Why it still makes sense to use companies to hold buy to let property in 2016
In this Practitioner Zone article we summarise the recent tax changes to the tax treatment of UK property and explain why it can still be advantageous to use a UK company to hold buy to let property.
THE ANNUAL TAX ON ENVELOPED DWELLINGS (THE 'ATED')
All 'non-natural persons' (namely corporates but, importantly, not trustees), irrespective of their residence status, are within the scope of the ATED regime if they hold residential property valued in excess of £1 million (and, from 1 April this year, in excess of £500,000), by reference to its 1 April 2012 value, and are subject to the following annual charges, by reference to the value of the property that they own.
An annual charge of £3,500 will apply to non-natural persons who own property with a value greater than £500,000 from 1 April this year.
Reliefs are available from the ATED regime for non-natural persons which run property development, rental and trading businesses, provide employee accommodation, are charities and own farmhouses. However, such reliefs will only be applicable if the relevant property is not (and is not capable of being) occupied by 'non-qualifying individuals' (namely, individuals who are beneficially entitled to the property or are connected with a person who is), notwithstanding whether market rent is paid for such occupation.
SDLT
(A) NON-NATURAL PERSONS WITHIN THE ATED
If a non-natural person falls within the ATED regime, the highest SDLT rate of 15% will apply on a purchase of the property by the company if the property is valued at £500,000 or more. However, if relief is available from ATED, the normal SDLT rates (as set out below) will apply to the purchase.
(B) EVERYONE ELSE
Prior to 4 December 2014, SDLT was calculated on the entire value of the property at a rate determined by which band the overall consideration fell within. The system, often referred to as a 'slab system', meant that where the consideration fell close to the band thresholds, a small increase in the value of the property purchased would have a disproportionate effect on the amount of SDLT payable.
The new 'normal' rates, as mentioned above, are now banded (in a similar way to income tax) as set out below whereby the SDLT rate will be payable on the portion of the property value which falls within each band:
0 - £125,000 = 0%
£125,001 - £250,000 = 2%
£250,001 - £925,000 = 5%
£925,001 - £1,550,000 = 10%
More than £1,550,000 = 12%
The practical implication of these changes is that the SDLT payable on the purchase of higher value properties has increased. For example, at today's rates, the purchase of a £3,000,000 property would give rise to a £273,750 SDLT charge, as opposed to the £210,000 charge which would have arisen prior to 4 December 2014. However, the SDLT payable on the purchase of lower value properties is broadly the same as previously.
CGT
(A) NON-NATURAL PERSONS WITHIN THE ATED
As with SDLT, if a non-natural person falls within the ATED regime, the highest CGT rate (currently 28%) will apply on a sale of the property. However, the value of the property for the purpose of this CGT charge will be rebased as at the property's 6 April 2013, 2015 and 2016 values for properties worth over £2 million, over £1 million and over £500,000 respectively.
(B) NON-UK RESIDENT INVESTORS
UK residents have always been subject to CGT on a sale of the UK (and worldwide) assets they own to the extent that those assets have increased in value since acquisition. However, prior to 6 April 2015, non-residents were not subject to CGT on the sale of their UK assets. From 6 April 2015, all non-residents are now within the CGT regime to the extent that they own residential property (whatever its value and nature -- there is no de minimis as there is with ATED and there are no reliefs available, save for principal private residence ('PPR') relief, the scope of which I shall come on to explain). However, as the CGT charge will not be retrospective, those non-residents will not be subject to CGT on any gains arising on the relevant property prior to 6 April 2015. A property may be subject to both ATED related CGT and non-residents CGT. However, the ATED CGT charge takes precedence over the non-residents CGT.
In the spirit of equality, PPR relief has been extended to non-resident individuals, such that a non-resident will be able to claim relief on the sale of their main or only UK residence, but only in respect of gains attributed to tax years during which the individual has (or their spouse or civil partner have between them) stayed overnight on at least 90 occasions in the property (or any UK property) owned by the individual. Therefore, non-residents may struggle to satisfy the 90-day test without becoming UK resident for the tax year concerned so the true value of this relief is limited.
INHERITANCE TAX ('IHT')
The UK (and worldwide) assets of individuals who are domiciled in the UK are within the IHT net, meaning that, subject to certain exemptions, those assets will be subject to an IHT charge on the individual's death (currently at a rate of 40%). However, broadly speaking, provided that a non-domiciled individual (or an offshore trust) holds UK property via an offshore company, that property will not be subject to IHT charges as ownership via an offshore company effectively acts as a 'blocker' for IHT purposes. For this reason, this has been a standard property ownership structure for non-domiciled individuals.
By 2020/21, it is proposed that an extra £175,000 IHT allowance in relation to the family home will be available on an individual's death. This will combine with the nil rate band allowance (an amount that can be passed free of IHT on an individual's death) that every individual has (no matter what their domicile status) to give some individuals a £500,000 allowance when leaving property to children and descendants on death and a combined £1 million for spouses and civil partners. This extension of the nil rate band will be phased in from April 2017. The allowance will be restricted to property that has been the residence of the deceased at some point during their lifetime, so it would not apply to a buy-to-let property (although it could apply to a property which used to be the deceased's residence, but which was let at the date of death). The draft legislation further provides that when an individual downsizes or ceases to own a home the ANRB would still be available provided the smaller replacement property and/or the proceeds of the sale of the property (or, potentially, whatever they subsequently become) are passed to the deceased's descendants.
However, there is a catch. Since the Government does not want to be seen to be benefiting those considered to be 'better off ', the ANRB will not be available to all. The allowance will therefore be reduced for estates worth more than £2 million at a withdrawal rate of £1 for every £2 over that threshold so that, effectively, the tapering of the allowance means that no relief is available for estates with a net value, in 2020/21, of £2.35 million or more (or £2.7 million on the death of a surviving spouse where the full main residence nil rate band is available to be transferred to the survivor).
INCOME TAX
As mentioned above, although there are certain tax benefits to being a landlord, the Chancellor does not intend these to extend to income tax and the Summer Budget also saw the announcement of changes that will have a significant impact on the net income many landlords generate, with effect from April 2017.
Under current rules, landlords are able to deduct 100% of their finance costs (namely mortgage interest, interest on loans to buy furnishings and fees incurred when taking out or repaying mortgages or loans) from rental income received. However, from April 2017, the deductions of interest permitted from profits will be reduced as follows:
75% for the 2017/18 tax year;
50% for 2018/19;
25% for 2019/20; and
0% thereafter.
WHERE DOES THIS LEAVE US FOR CORPORATE PROPERTY HOLDING VEHICLES
Given the equalisation of UK taxes applicable to UK residents and non-residents alike, and the punitive charges that now apply to corporates, foreign investors may wonder whether the traditional corporate property holding structures are a worthwhile mechanism for holding residential property and the answer is…it depends! The use of corporates is still attractive and, indeed, beneficial from a UK tax perspective where the underlying property is being let on a commercial basis as: