Meg Saksida considers when the best time might be to form a company and whether to keep the business unincorporated.
Owning property personally can be risky. There is potentially higher rate income tax to be paid on profits from an owner-managed property rental business of up to 45%, and with the limit on the additional band of income tax falling by nearly £25,000 from April 2023, entering into that bracket is more likely than ever before.
Furthermore, mortgage interest can no longer be deducted at higher and additional rates either, and with the increased legal and regulatory requirements surrounding being a landlord, such as issuing gas certificates, energy performance certificates, and keeping tenants’ bonds registered, there is an ever-present chance of litigation.
Is it time to obtain a lower corporation tax rate, offset the mortgage interest and benefit from the veil of incorporation? Maybe – incorporation is not a simple issue and there are a lot of points that should be carefully considered.
Limited on landlord’s liability
First and foremost, with the litigious environment in which we now live, protection of the landlord’s personal assets is a huge benefit of incorporation. If a tenant were to sue a landlord for a breach of duties in association with the rental, notwithstanding the fact that the landlord may be insured, there is a risk of the landlord’s personal wealth being impacted. In a limited company, the shareholders are only liable to the extent of the unpaid share capital. This would mean that in the face of litigation, the veil of incorporation would come down, limiting the landlord’s liability.
Although limited liability is a great benefit, there are costs associated with it. These include the practical costs of forming the company in the first place but also ongoing costs, such as accountants and legal fees for the increased administrative burden of the corporate wrapper.
As well as these ongoing costs, there are exceptional or one-off additional costs, which, although they may not be regular, would still be likely to cause a large financial impact. For example, stamp duty land tax (SDLT) (or equivalent in Scotland or Wales) would be calculated at an additional 3% supplement on the market value of a property for a company purchasing a property rather than an individual purchaser. This will impact the company on incorporation and also if further property purchases are planned. If charged on incorporation, this will be a ‘dry’ tax charge as no cash will be received.
Apart from the financial cost, there are many more additional administrative burdens of running a limited company compared with a sole trader business. Information on the owners of the company and the company address is made public by Companies House and these details must be kept up to date. Financial statements must be filed every year and these have to be drawn up in a standard, particular way, and again (depending on the size of the company) the information contained in these is also made public.
Finally, the company will need at least one director who will need to fulfil the obligations of the Companies Acts with respect to minutes of meetings, resolutions and other administrative duties.
Tax implications
One of the most common reasons incorporation is considered is the significantly lower tax rate a company is (up until recently) charged to corporation tax over an individual charged to income tax. However, this is changing. From April 2023, the main rate of corporation tax will increase from 19% to 25%. However, landlords would need a large portfolio of rental properties to be subject to this higher 25% rate. The 19% rate will still apply if profits are £50,000 or less, so most landlords owning only a handful of properties should still benefit from the 19% rate. At 19%, even a basic rate taxpayer will pay 1% less under corporation tax than the income tax basic rate of 20%. Furthermore, a company does not get an income tax personal allowance, so all profits in the company are charged from the first £1 earned.
This 19% (or 25%) rate is also applicable for gains made in a company and, as such, is also preferable when compared to the 28% a personal taxpayer would incur on gains for capital gains tax (CGT) purposes (if the rental property sold was residential). Even for a commercial let, corporation tax is 1% lower than the higher CGT rate for individuals at 20%. A cost of incurring gains inside a company, however, is the loss of the annual exempt amount (AEA). This ‘cost’ is reducing with the AEA, as although it is currently £12,300, from April 2023 it will reduce to £6,000 and from April 2024 to £3,000. This will significantly reduce any AEA advantage that an individual disponer has over a corporate one.
There may also be a significant CGT charge arising on incorporation of both the rental properties and any other chargeable assets inside the business that are being put into the company. Incorporation relief is unlikely to be available for a small landlord.
Retention of profits
Another issue to consider when deciding on the type of business structure is what the landlord wishes to do with the profits that are being generated from the lettings. If the income is required by the landlord, it may be better for them to remain an unincorporated entity.
This is because inside a company, although profits can grow taxed at a lower rate of 19% (assuming profits of £50,000 or under) unless the profits are retained and stockpiled inside the company or used to grow the corporate letting business, the profits will need to be extracted out of the company and into the hands of the shareholder to be spent by them.
Usually, the cheapest way to achieve this is through dividend payments. For a basic rate taxpayer earning dividends above the £1,000 (from April 2023) dividend allowance, this will increase the cost of the overall tax on the profits to 27.75% (i.e., 19% plus 8.75% ordinary rate on dividends). A higher rate taxpayer will pay 52.75% (i.e., 19% plus 33.75% upper rate on dividends); both percentages are well in excess of the profits being taxed on the individual landlord through income tax.
Succession planning
As shares can easily be split, owning the rental business through a company gives a far easier method to allocate ownership between families or pass it down to the next generation. Lower tax bands and unused personal allowances can be exploited by spreading ownership in life.
In addition, planning for succession and leaving the business to the next generation becomes easier when company shares can be seamlessly left to several different legatees.
Practical tip
Incorporation seems to stack up for higher rate or additional rate landlords that do not need to distribute the profits generated by the let property business and can retain and grow them in a company. If they also either have skills in accounting, tax or regulatory areas and will not, therefore, need to spend a great deal on legal and accounting fees and they value the tranquillity of limited liability, incorporation could work for them. Landlords such as those who are nearing retirement age could also benefit from easier succession methods.
The decision is, however, a very situational one decided on a case-by-case basis and dependent on so many factors, including (but not limited to) the inherent gains in the assets at incorporation and the structure of the financing.
