Given the minimal cost and fewer compliance requirements, people often choose a partnership structure when they first start their property business.
However, as the business expands, many landlords, property investors, and those with buy-to-let property partnership businesses in the United Kingdom consider transferring their business into a limited company.
A limited company is unquestionably a popular option for managing a portfolio of property investments. This transition is advantageous for many reasons, understanding the benefits of such an exchange is important.
1. Saving Income Tax
While income taxes for partners in a partnership range from 20% to 45%, limited companies only pay corporation tax at 19%. Therefore, your annual tax liability on rent is likely to be lower if a company manages your property portfolio than a partnership business.
The increment of corporation tax from the current 19% flat rate to variable rates up to 25% of the profits has been announced by the UK government and will be applicable from 1 April 2023.
Read about the tax rates and reliefs, 'Know Your Tax Rates and Reliefs for 2023/24'.
2. Saving Stamp Duty Land Tax (SDLT)
A question that you’re likely to ask on transferring property partnership business to a limited company:
You Asked !
How much stamp duty land tax will I have to pay?
SDLT is a tax you pay HMRC on land and property transactions. By default, any property transfer to a company is viewed as an SDLT event based on the property's market value. The good news is that when the property is transferred from a property partnership business to a limited company and the limited company is connected with partners in specific ways; there is an exception to this SDLT charge.
We Answered !
A company is connected to a person for SDLT purposes if that person has control over it or if they jointly control it with other people who are connected to them.
You must adhere to the following requirements:
- The ownership of the newly formed limited company should be identical to that of the original partnership (in terms of share allocation).
- The partnership should be registered with HMRC.
- The partnership has a separate bank account.
- A comprehensive written partnership agreement exists.
How SDLT Relief Works
As the transfer of properties from a partnership business to the company is a transaction between connected persons for SDLT purposes, chargeable consideration needs to be determined, which can be calculated using the formula,
MV x (100 – SLP) %
where, MV is the market value of a property and SLP is the ‘sum of the lower proportions.’
Here, the lower proportions can be determined by comparing the percentage holding of the owner before and after the transfer and taking the lower figure in each case. The interests of the connected persons are also considered which means that the holding of the company before and after the transfer is 100% for these purposes, and SLP = 100. As a result, the amount of market value upon which SDLT is charged is 0%, and no SDLT charge arises.
Nevertheless, you must be mindful of anti-avoidance rules, as HMRC will not permit transactions whose primary goal is to evade paying taxes.
3. Saving Capital Gains Tax (CGT)
Capital Gains Tax (CGT) is levied on the difference between the purchase price and market value of the chargeable asset. You can save CGT on transferring property partnership business to a limited company.
Lower Rate of Capital Gains Tax
As a partner in a partnership, you will pay capital gains tax at 18% or 28% on the gain for residential properties, depending on whether you are a basic or higher-rate taxpayer, respectively.
However, for a limited company, it is the same rate as corporation tax, i.e., at 19%.
By incorporating your partnership business into a limited company, you can be eligible for incorporation relief, which is a delay or deferral of capital gains tax. click here to learn more.
Capital Gains Tax Base Cost
Another benefit of the incorporation is the uplift of the capital gains tax base cost of the properties, i.e., the company takes on the properties with the base cost equal to their market value on incorporation. Consequently, on any future sale of the properties, the company would only pay corporation tax on the future growth in value of the properties.
4. No restriction on Interest Relief
The restriction on interest relief may have impacted your property rental portfolio in a partnership as it can no longer be used as a deduction against rental profits.
However, contrary to partnerships, the 2015 Summer Budget (Section 24 of Finance Act 2015) does not restrict tax relief regarding interest and other finance costs to a limited company.
Therefore, while operating as a limited company, you can deduct the entire mortgage interest as an expense. In contrast, you could only claim a tax credit of 20% of the mortgage costs from your tax liability in a partnership.
5. Saving Inheritance Tax through Freezer Shares
You can create ‘Freezer Shares’ by managing your property portfolio through a limited company. The value of the shares remains frozen, ensuring that your intended beneficiary benefits from any future value growth.
This can be achieved by creating different classes of shares.
Class A and Class B shares. Class A shares will have dividend rights, voting rights and capital appreciation, while Class B shares won't have any dividend rights, voting rights, or capital worth above their face value. Such Class B shares are transferred to your intended beneficiaries. The company's regulations are modified after the B shares have been transferred so that all future capital gains are credited to the B shares. As a result, there won't be any inheritance tax implications in these instances.
Other Benefits of Incorporated Partnership into a Limited Company
Another benefit of turning your partnership business into a limited company is the liability protection that it provides. Due to your limited liability to the company, you won't be held personally liable in a limited company for paying its debts, unlike in a partnership where you can be. Instead, the company will be held liable for all its debts, liabilities, and other obligations.
Tax Planning via Issue of Dividends
While you must pay income tax on your earnings as a partner in a partnership, you may properly plan your taxes as the owner of a limited company since you can choose to pay yourself in the form of dividends. Additionally, the highest band of income tax that you will be paying, at 45%, is greater than the highest dividend tax, at 39.35%.
The profits can be retained within the business in a limited company, whereas all partnership profits must be paid out to the partners on which income tax is incurred. In addition, as mentioned above, the company will be subjected to corporation tax, which is relatively lower than income tax.
If withdrawing profits subject you to a higher tax rate, you can leave excess income as retained profits within the company. Therefore, you can invest your funds in the company or earn interest in your business bank account instead of paying income tax. Unfortunately, the partnership business structure does not provide this flexibility.
Unlike in a partnership, a limited company can claim 130% super-deduction capital allowances on qualifying plant and machinery investments and a 50% first-year allowance for qualifying special rate assets.
Tax Position Comparison
Let's analyse the tax position of John (a residential landlord) when he operates his property portfolio via a partnership and a limited company structure, to understand better how incorporation into a limited company might lower your tax liability.
Suppose John owns a company with a net worth of £5,000,000 and mortgage payments of £100,000. After all costs are deducted, the operating profit is £75,000.
Tax Position via Partnership
John operates his business through a partnership; thus, the taxable profit is £175,000 because the mortgage expenses cannot be fully deducted; instead, a tax credit equivalent to 20% of the finance costs is granted.
The total amount of tax due is £63,750. He receives a £20,000 tax credit, leaving him with £43,750 of tax to pay.
Tax Position via a Limited Company
As a full deduction of the mortgage costs is allowed under a limited company structure, the taxable profit is £75,000. The corporation tax rate for limited companies is 19%; therefore, the total amount of tax due is £14,250.
While you compare John's tax situation when managing his property portfolio using the partnership and limited company structures, the tax savings are pretty obvious. His total tax obligation under a partnership is £43,750, compared to £14,250 under a limited business.
So even though the operating profit and mortgage costs for both landlords are the same, the tax liability via a partnership is nearly four times more than the tax paid in a limited company.
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