Lee Sharpe warns that putting a property portfolio into a company can be a bad idea for some, with the Spring Statement 2022 heralding leaner years ahead.
Going back beyond the last few years, most landlords found little tax-based incentive to incorporate their property business; unless profits were very substantial, there was no or negligible tax saving to be made. That is not to say that there were not other good reasons for landlords to seriously consider incorporation. It’s just that, unlike traders, your average annual property income tax bill would likely not be one of them.
Of course, this changed for many landlords when, in 2015, the Chancellor announced his plan to slowly squeeze out business tax relief for mortgage interest on personal residential property lettings, from 2017/18 to 2020/21 and onwards. While the government was keen at the time to point out that landlords could still get 20% basic rate tax relief on their residential finance costs, the fact that the first step in the tortuous process is to add back interest to your rental income has some quite far-reaching consequences; from student loan repayments, to capital gains tax rates, to potentially losing your income tax personal allowance – all thanks to pretend profits you never actually earned.
This will be familiar ground for many readers, so I shall not dwell on the intricacies, save to say that the idea of running a corporate property portfolio became a lot more attractive from 2017, but really only as a safe haven from the punitive costs of staying within income tax, if you had substantial mortgage interest to pay on residential lettings.
Spring Statement, etc.
The Chancellor’s Spring Statement included one or two proposals that will be relevant to the question of incorporation for many landlords:
-
Aligning (increasing) NICs starting thresholds with the personal allowance, so there will be only one threshold for when an individual starts to lose income tax and National Insurance contributions (NICs), be it the primary earnings threshold for employees or the lower profits limit for the self-employed.
The transition in 2022/23 is messy; the Chancellor clearly did not plan for this much more than about five minutes before he stood up to deliver the Statement. But it will be a quite useful simplification for the future – up to a point; there is no sign that the Chancellor intends for the employer’s secondary NICs threshold also to be increased, and most people have, I think, inferred that it will continue to rise at a slower rate. This is relevant when considering what is the optimal salary to pay if you are both employee and employer – such as if running your own company.
-
Reduction of the standard basic rate of income tax from 20% to 19% from April 2024. This may seem a long way off, but the decision to incorporate is a reasonably permanent commitment, so it should be a factor even if considering incorporation right now.
Just as with NICs, there is a more obscure point, which is that I think the dividend ordinary (basic) rate of income tax will not be falling, alongside. The Spring Statement document says that it will apply to ‘non-dividend income’ (but not in Scotland, whose devolved taxation powers apply instead to such sources).
At this point, it is also appropriate to mention recent changes which pre-date the Spring Statement proper but are also going to be relevant to the question of incorporation in the years to come:
-
The Health and Social Care Levy will effectively introduce a 1.25% increase to employees’ and employers’ NICs – and to dividend income tax (which is probably why the cut in income tax rates has not extended to dividends: it would seem a bit pointless to hike it by 1.25% one year, and then drop it for most taxpayers by 1% the next).
-
The main rate of corporation tax will rise from 1 April 2023, from 19% to 25%, for profits above £50,000 (it will stay at 19% for profits up to £50,000 for most companies). That is a more than 30% increase in the rate of taxation on company profits; it is only a few years since a previous Chancellor was proposing to reduce the main rate of corporation tax to less than 15%!
Overall effect on incorporating a property business
This is something of a movable feast; the comparison depends heavily on the extent to which a property business is exposed to tax-penalised residential mortgage interest.
In the following table, the underlying model assumes that such finance costs are running at 30% of the net accounts profit, e.g., £20,000 profit after £6,000 of interest; £50,000 profit after £15,000 of interest. Simply put, the business is losing almost a quarter of its income to disallowable interest, and the landlord needs as much of the profits after tax as they can extract.
Results
In 2015/16, the results were largely flat until very high profits taxable at the additional rate (where dividends proved a little cheaper than straight rental profits at 45%).
By 2021/22, the interest relief restriction was in full swing. Depending on the level of exposure to mortgage interest, running the business through a company could offer significant relative savings.
By 2024/25, the changes (1) – (4) listed below have significantly narrowed the margins and made the results quite variable due to their complex interaction. It is still potentially more tax-efficient in a company, but again, the level of interest cost is fundamental to the calculations.
Clearly, the increase in corporation tax rates makes running the business through a company much more expensive – once profits exceed £50,000.
The NICs alignment with the personal allowance means that a company can now pay quite a bit more tax-deductible salary, without significant NICs cost. This lessens the cost of incorporation at lower profit levels, but becomes increasingly over-matched by the 1.25% increase in dividend taxation, as post-tax rental profits (and therefore dividend income) start to rise.
But this becomes increasingly over-matched by the 1.25% increase in dividend taxation, as post-tax rental profits (and therefore dividend income) start to rise.
For portfolios owned personally, the 1% reduction in basic rate income tax is a double-edged sword: it helps to reduce the tax cost when profits are low, but once profits start to rise and the interest restriction and basic rate ‘credit’ start to apply, the net saving reduces and eventually turns to a net cost. This is because the residual basic rate ‘credit’ for mortgage interest will also no longer be 20% but 19% from April 2024 (although I doubt the government has realised it, based on past experience!). Once the individual starts to pay income tax at 40% or 45%, this new rate of 19% will be less helpful. But this adjustment also scales with interest, rather than directly with profits.
Conclusion
We are apparently entering a period of significantly higher inflation and, quite possibly, higher interest rates. This may, in turn, make incorporation more attractive for residential landlords – at least while interest remains a significant cost to their business. But without such costs, incorporation is looking less attractive from an annual income taxation perspective for the various reasons set out above.
Including the 2015/16 results reminds us just how much more tax these policy changes are costing, within roughly a decade. Yet again, directors or shareholders are paying for pandemic assistance they largely did not receive.
