money out of the company and into their own personal bank accounts, in the form of salary and/or dividends. This is often referred to as the ‘double tax charge’. Historically, the second phase of the double tax charge – the income tax part – has been relatively cheap. But this is changing and the tax savings are much ‘thinner’ than they used to be for many family companies, particularly since landlords were not historically obliged to pay self-employed National Insurance contributions as non-corporates, so the potential cut in overall tax cost on incorporation was not so great.
…is gold?
Having said that, there is no denying that there are a large number of buy-to-let (BTL) landlords who are facing very substantial tax hikes thanks to the new rules restricting income tax relief for finance costs such as mortgage interest, etc. Companies are not affected by these rule changes and may offer a relatively ‘safe haven’ for highly-geared landlords whose tax costs are set to rise by many thousands of pounds a year.
From that perspective, a company may offer a significant tax saving…effectively by not increasing the tax cost by anywhere near as much as not incorporating might. Having said that, the tax cost of incorporating a business in the first place can be a very significant hurdle in its own right.
Mortgage lending
It has traditionally been common knowledge that the market offered little choice for corporate BTL landlords. However, this is changing, thanks partly to increased interest by BTL corporates and also, as I understand things, because of the lending rules for larger property portfolios and personal borrowings introduced by the Prudential Regulation Authority.
Pensions
One has to have ‘relevant earnings’ in order to make pension contributions of more than £3,600 a year, and BTL income does not count as earnings for pension purposes. But wages or salary from a company does count as earnings, even if it’s your own rental company. For some landlords, this is a significant benefit.
Sharing around
One of the key benefits of corporate ownership is that it is much more straightforward to transfer ownership of shares in a property company than it is to move small shares in direct personal ownership of all the individual properties.
As and when landlords want to move wealth to other (perhaps younger) family members, moving a small number of shares regularly over the years can be achieved much more readily than the direct bricks and mortar equivalent. Family members can also benefit from the use of pensions planning, as above (although the company must be able to justify such payments in terms of benefit to the business, if it wants corporation tax relief).
Other tax issues
The new cash basis will apply by default to self-assessing landlord businesses with an annual turnover of £150,000 or less (although you can opt out). But it will not apply to companies, which must follow corporate accounting rules.
The corporate route does carry some potential extra burdens, however, such as:
- Annual tax on enveloped dwellings – basically an annual fee for owning residential property through a company. It applies only to dwellings exceeding £500,000 value and does not catch property investment or developing businesses, but an annual claim for relief is required.
- Higher rate of stamp duty land tax – again, for dwellings costing more than £500,000, the rate reaches 15%.
Practical Tip:
There are numerous issues to consider when weighing up incorporation, and it is important not to rush into a fundamental change to one’s business – tailored professional advice is essential, as it can be time-consuming and very expensive to unpick an incorporation after the fact.
Aside from the unwelcome pressure from the restriction of tax relief for residential letting finance costs, incorporation does suit those who plan to move small proportions of (i.e. shares in) their property portfolio to other family members, including the next generation slowly, over time. Once the owners can afford not to take all of the money out for personal use – so avoiding the ‘double tax charge’ – companies can really start to shine.
