Tag Archives: Inheritance Tax

Marcia Banner, Financial Planning Week tip: Tax planning considerations for property investors in the current climate

The pros and cons of personal versus corporate ownership of buy-to-let property and how the position has been affected by the recently announced changes to corporation tax and income tax rates.

While the Chancellor’s Growth Plan (and subsequent U-turn on the abolition of the additional rate of tax) may have inadvertently sparked a (temporary?) hike in interest rates, it’s not all bad news for buy-to-let property owners and investors who don’t need to borrow to finance their property investments.

The increase in the nil rate threshold for Stamp Duty Land Tax (SDLT) to £250,000 benefits not only those replacing their main residence, but also carries through to purchasers of additional residential property who pay SDLT at the standard residential rates plus a 3% surcharge. This is because the extension of the nil rate threshold also extends the 3% rate threshold. This will deliver a £2,500 SDLT saving on new purchases of additional residential property worth at least £250,000 completing on or after 23 September.

Property investors who are buying property via (or thinking of transferring existing residential property to) a company will also benefit from this SDLT saving and this may increase interest in using companies to hold property investments – especially as the planned increase in the corporation tax rate (from 19% to 25%) – which would have affected companies with profits (net annual rental income) of more than £50,000 – has now been reversed. 

An ‘accumulation-stage’ investor who is still buying property and building their portfolio may also be in a position to make a loan to their company to fund the property purchase which would pave the way for tax-efficient extraction of accumulated rental profit at a future date; but where the property investor has already amassed a substantial personally-owned property portfolio there are a whole host of “tax factors” that need to be considered before deciding whether to transfer to a company or to retain the properties in individual ownership. 

Main considerations on transferring existing properties to a company

Assuming that the properties are not mortgaged (mortgages can create other complexities) the main considerations will be capital gains tax (CGT) and SDLT.

The transfer of one or more properties to a company will be a disposal for CGT and the property owner will therefore usually need to pay CGT on the difference between the market value at the time of the transfer and the acquisition cost of the property, unless incorporation relief can be claimed.

Incorporation relief can be claimed to defer the payment of CGT only if all of the conditions of s162 Taxation of Chargeable Gains Act 1992 are satisfied – including the need for the individual to be operating as a business. HMRC will generally accept this to be the case if the property owner is dedicating around 20 hours a week of personal time to the management of the property letting, but this is often going to be difficult – especially if the owners are past retirement age and winding down or the property investor has a full-time job.           

Where residential property is transferred to a connected company, SDLT will also be payable by the acquiring company on the market value of the property at the time of transfer at the higher rates applicable to purchasers of additional properties (although multiple dwellings relief may be available to reduce the charge if more than two properties are transferred in the same transaction). While the SDLT bill is now, as we have already noted, going to be marginally less than it would have been for transactions completing prior to 23 September, let’s not forget that the individual may have already paid SDLT on the purchase price at the higher rates when they bought the property.

An exemption from the SDLT charge on incorporation is available where the transfer is made from a partnership to a company owned by the same individuals. However, the partnership must be a genuine partnership that is registered with HMRC and that has subsisted for a reasonable amount of time. Joint ownership, in itself, is insufficient and HMRC may seek to challenge claims for relief in cases where the partnership has been in existence for only a short period (as a ‘rule of thumb’ less than three years) and/or there seems to be no other genuine commercial reasons for establishing the partnership.

But that aside….

Where SDLT and CGT costs can be mitigated or are not prohibitive, transferring property into corporate ownership can provide considerable tax benefits to those who wish to build up a portfolio of properties over time and use it to generate income in later life. This is largely due to the fact that the company will pay corporation tax at just 19% on rental income net of deductible expenses (including mortgage interest) as compared to the 40%/45% rate of income tax that could be payable on the rental profits if the property was held personally. As a consequence, where the taxed income is saved and reinvested in further properties, the company will be able to build the portfolio much more quickly than an individual investor could do – and the additional income that a larger portfolio will generate will provide an overall higher net return for the client in retirement, even after allowing for the extra tax at shareholder level. The reinvestment of the additional net income receivable through using a company over time may also eventually produce a sufficiently improved position to compensate for the disadvantages of realising residential property gains within a company structure and suffering a second layer of tax when extracting the net sale proceeds.

It is, however, important to appreciate that the company route will rarely be beneficial if the property investor is planning to extract the company rental profits. Not only will the investor lose out on the compensatory portfolio growth that accumulation and reinvestment within the corporate wrapper will bring, (unless they have made a loan to the company to finance the property purchase), the profit will usually need to be extracted in the form of a dividend, meaning that there is going to be additional tax at shareholder level. While this will improve post 6 April 2023 (when the tax rates on dividend income will fall) this element of double taxation still means that the client who intends to extract all the rental profit from the company as a dividend will often be better off keeping the properties in individual ownership.

What about inheritance tax?

Shares in a property investment company don’t tend to qualify for the reliefs available in respect of shares in trading companies so the value of these shares will form part of the client’s taxable estate for inheritance tax (IHT) purposes unless they give them away during their lifetime. The value of the shareholding will broadly reflect the value of the company’s net assets (so a shareholder who has also made a loan to the company – and has an outstanding amount as an asset of their estate – won’t be taxed twice).

Of course, as the properties grow in value, so will the value of the investor’s shareholding but, fortunately, estate planning with company shares is a lot easier than estate planning with property. A gift of shares, if made outright, will be a potentially exempt transfer (PET) which means that an immediate liability to IHT will never arise regardless of how much value is gifted at once. And if the gifted shares don’t carry voting rights, the PET can be made without necessarily giving the recipient immediate access to the underlying value. It should be remembered that a gift of shares will also be a disposal for CGT purposes, but as long as any planned gifts are made shortly after incorporation, any gain should be covered by the shareholder’s annual exemption.      

Conclusion

It will be clear that there are a lot of different factors to bear in mind when considering whether to hold property investments personally or within a company structure but, in summary, the company ownership approach tends to work best with new properties (or existing properties where SDLT and CGT can be mitigated or deferred) and where the client isn’t likely to need to start withdrawing the rental income for many years. An exception to this rule might be where the property investor is a higher rate taxpayer with significant finance costs – in these cases using a property investment company can sometimes yield savings even if the higher rate taxpaying residential property investor is extracting all their company’s after-tax profits. This is because, unlike individuals, a company is still able to deduct mortgage interest from gross rental income in order to arrive at their taxable profit.

There are also other factors specific to the individual client circumstances and objectives that could swing the balance one way or the other and it will therefore be vital for the client to take independent tax advice before making a decision or pursuing any particular course of action.                                

Treasury responses to the OTS reports on CGT and IHT

A period of stability in store for CGT and IHT : No material changes emerging from the OTS reports.

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Capital Tax Reform

With no reform of CGT or IHT announced in the Autumn Budget, what is the likelihood of future reform now?

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Helen O’Hagan, Financial Planning Week tip: Multiple trust planning

When your client creates a discretionary trust it will have its own IHT nil rate band (NRB) which will be used throughout the lifetime of the trust. This is used to calculate the 10 yearly charge commonly called the periodic charge.

The available NRB is calculated at the creation of the trust by looking back seven years and adding up any previous chargeable lifetime transfers (CLTs) that the client made before this new one. These are deducted from the NRB available at the 10 year point. This means that, the NRB for the client’s new trust is the NRB at year 10 less those previous CLT’s.

Tax saving

By creating several trusts over several days your clients are able to take advantage of multiple NRBs, as shown in the following example:

Agnes has just started her IHT planning and this is her first set of gifts. She creates three discretionary gift trusts as follows:

 DateValue of CLT
Trust 1August£150,000
Trust 2September£100,000
Trust 3October£75,000

When the time comes for the calculation of the periodic charge, Agnes’ trusts will have the following nil rate bands to use at the 10 year point:

NRB for periodic chargeLess value of previous CLT
Trust 1NRB at 10 year point£0
Trust 2NRB at 10 year point-£150,000
Trust 3NRB at 10 year point-£250,000

Let us assume the trust funds grow as follows:

 Value of fund at 10 year point
Trust 1£300,000
Trust 2£200,000
Trust 3£150,000

And if the NRB increases to £375,000 at the 10 year point, the periodic charge for Agnes’ trusts will be as follows:

 NRB for trustValue of trustTaxable at 6%
Trust 1£375,000£300,000£0
Trust 2£375,000 – £150,000 = £225,000£200,000£0
Trust 3£375,000 – £150,000 – £100,000 = £125,000£150,000£25,000 x 6% = £1,500

Trust 1 has the full NRB to use at the 10 year point, and, as the value of the trust fund is below this, there is no tax to pay.

Trust 2 has the NRB at the 10 year point less the previous CLT of £150,000, which gives £225,000 of NRB to use against the trust, and, again, as the value of the trust fund is below this, there is no tax to pay.

Trust 3 has the NRB at the 10 year point less the two previous CLTs of £150,000 and £100,000, which gives £125,000 of NRB to use. However, as the trust fund is £150,000, which exceeds this by £25,000, this results in a tax charge of £1,500.

If we compare this with the position if Agnes had just set up 1 discretionary trust the calculation of the periodic charge would be:

 NRB for trustValue of trustTaxable at 6%
Trust 1£375,000£650,000£275,000 x 6% = £16,500

As you can see, creating multiple trusts for your clients can make tax savings for them at the 10 year anniversary for the calculation of the periodic charge.

Beware of the related settlements rules

Under the statutory definition of “related settlements”, contained in section 62 Inheritance Tax Act 1984, related settlements are treated as a single settlement and so would not each have a separate NRB.

For two or more trusts to be related settlements, the settlor must be the same in each case and the trusts must have commenced on the same day.

Make sure when setting up multiple trusts for clients that they are set up on different days and the investment bonds start on different days.

Same day additions

There were anti avoidance measures introduced, which created a new section 62A, which states that trusts will be treated as related if  the value of property in each  trust is increased by a transfer of value on the same day, for example, if assets are added to them on the same day.

When using multiple trusts, your clients ought to set them up on separate dates and ensure that funds transferred into the trusts are paid on different days, on set up and when topping up the trust.

Planning

Don’t forget that, if you are setting up loan trusts and gift trusts for your clients at the same time, there is no transfer of value under a loan trust, so set this up first. This will potentially give the client 100% of the NRB for the loan trust and also 100% of the NRB for the gift trust to use at the periodic charge point.

If your clients are using loan trusts in their IHT planning consideration should be given to setting up multiple smaller trusts. This will not only help with the periodic charge point giving multiple NRBs to use, it also gives the client flexibility when it comes to waiving the loans. Under certain provider’s loan plans you can only waive all of the loan. There is no facility to waive part of the loan. If you have multiple smaller plans it gives clients the ability to waive each loan at different times, keeping some if needed for future use.

One last point to note is that, with the extension of the Trust Registration Service, each of the trusts will have to be separately registered with HMRC.

Inheritance Tax receipts and potential reform

The latest HMRC figures for IHT yield and thoughts on the potential for reform and opportunities to effectively communicate with clients.

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Is there a compelling case for capital tax reform?

How likely is a fundamental reform of IHT and CGT as part of a wide ranging reform of capital taxation?

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Budget 2021 – Inheritance Tax & Property Related Changes

An overview of the Budget announcements that may be of interest to property investors and those affected or potentially affected by IHT.

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All Asset Intergenerational Estate Planning

How to effectively take an “all asset “ approach to intergenerational estate planning.

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All Asset Estate Planning

The importance of taking an “all asset” approach to holistic estate and intergenerational planning.

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IHT Simplification – The OTS Review

The first part of the OTS report on IHT simplification and it’s possible implications for the future of IHT administration.

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