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Transferring FHL to a Limited Company: Benefits and Drawbacks

Published by Susan Basnet
Posted Date: July 2, 2024 , Modified Date: July 3, 2024

After Chancellor Jeremy Hunt announced in his spring budget that Furnished Holiday Lettings (FHL) will be abolished starting April 2025, landlords have been exploring options to maintain the tax advantages previously available under the FHL regime.

A common strategy that has emerged is incorporating the FHL into a limited company. Although transferring an FHL to a limited company might seem like an obvious choice due to its lower tax rates and the full deductibility of mortgage interest, several tax implications need to be carefully considered before proceeding with such a transfer.

Tax Benefits of Transferring FHL to a Limited Company

Limited companies operate as separate legal entities, meaning the liabilities of the company do not extend to its shareholders or directors. This separation of liability is a primary reason why many people are attracted to establishing a limited company. In addition to this feature, there are several advantages of transferring an FHL to a limited company, which we will explore in this section.

Capital Allowances

A company can still claim capital allowances on the ‘plant and machinery’ used in their FHL properties. ‘Plant and machinery’ can include items such as furniture, appliances, fittings, etc. The ability to claim capital allowances can result in significant tax savings for the company, as these allowances can be deducted from its profits, reducing its taxable income.

The capital allowance for a FHL cannot be claimed as an individual after the abolition of the FHL special tax regime.

Lower Tax Rates

Individuals operating FHLs pay taxes on the rental income at the personal tax rates, ranging from 20% to 45%. However, limited companies pay corporation tax that ranges from 19% to 25% depending on the total taxable profits of the company, with a profit between £50,000 and £250,000 getting a marginal relief.

The rental income from FHL will be taxed at the following rates if the FHL is operated as a sole trader.

Band

Taxable Income

Tax Rates

Personal allowance

Up to £12,570

0%

Basic rate

£12,571 to £50,270

20%

Higher rate

£50,271 to £125,140

40%

Additional rate

Over £125,140

45%

However, the tax rates are comparatively lower if individuals decide to incorporate the FHL business.

Band

Taxable Income

Tax Rates

Small profit rate

Up to £50,000

19%

Main rate

Above £250,000

25%

Comparing the two tables, it seems quite obvious that companies pay taxes at lower rates than the sole traders.

Mortgage Interest Deduction

One benefit of the FHL regime over other property businesses is that the mortgage interest paid is deductible in full. Once the FHL regime is abolished, the mortgage interest deduction will no longer be there. However, companies will continue to enjoy the benefit of mortgage interest deduction, which will add to the benefit of limited companies.

Effective Inheritance Tax Planning

Companies have a relatively broader option for inheritance tax planning than individuals. One of these is the family investment company, which is an inheritance tax plan to shield personal assets from potential creditors and legal challenges. With careful planning, a comprehensive and effective inheritance plan can be developed to meet your specific needs and goals.

Drawbacks of Operating FHL Via a Limited Company

While the benefits of operating a Furnished Holiday Letting (FHL) through a limited company may seem appealing, it’s crucial to understand that this approach comes with its own set of costs or the benefits being lost, which can be significant. In this section, we will explore some potential drawbacks of managing an FHL through a limited company.

Higher Compliance Costs

Running a company comes with a cost, the most common of which is the higher compliance costs. Companies must send copies of the statutory accounts to all shareholders, Companies House, and HM Revenue and Customs (HMRC) as part of the Company Tax Return. Along with these costs come the professional fees.

No Personal Allowance

Individuals benefit from a personal allowance of £12,570, which means that income up to this amount is tax-free. However, this privilege does not extend to limited companies. Although the corporation tax rate is lower than individual tax rates, the absence of a personal allowance could be a disadvantage that leads some individuals to reconsider the option of a limited company structure.

Annual Exemption Allowance

Similarly to the personal allowance, individuals benefit from an annual exempt amount of £3,000, which can be used to reduce their chargeable capital gains. This allowance, however, is only available to individual taxpayers and not to companies. This lack of a capital gains tax exemption adds another disadvantage to operating under a limited company structure.

Tax and Legal Considerations

In addition to the benefits of incorporating a Furnished Holiday Letting (FHL) business into a limited company, individuals must also carefully weigh the tax and legal implications associated with this decision. The costs involved can be significant, and the immediate financial impact may render the option of transferring FHL ownership to a limited company less attractive.

Stamp Duty Land Tax (SDLT)

Every property transaction triggers the imposition of SDLT by HM Revenue and Customs (HMRC) if the transaction value exceeds the SDLT threshold. The SDLT costs can add a substantial expense when an FHL business is transferred into a company structure.

If the value of FHL is below £40,000, the transaction is outside the scope of SDLT, and therefore, an SDLT return does not have to be filed. However, transactions with a value between £40,000 and £250,000 must file an SDLT return without any SDLT being paid.

The SDLT rates applicable to companies on the acquisition of FHLs can be summarised as follows:

Property Value

SDLT Rates

0 - £250,000

3%

£250,000 - £925,000

8%

£925,000 -  £1.5 million

13%

Above £1.5 million

15%

When the value of the FHL exceeds £1.5 million, companies are typically required to pay SDLT at 15% of the property’s value. However, HMRC offers reliefs allowing companies to pay SDLT at standard rates, as outlined in the above table, to certain types of businesses, including those involved in property rental and property development, among others. For more detailed information on these reliefs, HMRC’s guidance can be consulted.

Capital Gains Tax (CGT)

CGT is applicable when an asset that has increased in value is sold or transferred. For sole proprietors transferring their FHL business to a limited company, CGT is levied on the realised gain, adding another layer of tax liability.

At present, the transfer of furnished holiday let to a company will attract the capital gains tax at 10% on the gain up to £1 million, thanks to the Business Asset Disposal Relief (BADR). However, once the FHL is abolished, this benefit may not apply to FHLs as the FHL will no longer qualify as ‘trade’. Therefore, the transfer of FHLs after 5th April 2025 will be subject to CGT at the normal rates on residential property, ranging from 18% to 24%.

One way to escape the immediate impact of the capital gains tax (CGT) is by claiming the Incorporation Relief before the abolishment of the regime. Incorporation Relief is a relief offered to individuals who transfer their business assets to a company in exchange for the shares during the process of incorporation. Transactions qualifying for the relief do not have to pay either the CGT immediately. Instead, the capital gain arising is held over into the base cost in the shares of the company, delaying the capital gains tax liability.

However, the relief is subject to several conditions. Refer to our complete guide on Incorporation Relief to determine if your business qualifies.

Registration and Compliance Costs

The process of setting up a limited company involves extensive paperwork and incurs significant registration fees. These costs can include incorporation fees, fees for filing annual confirmation statements, and various professional service fees.

Registration and Compliance Costs - Transferring FHL to a Limited Company

For a detailed breakdown of the potential costs, explore HMRC’s guidance on Companies house fees.

A Practical Example – Potential Costs on the transfer!

Mr K has been running an FHL business for over a decade, which he initially purchased at £300,000. Following the spring budget announcement, Mr K decided to transfer the property, which is currently valued at £1m, into his company, Sunday Ltd.

As the limited company is already in existence, the registration costs will not be applicable in this case. However, the stamp duty land tax (SDLT) and capital gains tax (CGT) will come into effect.

Given the nature of the transaction, Sunday Ltd will pay SDLT at the market value of the property, i.e. £1 million. Sunday Ltd’s SDLT liability is computed as follows:

Property Value

SDLT Rates

Initial £250,000 at 3%

£7,500

The next £675,000 at 8%

£54,000

The remaining £75,000 at 13%

£9,750

Total liability

£71,250

Therefore, Sunday Ltd.’s SDLT liability will amount to £71,250.

Generally, Mr. K would be required to pay capital gains tax on the chargeable gain of the property. However, due to Incorporation Relief, the CGT liability will not be payable immediately. Instead, it will be deducted from the base cost of the shares, and the gain will only be realized when the shareholders sell the company shares. If the FHL was operated as a partnership rather than a sole trader, even the SDLT might qualify for Incorporation Relief, avoiding the immediate cost.

Therefore, even without accounting for the registration costs, the total financial burden for Mr K and Sunday Ltd comes to £71,250. This substantial cost may lead Mr. K to reconsider his decision to incorporate the FHL business and sell it now instead.

Conclusion

In conclusion, the decision to transfer a furnished holiday letting (FHL) business into a limited company structure following the Chancellor’s budget announcement presents both opportunities and challenges.

While incorporating may offer lower corporation tax rates, full mortgage interest deductibility, and benefits for inheritance tax planning, it also brings with it increased compliance costs, absence of personal allowances, and potential liabilities for capital gains tax and stamp duty land tax. Given the complexities involved, consulting with tax professionals and legal advisors is advisable to navigate the transition effectively.

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Susan Basnet
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