Property Update | Summer 2018

Property Update Summer 2018

In this Issue

Property Incorporation Tax Implications Should you incorporate your property portfolio?

London Property Investment Market

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The Let Property Campaign

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Changes to Property Taxation

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Ever since the government announced plans in 2015 to restrict the tax relief on buy-to-let mortgage interest for individual investors, the hot tax topic for those affected has been whether to transfer properties into a limited company.

The main issues that arise for those considering incorporating are: • Capital Gains Tax (CGT) – a transfer to a company would normally be a deemed disposal for tax (at current market value), something that often triggers significant CGT liabilities.

• Stamp Duty Land Tax (SDLT) – the acquisition by the company would normally trigger SDLT calculated at market value.

• Refinancing – the need to replace existing borrowings, which are at advantageous interest rates and can no longer be replicated in today’s lending market.

In order to incorporate without creating a CGT liability, we need to apply the provisions of section 162 of the Taxation of Chargeable Gains 1992 – referred to as “incorporation relief”. One of the main conditions for incorporation relief to apply to a transfer is that the property portfolio in question must constitute a “business” in its own right.

Unfortunately, what is or is not a business – as opposed to a simple investment – is often not clear cut. There are a wide range of factors to consider, but in the main, these concern the level of activity undertaken by the “business owners”. Passive investment is unlikely to be a business, whereas active management likely is. Of course, in the real world the line between these is often blurred. This is why we need to examine different factors to see if property incorporation is the best option.

Scale is a factor – a portfolio made up of dozens of buy-to-let properties is likely to require a high degree of active input and thus is probably a business. A portfolio of one or two – probably not. But when the potential

What is or is not a business – as opposed to a simple investment – is often not clear cut. downside risk of huge CGT liabilities is at stake, few people are happy to rely on “probabilities” from their advisers.

The solution therefore was always to apply to HMRC for a clearance under their nonstatutory clearance procedure. Under that procedure, you could write to HMRC setting out why you believed a particular portfolio met the threshold to qualify as a “business” and HMRC would typically write back with its view, often agreeing.

In recent months however, there has been a dramatic shift in policy and HMRC has taken to refusing to deal with non-statutory clearances in this area.

Their justification is always the same – that the non-statutory clearance process is designed to deal with areas of uncertainty in tax legislation and the question of whether there is a business doesn’t constitute an uncertainty! Personally, I can’t think of anything more ambiguous and in need of clarification, but try as we might – we can’t move them from this position.

This new policy – rightly or wrongly – has put a massive obstacle in the way of those buy-tolet investors that for whatever reason delayed thinking about incorporation.

Anyone in that position now seems to be faced with an impossible choice. Either swallow the huge increases they face under the new interest regime or take a chance that HMRC will not disagree that the portfolio is a business and drag them through a long, difficult, stressful, expensive and potentially disastrous tax enquiry.

By Barry Soraff Partner and Property Specialist 020 3146 1603 barry.soraff@raffiingers.co.uk

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London Property Investment Market

Maximising the Effect of Business Property Relief

Research conducted by Kent Reliance portrays a very rosy picture for landlords. The research forecasts that a typical landlord in Britain will see an estimated net profit of over £265,500 per property over the next 25 years, through rental income and capital gains. Returns vary significantly across regions, with profits in London estimated to reach over £307,000, almost £12,500 per annum.

Business Property Relief (BPR) is a very valuable tax relief as it takes the value of the business property outside the scope of the Inheritance Tax (IHT) net – but consider how the relief can be maximised by implementing some basic planning.

The Good Capital gains comprise a significant portion of these returns. However, the report points out that landlords need not exclusively rely on them. According to the report, even if a landlord did not sell their property and therefore did not make a capital gain, income alone would not only cover outgoings, it would provide a profit of over £65,500 over the period, over £2,500 per annum.

The Bad According to BA Marketplace, making a profit from London property investment is difficult due to “prices in the capital falling and profits diminishing”. In the latest house price figures released by Halifax, London was one of only two areas in the UK to see house prices fall in March compared to the same month the previous year. They warn that investors need to have a plan and could “look outside the capital to where property prices are significantly cheaper”.

The Ugly RICS measures confidence in the property market by balancing surveyors seeing price rises against those seeing price falls. It said the figures were the lowest since 2013. The downshift is deepest in London and the south-east of England, but prices were still rising in parts of the Midlands and North. They also note that the predictions that rents would rise following the introduction of greater taxation on buy-to-lets have yet to materialise, with tenant demand weak in many parts of the country.

With the market turbulent, the best advice I can give is to ensure that you have a plan in place, as well as appropriate funding in line with your rental income, ensuring that you do not put too much pressure on your cash flow, and act fast to changes in the industry, be those legislative, market or interest rate changes.

By Andrew Coney, Partner

Example 1 Alan died in August 2013 leaving the following estate: Home (jointly held with spouse) £325,000 Unquoted shares in family £600,000 trading company Quoted shared and cash

£900,000

Total

£1,825,000

On Alan’s death his half share in the house passes to his surviving spouse (Maureen) who was well provided for as sole beneficiary of his self-employed pension plan and had personal savings herself of £250,000.

Alan’s Will left £325,000 cash to his two children and the residue of his estate to his spouse Maureen.

For IHT purposes, the cash gifts to the children are covered by his IHT Nil Rate Band of £325,000 and the balance of his estate passes to Maureen exempt from IHT due to the spousal exemption - there is no IHT payable on Alan’s death.

The question of BPR on the unquoted trading company shares did not arise.

unquoted trading company shares – qualifying for 100% BPR, and the residue of his estate passed to Maureen, there would be as before no IHT payable on Alan’s death – but now his IHT Nil Rate band has not been utilised and is available for Maureen on her death.

In February 2014, a few months after Alan’s death, Maureen bought the unquoted trading company shares from her children at their full value of £600,000 thus providing the children with more cash than they had originally expected to receive from their father’s estate.

On Maureen’s death in April 2016, assuming again the value of her assets had remained unchanged, she would leave the following estate.

Example 2

Home

Maureen died in April 2016 leaving her whole estate divided equally between the two children. Assuming that the value of her assets remained unchanged from August 2013, she would leave the following estate:

Unquoted shares in family £600,000 trading company

Home

£325,000

Unquoted shares in family £600,000 trading company Quoted shared and cash

£825,000

Total

£1,750,000

If all qualifying conditions were met and the unquoted trading company shares qualified for BPR, her estate would attract an IHT charge of £330,000 after accounting for her own nil rate band (*the new main residence nil rate band has been ignored for illustration purposes here).

Better Planning To achieve a better outcome, the assets in Alan’s estate could be distributed in a different way – either by an amendment to his will during lifetime or via a Deed of Variation post death.

If the children, instead of sharing £325,000 from their father’s estate, shared equally in his

£325,000

Quoted shared and cash

£550,000

Total

£1,475,000

Maureen’s estate would benefit not only from her own £325,000 nil rate band but also from the transferable nil rate band which had been left unused by Alan. Assuming the qualifying conditions for the unquoted shares were met such that, they qualify for 100% BPR, her estate would attract an IHT charge of £90,000 – a saving of £240,000 to the original example above.

Conclusion If there are Business Property Relief qualifying assets within an estate, consideration should be given to leaving these to other beneficiaries rather than the surviving spouse as the spouse exemption is not needed to use against such assets.

By Paul Dell Partner 020 3146 1606 paul.dell@raffingers.co.uk

andrew.coney@raffingers.co.uk

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The Let Property Campaign Applies to you if you are: • renting out a single property • renting out multiple properties • a specialist landlord, e.g. student or workforce rentals • renting out a room in your main home for more than the Rent a Room Scheme threshold • living abroad and renting out a property in the UK • living in the UK and renting a property abroad • renting out a holiday home even if you use it yourself

Contact: Neill Staff, Partner neill.staff@raffingers.co.uk | 020 3146 1605

The Let Property Campaign Raffingers’ tax team are extremely experienced in dealing with tax issues involving making disclosures to HMRC using The Let Property Campaign, as our Tax Partner, Neill Staff explains.

I think that by now, everyone knows that HMRC has details of all property transactions dating back many years, and if you’ve been receiving rental income and haven’t declared it, then it is simply a matter of time before you receive a letter from HMRC. Of course, there are many reasons why rental income doesn’t get reported, and one of the more common reasons I hear is that people don’t think they are making a profit. A typical example is that the mortgage payments and expenses are higher than the rent received, so people assume there is no profit. Unfortunately, tax doesn’t work that way and you only get tax relief for the mortgage interest, not the capital repayment.

I have also found that people are sometimes not aware that, regardless of whether they

make a profit or not, rental income needs to be declared to HMRC and the person should have registered for self-assessment and declared the profit (or loss) on their tax return.

My advice to anyone who thinks they may have under-declared or not declared their rental income is to consider using the Let Property Campaign. It gives people an opportunity to bring their tax affairs up-to-date, and to get the best possible terms to pay the tax they owe.

The procedure is very simple in that you register for the scheme, and you then have 90 days to calculate and pay what you owe. In certain circumstances I have seen HMRC give time to pay.

Who can do this?

You can report previously undisclosed taxes on rental income to HMRC under the Let Property Campaign if you’re an individual landlord renting out residential property.

Unlike many historic HMRC campaigns, the

Let Property Campaign has not got a date by which HMRC will close it, so it is available for the foreseeable future. It is also worth noting that the campaign is not just about putting an individual’s tax affairs right relating to the rental income. There does have to be rental income to take part in the Let Property Campaign, but the campaign should also declare any other undisclosed income. So, if someone who is self-employed has also not declared all of their income from self-employment, they should use the Let Property Campaign to disclose and correct all of their tax affairs.

The Let Property Campaign really is something that people should be considering. HMRC also obtain information regarding housing benefit, or from letting agents and local authorities (HMRC have the legal power to force local authorities or letting agents to provide this information) and HMRC will write to the individual to whom the rent is paid and invite them to take part in the campaign.

Worldwide Disclosure Facility The Worldwide Disclosure Facility is suitable for dealing with undisclosed foreign rental income.

Recently we dealt with a client who has a holiday home in the Algarve which is rented for most of the year. The property is in something of a state of disrepair but our client makes a few thousand pounds a year after deducting expenses. Apparently, this has been happening for about nine years and the client never realised that tax was payable on any profit made because, in their mind, the property isn’t in the UK. HMRC recognise that there are many people who are not completely up-to-date or accurate with their tax affairs, which is where the Let

Property Campaign and Worldwide Disclosure Facility come in.

We explained everything to our client. All they needed to do was provide a schedule of the rental income received and a list of all the property rental expenses paid each year. We would then sit down together and see what costs were allowable for tax, and consider if there are any other costs, such as the annual flights to and from the property. There is no managing agent and the client does all the repairs and upkeep himself.

We the We the

had the review meeting and calculated rental profit, which isn’t particularly high. have also attributed some of our fee to preparation of the rental accounts which

reduced the profits even further. Our client’s daily income isn’t particularly high so income will only be taxed at 20%, and his final settlement, including interest and penalties, will be a few thousand pounds. We’ve registered for the Worldwide Disclosure Facility, and we’ve registered for Self-Assessment because the property is still rented.

If you are one of those people who has some undeclared income and wants to get straight with HMRC then it really doesn’t have to be as scary as you think it might be. We are always happy to have a chat with anyone who finds themselves in this position, and if we can help, we will explain what it would cost you in terms of fees and how long the process will take.

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Changes to Property Taxation Means you Could be Making ‘45%’ less than 10 Years Ago Truly the worst thing about advising property clients is that every so often, you meet a new client and they start to tell you about their plans and the work they are doing, only for you to discover that because they are speaking to an adviser too late in the day, they have missed an opportunity – often to save a great deal of money.

Because of this I always tell clients to keep us informed of everything they are doing.

Sometimes that will mean telling us things that we can add little or no value to, but in those circumstances where we can add value, it is worthwhile. Even the most experienced of property clients need advice if, for no other reason than to keep up with the huge number of changes that have emerged in recent years in property taxation.

I was thinking about this recently and I was wondering about the real scale and impact of all those tax changes and, for reasons I can’t explain, I thought it might be interesting to take a much closer look. And when I did, I was truly staggered at the outcome.

To demonstrate the point, I took a simple example. Mr X is employed and earns £100,000 as an IT consultant. He has inherited some money and built up some small savings, which aren’t earning much, and has decided to buy a small buy-to-let investment to make his savings work a bit harder. He currently lives with his wife and children in their modest semidetached home.

He has found a small house to buy and agrees a price of £250,000, against which he gets a buy-to-let mortgage of £160,000 at a fixed rate, interest only mortgage of 4% (say, £6,400 each year).

He rents the house for 10 years at a rental of £15,000 per annum and incurs other costs such as repairs, insurance and management fees of £5,000 each of those years. At the end of 10

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Even the most experienced of property clients need advice if, for no other reason than to keep up with the huge number of changes. years he sells the property for £350,000.

Using the tax rates of 2005 for these transactions, Mr X would have paid the following taxes: • Stamp duty on purchase = £2,500 • Income tax on rental £1,440 x 10 years = £14,400 • Capital gains tax on disposal = £20,600 • Total return over 10 years net of tax = £98,500 If we take a look at exactly the same circumstances today, he would be taxed as follows: • Stamp duty on purchase = £10,000 • Income tax on rental = £4,720 x 10 years = £47,200 (a net loss after tax!)

• Capital gains tax on disposal = £24,836 • Total return over 10 years net of tax = £53,964 In other words, due to changes in the overall tax burden, the same gross return has generated 45% less after tax! It’s a staggering difference and goes a long way to explaining why the small buy-to-let investor is being pushed out of the market.

The good news, however, is that with good planning and a clear investment strategy, it is possible to mitigate the worst of this – which I guess leads me back to where I started. The importance of getting timely as much as good advice.

By Barry Soraff Partner and Property Specialist 020 3146 1603 barry.soraff@raffiingers.co.uk

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