How property incorporation can support tax planning

One of the most common requests we receive at Gravita is for advice on how best to incorporate an investment property portfolio, either to try to shift the rental income into a lower tax regime, or for perceived Inheritance Tax (IHT) planning purposes and we often get asked about setting up a “FIC” (Family Investment Company) for these purposes can work.

Whilst it is usually possible to incorporate a property portfolio, doing this without triggering taxes at the time of the transfer is more complicated, and in some cases, the tax on set up can be onerous enough to negate the potential future tax savings, at least in the short to medium terms, so as a strategy it must be approached with a great deal of care and is not necessarily the silver bullet solution that it is often seen to be.

Tax on set up

The first issue to consider is the potential taxes due at the point of incorporation.

This includes Capital Gains Tax (CGT), which could be due at a rate of up to 24%, because the transfer of the properties is treated as a disposal at full market value.

Usually, the properties are exchanged for a loan, due back to you as the original owner, but there is not usually any cash floating around, so the CGT is a “dry” tax charge, payable to HMRC with 60 days of completion which you need to consider how to fund.

Under very specific circumstances you may be able to avoid the charge to CGT by claiming incorporation relief and exchanging the properties not for a loan but for shares in the company instead. For most modest portfolios this relief is not available, and for even very large portfolios, the risk of the relief being denied can be significant, depending on how the portfolio is being managed in the first place.

The second potential tax is Stamp Duty Land Tax (SDLT). When properties are transferred into a company, the company will pay SDLT based on the full market value of the property (at the higher rates), even if no money changes hands. This surprises many people who expect the charge to be limited to the mortgage balance being transferred, which is not the case.

Again, there are reliefs available, but these only apply in very specific circumstances and HMRC can apply anti-avoidance provisions to defeat planning that aims to achieve the circumstances required where there is no commercial reason other than to save SDLT upon a future incorporation.

Income tax planning

Assuming you go ahead with incorporating your portfolio, then there can be significant ongoing income tax savings. Companies not only pay tax at a lower rate than individuals – 25% as opposed to up to 45% – they also still qualify for full tax relief against mortgage interest.  When combined this can produce an annual tax saving.

However, this works best if you do not then need to withdraw income from the company or you have created loan account to draw upon, tax free. If not and the rental income is still required by you, you will be an income tax on the dividends/salary required to get the money into your hands, which can result in either a double charge to tax, negating most of the saving, or exposure to National Insurance Contributions (NICs).

Capital Gains Tax planning

If you have successfully claimed incorporation relief, then there is a quirk in the legislation that may enable the company to sell properties onward with very little corporation tax on the gain, as the company can sometimes benefits from an uplift in the value of the property to its market value at the point of incorporation. This can enable the company to reinvest more of the proceeds, but if the proceeds are extracted, the tax you pay can be higher than had CGT simply been paid in the first place.

Inheritance Tax planning

Finally, if you are incorporating your property portfolio with the aim to reducing IHT, please bear in mind that the mere act of incorporating the portfolio will not reduce your IHT exposure. All you have done is exchange, say, a £1 million property portfolio for £1 million worth of shares in a property company and this value still sits in your estate and which will still one day be exposed to 40% IHT. Owning shares in this sort of company will not give you access to Business Property Relief (BPR).

If you use some form of FIC structure and this is set up carefully, then you may be able to pass on the growth value IHT and CGT free, but those structures do not solve the problem of passing on the existing value without a tax liability.

If you give the shares away in your lifetime, these will be subject to normal CGT rules, without the benefit of holdover relief. You may still avoid a charge to IHT, but only if you then survive the full 7 years after making the onward gift of shares.

If you still hold your shares at death, 40% IHT will be payable in the normal way.

Of course, on a practical level, passing on shares rather than passing on fractional interests in individual properties can simplify the situation for the family, especially if the family plans to hold the investments over a number of generations.  But this sort of planning is complex and does not always result in tax savings and so it is important to ensure that your specific situation is considered before you begin the process of incorporating.

How Gravita can help

Property incorporation can offer valuable tax benefits, but the right approach will depend on your portfolio, income needs and longer term plans. Our private client team can assess the potential tax costs and savings, explain the reliefs that may be available and help you decide whether incorporation is right for you.