In Winter 2019 we released an article entitled “Should you incorporate your property letting business?”.
The broad message of the article was that, even though the interest relief income tax restrictions (whereby tax relief on finance costs in relation to a residential property letting business would be limited to a maximum of 20% of those costs, even for higher or additional rate taxpayers) had originally been announced in 2016, that because those rules were gradually phased in between 2017 and 2020, it was only then that the new regime was truly starting to “bite”. As a result, a number of landlords had been and would be thinking about re-reviewing their positions.
The article went on to explain that one particular point in favour of incorporation (aside from potentially full tax relief for financing costs) was that corporation tax rates were (and are currently) far lower than income tax rates. This meant that, to the extent the post-tax rental profit did not need to be fully withdrawn from the company by its shareholders, there was likely to be a substantial year-on-year tax saving from switching over to a limited company. We referred to this as a “tax shield”.
Whilst that argument remains relevant, the announcement in the Chancellor’s March 2021 Budget that the main rate of Corporation Tax will increase to 25% on 1 April 2023 (now less than 2 years away), from its current rate of 19%, substantially eats into that saving.
Furthermore, although the first £50,000 of profits will effectively be taxed at the current rate of 19% even beyond 1 April 2023 (because of the re-introduction of a smaller profits rate), there is then a marginal rate band between £50,000 and £250,000 of profits where the effective tax rate will be 26.5%. This is to grow the average tax rate to 25% once profits hit £250,000, with that 25% rate applying in full above that level.
While the tax saving of incorporating could still be substantial, often these situations have involved weighing up that annual saving against the potential one-off costs of making the switch, particularly SDLT which in our experience can only rarely be fully mitigated on property business incorporations (and also CGT if the conditions for relief are not met). The calculation normally gives a predicted “payback period” - in other words how long will it take to recoup the upfront cost in potential future savings. That period will in many cases now be far beyond 2023.
Another impact the increased rate has on the whole incorporation debate is that one downside of transferring a property business to a company (particularly since indexation relief was frozen for companies in December 2017) is the risk of “double taxation” - when one or more properties in the portfolio are sold.
By this we mean paying two layers of tax on future gains arising on the property - both corporation tax in the company and personal tax (typically income tax) to extract the funds from the company and have them available to spend. The overall tax rate from those two layers will, of course, often be higher after April 2023.
Although the increased rate will inevitably put some landlords off of incorporating, for many there will still be large tax savings to be realised, particularly where there are high borrowing costs on a wholly or predominantly residential portfolio and/or where the landlord doesn’t need to draw a high proportion of the rental profit for their own use.
Larger property businesses are generally better candidates as well, as they can justify the extra costs involved in running the business through a company and can often make the switch without incurring an immediate CGT liability.
If you would like to discuss your specific circumstances and get advice on the relative merits of incorporating your letting business, please get in touch.
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