As April is tax month, we are joined this week by Alan Kennedy, an expert in taxation with many years of experience assisting high net worth clients.
Alan talks us through the difference between Buy to Let for individuals and for companies and what to consider when planning for this. He discusses the balancing act between personal tax rates and interest element tax rates and what to think about when deciding if you are going to invest as an individual or a company.
We also discuss what are the potential Capital Gains Tax implications of an individual investment versus a company portfolio. And what actually constitutes a valid company portfolio from a tax perspective and the challenges around incorporation as a process.
Even if you already own a property at an individual level, this interview will give you some guidance on how to maximise your tax deductions and set up your tax process as efficiently and effectively as possible.
As always, we love to hear your thoughts. If you would like to work with other Experts like Alan, we invite you to join our platform and connect with us at email@example.com or on our social media channels.
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Interviewer - Farnaz Fazaipour | Property Investment & Ownership
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farnaz Fazaipour 0:11
Hello, and welcome to the London Property Podcast. I'm your host Farnaz Fazaipour and today we're in conversation with Alan Kennedy again back on our show, who is an expert in taxation. He started his career with the HMRC and has now moved on to advise high net worth individuals, either before they buy their properties, or those who own property in the UK, to make the most of their taxes. Welcome back, Alan.
Alan Kennedy 0:42
Hi Farnaz! Good to be back.
farnaz Fazaipour 0:45
So, you know, with it being tax season, we thought it'd be quite topical to have some basic conversations with you, for our listeners on what they need to know, both on a personal level and on a company level. And let's, let's talk about buy to let. So shall we start with with with those who own properties in a personal level? And what they need to be aware of when they're preparing for their taxes? What's deductible, what's not deductible, and just making sure that they're prepared? You know, if not now for this year, but certainly preparing for next year?
Alan Kennedy 1:23
Yeah, sure. Well, I think for people who own portfolios of properties in their own name, usually the big issue is whether they've got some bank debt or not. And as many of the listeners will already be aware, there is a restriction, unfortunately known for interest deductions, which means that interest gets a tax deduction at a value of 20%. But the rental income itself will be taxed at the marginal rate of the owner of the property, which in many cases may be 40%, or even 45%. So you get a very unusual situation that can develop, where you might have a rental property, for example, that just breaks even because of the interest costs and the other costs on the property. So you're not actually making a profit at all. There's no money left after all the expenses have been paid. But if you're 40% taxpayer, the interest element, because it's only deductible of 20%, you will actually end up with a tax bill, even though you've not made any money. So that is a real red flag for people that they need to be aware of, particularly if you're thinking about investing in property for the first time. If you're already in that situation, it would be great if you could move to a company owning the property. Now, that's not straightforward. But the advantage of a company is that the interest will be deducted at the same rate as the income is taxed. So you don't get this on economic consequence of bank debt, causing you problems. It's not simple, however, to move property into a company with the capital gains tax consequences and that the stamp duty land tax to pay. But there is a way to do it, but only if you have the right circumstances. So if you're someone who's got a portfolio of properties, and broadly speaking, you're working at least 20 hours a week to manage that portfolio, then it can be possible to incorporate and not have any CGT when you do that, because there is something called incorporation relief for a business. It's a bit of a hot topic with property as to whether people are actually doing enough to be treated as a business. And there's been some tax cases on this, but that cancells the CGT problem. For stamp duty land tax bizarrely, even if you incorporate there's no automatic relief, unless you have a partnership. And as we know, lots of people just operate on their own. And it can be possible, particularly in the situation of a married couple, for example, to move into partnership. And if you do that on a genuine and proper basis, and you run the Partnership for a reasonable period of time before you incorporate, then you will get the relief from SDLT. But for people who are starting out in property for the first time, I think company is probably the recommended way to go in most cases.
farnaz Fazaipour 4:30
Yeah, no, absolutely. And isn't there? Also if you've got debt on a portfolio? Is there something about that when you're in a partnership to try and move over into a company to avoid SDLT?
Alan Kennedy 4:44
Yes, the SDLT is payable on debt. So if you're giving someone an asset in the form of property, but at the same time you're asking them to accept the debt, then there will be SDLT payable on that but with the incorporation relief, it could be possible to avoid that too.
farnaz Fazaipour 5:04
Okay, good to know, because we were feeling it in the rental market that actually, and I don't know whether this is the result of individuals being, you know, squeezed on their cash flows, but we're feeling in the rental market, that there is actually a shortage of stock. And I wonder whether people have now started to react to this situation of being, you know, taxed heavier, really, as individuals than as corporates. Because the, you know, rents have gone up, I think, 13.8%, or something I read yesterday. So there is really having an impact?
Alan Kennedy 5:39
Yeah, I think it certainly means, buy to let, less attractive for individuals. And some people, I guess, just find the concept of starting a company maybe for the first time a little bit early and, and maybe that stops them stepping into the market and offering properties for rent.
farnaz Fazaipour 5:59
And if you are to set up a company, because we all know that, you know, when you're when you're going into into a buy to let situation, you know, you need to get all your numbers right, and make sure that everything makes sense. But the stamp duty is higher for corporate purchase. Are there any reliefs for genuine rental investors? Or is there not such a thing?
Alan Kennedy 6:23
Well, the stamp duty for a company that it will always pay the additional 3% surcharge box. For an individual who's going in to buy to let, it's unusual, I would say for them not already to own a property. So they will almost invariably have to pay the additional 3% themselves. So I think in that sense, it's neutral. One disadvantage, or one of the disadvantages of a company, of course, is the extraction of profits. So if you are making profit, the company will pay corporation tax, and that's currently in 19%. But then as an individual, if you want to take that profit out, you're going to have to pay dividend tax. And depending on your tax rate, that could be as high as 39.35% on the dividend if you're have 45%. taxpayer. If you're 40% taxpayer, it's 33.75%. So the overall tax burden then becomes quite high. And you have to decide, you know, when you're looking at personal ownership, maybe versus company, is this something where you want to roll up the profits, for example, or will you need to take the money out every year, because even with the restriction on interest deductions, it still might be cheaper in the end, to have the money available to you rather than having to take a dividend. And the other point, of course, is there's the capital gain at the end. So if you're going into maybe a single property investment, and your your plan is to rent it for five years, and then sell, then you're going to pay capital gains tax at 28%. So you'll realise your profit at 28%. If you do the same thing in a company, then again, we'll have the company thing corporation tax when it sells the property. But you still have to get the money out of the company. And you'd have to liquidate the company at that point, and probably pay another 20% CGT of liquidation proceeds. So having an eye on the end game, and how much of a portfolio you're going to build, I think will influence how you structure it from day one.
farnaz Fazaipour 8:31
Yeah, sounds like you got to make sure you get advice before you do any of this stuff. So on the subject of capital gains, there's different ways that that they look at capital gains, right, you've got some things that you can deduct, and then there is a difference between trading calm, short term long term ownership is, is that something you can talk to us about?
Alan Kennedy 8:53
Yes, so the main the main issue with property and what's deductible usually revolves around whether it's a capital expense, or just a revenue expense. And the simplest way to think about this, because people do get confused about it, is for capital gains tax purposes, you can deduct anything that is an alteration and extension or an improvement to the property, running repairs, you will deduct in your profit and loss again, every year against your rental income. But it's things like, you know, a dormer extension to a bungalow or something like that, or putting in an extra basement and on you know, those are extensions improvements, and they all came for capital gains tax purposes. And obviously, it's not just the fabric of the building. It's all the professional costs associated with that, that come into play, and and really form part of what the asset is at the end. And if it's represented in the form of that asset you have architects, planners fees, legal fees, etc. They all form part of the base cost for capital gains tax purposes.
farnaz Fazaipour 10:07
As does SDLT.
Alan Kennedy 10:09
farnaz Fazaipour 10:10
So you can deduct that as well. And then as you see the other things like the running expenses, the wear and tear, these all get deducted on an annual basis from your profit and loss. What about enhancements to the property that are requested by tenants? So tenant says, I'm not going to rent that house, unless you paint the walls in this colour and, you know, change the cabinets.
Alan Kennedy 10:32
Yeah, but, you know, painting the walls a different colour, that's, that's not going to be regarded as a capital gains tax base costs, but it will be a revenue expense that you can deduct in the year. And, you know, with the cabinets, etc, we have, you know, the wear and tear allowance regime that can be used for things like that, where you get a straight line deduction for that over a period of time.
farnaz Fazaipour 10:59
And are there any, does the revenue look at things differently? Because I mean, you also have developers, for example, where they buy a property, and they fix it, to sell it. And that market, you know, is under a lot of pressure for a lot of different reasons. But are there any tax incentives, to actually encourage people to provide housing to buy things to fix to sell, is there you know, something that if you are a bonafide developer, you can benefit from?
Alan Kennedy 11:31
I think if you're a developer, again, if we look at company versus individual, people would invariably go down the company route, because the individual will be chargeable to income tax on a development, that's the key thing. It's not capital gains tax. There are a lot of arguments, lots of tax disputes that we've come across over the years, where people are just unaware of this rule. And they take on a project. And they expect and the budget for capital gains tax at the end. And then suddenly, the accountant or maybe it's HMRC, even says, Actually, no, you don't owe us 28%, is 40% tax or 45% tax. So derisking that through a company is probably the first thing that I would say. If you are a trading company, if you have a holding company structure, so you don't own the shares directly, but you have a holding company above that trading company, it can be possible, if you've got someone who's prepared to buy the shares in the company instead of the property itself, because maybe they want to save the SDLT and only pay 0.5% stamp duty on the purchase of the shares, instead of maybe a blended rate of 10% or something SDLT, then they can save money with the SDLT by purchasing the shares. And if the holding company sells a trading subsidiary, it's possible that that can be completely exempt from corporation tax at that point, which would then allow you to liquidate the holding company, and take all the value out at a flat tax rate of 20%.
farnaz Fazaipour 13:17
Um, so there's, I've got myself a note here, which, which I was hoping you will clarify, but there's no difference in taxation for short ownership and long, long term ownership. I know in France, for example, if you hold a property for 30 years, then you become free of CGT. And I know that here, we've got the principle home, being, you know, the most tax efficient way of holding your property, but there's nothing about short term and long term?
Alan Kennedy 13:48
No, there's nothing, there's nothing specific. I think in France now, the maximum period for the sort of tapering of the CGT rate, I think it's about 22 years or something. But in this country, really, the length of ownership influences how HMRC look at the transaction for sale. So if you have, for example, developed a property, and you sell it within 12 months, even if you had the intention of renting it out, and you change your mind, and someone makes you a fantastic offer, and you decide to sell it, because it's happened so quickly, there'll be an argument, if you're not using a company, if you're an individual or a partnership, they'll have an argument with you about is this really capital gains tax? You know, didn't you always intend to sell it? So the length of time that it's been owned, influences the attitude of the tax authority as to whether it's really an investment transaction or a trading development transaction.
farnaz Fazaipour 14:53
Right. I mean, we sort of feel a little bit under attack from HMRC since 2013, I think in prime central London. Have we got any other surprises in store for us that we should be preparing for?
Alan Kennedy 15:05
I hope not. I hope not. I mean, it's worth seeing, you know, it's this time of year, which it's April 2022. So it's a big event in the world of ATED right now, because we're the five year revaluation of all the properties for ATED purposes. So anyone who's got a company that's liable to ATED needs to get their property revalued as of 1 April 2022, if they think they're going to be anywhere close to one of the edge of the HMRC bans, to avoid any potential dispute about which ATED ban and therefore how much money, it's going to cost them every year. And obviously, the ATED filings need to be done by 30th of April each year. So that's, that's kind of on people's minds right now. I think, just as a general reminder, it's not that long ago that we got the the extension of non-resident Capital Gains Tax to non residential property, and to what we call property rich companies, where 75% of the company's values from UK real estate. Now, the capital gains tax only came in from April 2019. If people have not already had a retrospective valuation, April 2019, I'd recommend they do that as soon as possible because again, in years to come, properties will be sold, companies will be sold. And everyone will be scratching their heads as to what was our capital gains tax base cost. And if you're getting a valuer, you know, in five years from now, you're selling a property, 2027, valuer says this is what I think it was worth in April 2019, this is your base cost. And HMRC value comes along and says, Well, I've got a different opinion, then you've got what I would call equality of arms, you've got two people arguing about what something was worth the years ago. If you get your evaluation done today, if you haven't already done it, then you've got a valuer who did a retrospective valuation, but only three years after the event, it's much more difficult than for the HMRC value to say, well, actually, you know, five years after that, I'm going to dispute what you said three years ago. So it gives you a much stronger position of certainty that your evaluation will stand up and will be much more difficult to challenge by HMRC.
farnaz Fazaipour 17:38
Yeah, and obviously, this is payable on properties that are not being let out, that are held in corporate names.
Alan Kennedy 17:44
Yes, any property. I mean, it's land as well, undeveloped land will also come into this. So any land, any interest in land at all, it's sold in the UK, no, by a non resident is liable to this tax. And we've had a a minor relaxation of the filing requirements for capital gains tax for non resident. So it used to be they had to file a return within 30 days of the transaction. That's now been extended to 60 days, but it's still a really tight timeframe. And it can work slightly different companies, because they base it on their accounting period sometimes.
farnaz Fazaipour 18:27
Right, okay. What you've got a pending talk that your company is doing about this register for overseas landlords, which will be a whole other conversation to have, but just to touch on it briefly before we say goodbye. And and we will should be sure to tap into your intel on this on a future future show.
Alan Kennedy 18:50
Yeah, of course. So this is part of what they're calling the economic train bill, which I think was brought forward about 12 months because of the war in Ukraine. Because there's a realisation that, that there's a lot of oligarchs who've got high value UK real estate, and the government is not always happy. Simply knowing that, for example, there's a BVI company that owns a large, a large property in Knightsbridge, but who really owns it? So this is going to bring transparency so any overseas company that owns UK real estate of any kind, will have to on a registered at Companies House, the schools, who the beneficial owners of that company are, and that's going to obviously bring a lot of difficulties for privacy. And it's not restricted to any particular nationality. So it's going to affect everyone. So high profile people I know in the past, Emma Watson, the actress from the Harry Potter movies, she had a problem with a stalker and for that reason her property was owned by an offshore company, so that no one can actually find out where she left. You know, for people like her, her privacy's blown, so there's a lot of collateral damage. But it will also have an interesting effect, possibly for inheritance tax purposes. Lots of foreign owners don't actually realise that since 2017, they have an inheritance tax liability. If someone dies owning shares in an offshore company that owns UK residential property, they actually should be inheritance tax. A lot of people just don't know that. And obviously HMRC don't know who owns the offshore company. But very soon, they will. And that means that a lot more inheritance tax will probably start getting paid, people will think about the need to take out life insurance to cover that risk. So there's, there's a lot of there's kind of a ripple effect is going to happen from this. We also think a little bit builds on only in draft, that for offshore companies that own property, which are then owned by a trust offshore. Because no one can actually own a trust. It's difficult to see how anyone can be named as an order in those circumstances. So it'll be interesting to see if the final version of what becomes law will pick up on that point or whether that will remain perhaps a grey area.
farnaz Fazaipour 21:32
Well we'll be sure to come back to you with a much more in depth conversation on this topic and definitely make sure to be at your event on the 4th of May. Thank you so much, Alan.
Alan Kennedy 21:44
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