Lee Sharpe considers the merits of running one’s portfolio through a limited company as tax rates seemingly march ever upwards.
Readers will be aware that landlords have long mulled the possible benefits of running their rental businesses through a limited company. Over the last several years, this has more than likely been prompted by the government’s wholly artificial restriction of income tax relief for the finance costs of letting residential property, as gradually introduced for non-corporates from 6 April 2017 onwards.
More recent developments include:
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increased corporation tax rates from 19% to 25% since 1 April 2023, largely where taxable profits exceed an initial £50,000 per annum (with a particularly painful marginal rate of 26.5% where taxable profits fall between £50,000 per annum and £250,000 per annum);
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increased rates of dividend taxation (aside from the initial zero rate, all rates increased by 1.25% from 6 April 2022); and
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higher interest rates on borrowing – at the time of writing, standard variable rates up to 75% loan to value can be between 8% and 10%.
We shall look at how these developments have affected post-tax income yields for individual landlords when compared to their incorporated counterparts.
Comparisons
The following chart shows three comparisons:
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How the net-of-tax income to an individual residential buy to let (BTL) landlord, in business on their own account, compares to the 100% director shareholder of their own property letting company, for various levels of rental profit in 2015/16 (i.e., before the new restriction on tax relief for residential letting finance costs was introduced); the director shareholder takes a modest salary and the balance of any post-corporation tax profits as dividends in that year.
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A similar comparison in the current tax year 2023/24, now that corporation tax rates and dividend taxation have been significantly increased, with no residential letting finance costs.
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A similar comparison for 2023/24; but this time, the BTL portfolio’s interest costs equate to 50% of the accounting profit before tax adjustments; so, for example, where the rental accounts profits are £50,000, this is after £25,000 mortgage interest has been deducted in the accounts (but it will be disallowed for tax purposes).
This is a substantial level of interest, but not impossible; take as a very simple example a property portfolio worth £1m, with 60% gearing and paying 5% annual interest, but with a gross yield of 9%.
Gross rents would be £90,000, and (assuming all other expenses are nil) net profit per the accounts would be £60,000 after £30,000 of mortgage interest for the year.
The model assumes that it will cost an extra £1,000 a year to run the portfolio through a limited company, in terms of extra time and professional fees, that the interest rates will be the same in either vehicle and that the individual has no other income sources (the tax hurdles to incorporation are ignored here, and the employment allowance is also assumed to be unavailable).
Results and conclusion
As veteran landlords and their advisers might expect, there was little annual income tax incentive for singleton property landlords to incorporate their business in the good old days before landlord taxation was overhauled. And property finance costs made no particular difference to the outcome. Since then, the increase in headline corporation tax and ‘reforms’ of dividend taxation have made incorporation even less attractive – particularly at higher rates of profits and dividend taxation, where the relatively tame ordinary rate of 8.75% has been overtaken. In this model, where rental profits are as high as £300,000 a year, the additional cost of running a debt-free portfolio in a company surpasses £25,000 a year.
Interest rates have now become strongly influential, as indicated in the difference in outcomes between Comparison 2 and Comparison 3 (and once the unincorporated landlord risks at least 40% income tax). Now, in cases where a sizeable portfolio suffers from relatively high finance costs that will trigger punitive tax restrictions for the unincorporated landlord, the company model may still offer a comparatively safe haven – a ‘less bad option’. For non-corporates, higher interest rates only exacerbate the difference between economic reality and tax-adjusted fiction, as taxable income ignores rising interest costs. Of course, a portfolio may well pay off its debts in time, and the government is determined that interest rates should not stay so high for too long (strictly, the focus is on inflation, but interest rates will typically fall as inflation becomes more ‘manageable’).
As the risks of punitive interest costs will hopefully subside in the longer term then, absent appropriate planning to make best use of the company wrapper, the incorporated portfolio may seem less of a haven, and more like a prison.
