If you are a sole trader or in a partnership, you might have considered switching to a limited company. There are various reasons why a business might make this move, including tax efficiency, protection of personal assets, and increased credibility.
In this article, we will explore the benefits of incorporating a limited company and the considerations you need to make before making the switch.
We will also discuss the process of setting up a limited company and the legal requirements that come with it. Whether you are a small business owner or a freelancer, this article will provide you with valuable insights into the advantages and challenges of becoming a limited company.
Advantage of transferring to a company
If you or your partner make a lot of money from work or business, it could be a good idea to set up a limited company. This is especially true if you don't depend on the income you get from your property investments.
Landlords have various reasons for running property business using a limited company.
Some key benefits are:
1. Corporation Tax Vs Income Tax
The government charges income tax on the money you earn, and the more you make, the higher the tax rate you pay.
It ranges from 20% to as much as 45%!
But if you set up a limited company, you'll only have to pay corporation tax, which is charged at 19% or 25% depending on how much profit you make.
Let's take a closer look at the tax rates for the upcoming year (2023/24).
Income tax- for partnership business or when properties are on individual’s name
up to £12,570
£12,571 to £50,270
£50,271 to £125,140
Small Profit Rate
up to £50,000
Any profit between £50,000 and £250,000 get marginal relief providing a gradual increase in effective corporation tax rate.
If you earn up to £12,570, you won't pay any income tax at all (that's the personal allowance). But for the next £37,699 you earn (up to £50,270), you'll pay a 20% tax rate. The higher your income, the more tax you pay.
However, if you're a limited company, you'll only pay 19% tax on profits up to £50,000 and 25% on profits above £250,000.
So, if you compare the two tables, you'll see that individuals end up paying more tax on the same amount of profit or taxable income compared to a limited company.
2. Mortgage Interest is Fully Deductible for Companies but not for Individuals
In 2015, the government proposed changes to the tax relief that landlords could claim on interest and other finance costs. This has big implications for people who run a property business.
Basically, you won't be able to deduct mortgage interest as an expense anymore. Instead, you'll get a tax credit of 20% on your interest payments.
So, if you are a higher rate tax payer and have rental income of £10,000, estate agent fees and other allowable expenses of £1,000, and mortgage interest of £7,000, your net rental profits will be £9,000. You'll then have to pay tax on that profit at a rate of 40%, which means a tax liability of £3,600.
However, you'll get a tax credit of £1,400 for your mortgage interest payments. This brings your total tax liability down to £2,200.
But, if you run your property business as a limited company, your net tax liability would only be £2,000, with a net tax liability of just £380 (at a rate of 19%). That's a saving of 82.72% on your tax liability!
So, if you're a landlord, it's important to consider whether setting up a limited company could save you a lot of money in taxes.
If you want to explore more on the topic you can read our articles:
Should I Incorporate to Avoid Section 24?
This article explores the strategy of incorporation as a means to deal with Section 24. It discusses the advantages and potential pitfalls of transferring your property portfolio to a company.
A Complete Guide on Interest Relief Restriction Section 24 on Landlords
A comprehensive guide on Section 24's impact on landlords. Learn how tax relief restrictions could change your tax situation and prepare for potential future interest rate increases.
Transferring Your Property to Spouse as Solution to Section 24
Explore the possibility of transferring property ownership to a spouse as a solution to Section 24. Understand the legal and tax implications of this strategy.
3. Limited Liability in Company Vs Unlimited Liability for Independent Business Landlords
Imagine you're a landlord who owns a rental property. You're responsible for making sure the property is well-maintained and safe for your tenants to live in. But what happens if someone gets hurt on your property? Or if there's a fire and the building is damaged? If you're running the property business as an individual, you're personally liable for any damages or legal claims that might arise. This means that if something goes wrong, you could be on the hook for a lot of money, even if it means losing your personal assets like your car, your home, or your savings.
On the other hand, if you set up a limited company for your property business, you'll enjoy limited liability. This means that if something goes wrong, your personal assets won't be at risk. The company is a separate legal entity from you, and it's responsible for any damages or legal claims. You're only liable for the amount you've invested in the company.
So, imagine that same scenario where someone gets hurt on your rental property. If you're running the property business as a limited company, your personal assets are protected. The company is liable for any damages, and you won't have to worry about losing your car, your home, or your savings.
In summary, setting up a limited company for your property business can offer you peace of mind and protection from financial risk. While running a business as an individual might seem simpler, it's important to consider the risks involved and weigh the benefits of limited liability that a company structure can provide.
4. Retain Undistributed Profits
As a business owner, you may have heard about the strategy of retaining undistributed profits within your company, and for good reason. By keeping a portion of your company's earnings within the business, you have the ability to take out cash as needed, while also taking advantage of tax planning options.
Retaining undistributed profits can help your company maintain financial stability, invest in new opportunities, and weather economic downturns.
Additionally, it can offer tax advantages deferring taxes on those earnings until they are distributed, which may result in lower tax rates for both the company and its shareholders. Ultimately, by retaining undistributed profits, you can maintain more control over your business's finances and position yourself for long-term success.
5. Effective Inheritance Tax Planning
Inheritance planning can be a complex and emotionally charged process, but incorporating a company into your strategy can offer numerous benefits. By transferring assets and wealth into a company, you can structure your inheritance plan to ensure a smooth transition of ownership and minimise tax liabilities for your heirs.
A well-crafted inheritance plan through a company such as a family investment company can also protect your legacy by shielding your assets from potential creditors and legal challenges. With careful consideration and guidance from legal and financial experts, you can develop a comprehensive and effective inheritance plan through a company that meets your specific needs and goals.
If you want to know more about Pros and cons of buying property through a limited company.
In short, we see more landlords setting up a property company to save short term and long-term money.
All the properties in your property business portfolio is under your name, is there a way you can transfer the properties into the company? And are the tax implications on the transfer?
Lets have a look!
Considerations for Transferring Properties to a Limited Company
A typical tax implication when transferring properties into a limited company is that it attracts Capital Gains Tax for seller (in this case the individual) and Stamp Duty Land Tax for buyer (in this case the company.)
Let us look at this in detail.
Capital Gains Tax
Capital gains tax is like a government fee you pay when you sell something that has gone up in value, such as a house or stocks. It's like a way for the government to say "hey, you made a profit, so we're going to take a little cut of that".
The capital gains tax is calculated by subtracting the purchase cost and any capital items from the sales price. There are some reductions you can make such as Annual exemptions.
If you want to know more on this you can read our complete article on Capital Gain Tax. Like any other capital transfer or sale you will need to pay capital gains tax on transfer of properties into the company.
I know, I know you did not come this far to hear that “Look you have to pay your taxes.”
There are legal ways to reduce capital gains tax for property businesses. One we are about to discuss later in this article is Incoporation Relief.
Stamp Duty Land Tax
Stamp Duty Land Tax (SDLT) is a tax that you must pay when you buy a property in the UK.
It's like a fee that the government charges you for the privilege of owning a property. The amount of SDLT you must pay depends on the value (the consideration) of the property, and the more expensive the property is, the more you have to pay.
You Asked !
You just said that stamp duty land tax depends on consideration does that mean if I transfer my property into a limited company with no consideration there is no Stamp duty land tax?
Basically, when a property is transferred to a company, the SDLT is calculated based on the market value of the property, not just the amount that the company paid for it. So, even if the company only pays a chargeable consideration of £150,000 for a property that has a market value of £300,000, the SDLT will still be calculated based on the higher value of £300,000.
SDLTM09835 states that if you meet both Condition A and Condition B for at least one of the dwellings, the higher rates of SDLT will be applicable.
We Answered !
You Asked !
What do you mean by Condition A and Condition B?
Condition A means that the dwelling, or a major interest in it, must be purchased for a chargeable consideration of £40,000 or more.
Condition B stipulates that the chargeable interest acquired cannot be subject to a lease that has more than 21 years remaining on the date of purchase.
And we all know in most cases when you purchase the property the market value is more than £40,000. Hence, in most cases if company purchases a property not only is the property valued at market value it is also charged at higher SDLT rates.
This means that if you're considering transferring a property to a company, it's crucial to carefully weigh up the potential costs and tax implications to ensure that you're making the right financial decision. As a tax advisor, I would always recommend seeking professional advice to ensure that you're fully aware of all the tax obligations and potential pitfalls involved.
We Answered !
Look no further, if you want to know more about Stamp Duty Rates, you can read our Stamp Duty Rates 2022/23 article, where we have listed everything.
I understand that you're probably tired of hearing that age-old advice of "you have to pay your taxes." But the good news is, like in case of capital gains taxes there are legal ways that can reduce your SDLT this is where transfer of partnership business into the limited liability comes in.
Let’s call this partnership incorporation moving forward and move to the exciting part, how do we save taxes?
Save CGT and SDLT on transfer to company with partnership!
In the world of business transfers, the concept of moving from an individual to a company might seem straightforward, but there's a twist - introducing the partnership model.
Why partnership you may ask? Why not transfer the business from an individual to a company?
The answer is to be eligible for both stamp duty land tax relief and incorporation relief i.e., relief for capital gains tax.
Before we dive deep into partnership let’s look at the reliefs first!!
Incorporation relief basically helps you to defer your capital gains tax. During transfer of business to a company instead of having to pay the capital gains tax immediately; incorporation relief transfer the liability to shares.
Well, how does this work?
Incorporation relief is guided by Taxation of Chargeable Gains Act 1992 section 162.
In simple words, this section states that if you (individual sole trader or partnership) transfer your business to a company in exchange of shares in return, you might be able to get some tax relief. This only applies if you transfer the whole business, including everything it owns, except for cash. The business must also be transferred as a "going concern," meaning it will continue to operate under the new ownership.
The capital gains that would have otherwise been realised on the disposal of the chargeable capital assets are effectively held over into the value of share consideration issued to the transferors by the acquiring company through the application of incorporation relief.
As the deferred gain is rolled over, it is deducted from the base cost of the shares. When the shareholder sells his company shares, the gain will be charged.
If you want to know more about incorporation relief you can read our article Incorporation Relief for Landlords: All You Need to Know
Stamp Duty Tax Relief
As discussed earlier if a property is transferred to a limited company higher rate stamp duty land tax applies on the market value of the property. So simply gifting the property to the company will not help you avoid stamp duty land tax.
However, if you are transferring your property from a partnership to a limited company you might be able to get stamp duty land tax relief.
If you are transferring, you whole business from a partnership to a limited liability company in exchange for shares; this shall be transaction between connected persons for Stamp Duty Land tax purposes.
This transaction would be guided by Schedule 15 of Finance Act 2003 transfer of chargeable interest from a partnership: Sum of Lower proportions.
In order to make sure you are eligible for both stamp duty land tax relief and incorporation relief it is very important that the partnership business is legitimate during the time of transfer.
This brings us back to partnership.
What Is Partnership?
A partnership is formal arrangement by two or more partners to manage and run a business with view of sharing profit.
HMRC manual PM120100 states, a partnership is a business relationship between people who work together with the goal of making a profit. This can include individuals, companies, and other organisations. The partnership is created through an agreement, either written or oral, and there is no limit to the number of partners who can be involved.
While partnerships are not considered legal entities in England, Wales, or Northern Ireland, they are still recognised as "persons" for tax purposes. This means that partnerships are subject to the same tax laws as individuals and corporations.
So, does this mean you can have a partnership without an agreement?
When you are transferring the property to a limited company and dealing with HMRC you need to make sure the partnership is a legitimate one.
Partnership agreement though not compulsory helps provide structure to partnership in written form which makes the whole setup even more structured and systematic.
This written document can help act as strong evidence to assess whether the partnership is legitimate.
How do we know if a partnership is legitimate?
Whether or not a partnership is legitimate depends on the intention of the parties.
As discussed earlier partnership agreement can act as an evidence showing partnership is a legitimate one.
Besides this there are other legal requirements a partnership business needs to follow when it is established such as:
- Notifying HMRC of incorporation of partnership;
- Submission of partnership return on timely basis;
- In case of rental business having tenancy agreement between the partnership and tenants and so on.
What are the requirements for partnership business to be legitimate?
If we go back to requirements for incorporation relief, it is clearly mentioned “transfer of business to a company in exchange of shares in return,”. Therefore in order to be eligible for both stamp duty land tax relief and incorporation relief it is not only important to have a legitimate partnership; that partnership should also be running a legitimate business.
One of the very famous case law on whether business exist is “Ramsay vs HMRC” where key indicators of a business were set out, some of the key indicators were:
- Is the activity a ‘serious undertaking earnestly pursued?’
- Is there an occupation or function actively pursued with reasonable or recognisable continuity?
- Is there a certain measure of substance regarding turnover?
- Is the activity conducted in a regular manner and on sound and recognised business principles?
- Is the activity predominantly concerned with the making of taxable supplies to consumers for consideration?
- Is the activity of a kind which, subject to differences of detail, commonly made by those who seek to profit by them?
If you want to more about this topic we have a detail article dedicated to this topic “Does Your Business Qualify as a Partnership Business?”.
Frequently Asked Question
Here we need to look at the legitimacy of partnership.
As discussed earlier in this article we need to see things such as : have we notified the HMRC? Have the legal requirements to have a partnership in place filled?
Though there are no any such fixed requirements by HMRC we suggest our clients minimum five properties.
As discussed above there are various advantages to transferring properties to a limited company such as:
- Limited liability in company,
- Payment of corporation tax in company as opposed to income tax which in general higher.
- Mortgage interest is fully deductible in company.
- Companies can retain undistributed profits.
Yes, you can but I would suggest taking help from legal tax advisors so that the partnership fulfils legal requirements which you might not be aware of.
There is no restriction on transfer of liabilities for incorporation relief, though transfer of borrowings from individual to partnership might attract some issues with mortgage provider regarding borrowing terms.
Our team has written detail article which might provide some guidance for your problems: Incorporation for Landlords: Understanding Transfer of Liabilities.
Incorporating a limited company for your business can offer numerous advantages, including tax efficiency, protection of personal assets, and increased credibility.
This article has highlighted the benefits of transferring from a partnership to a company and the considerations involved in making this switch. By setting up a limited company, you can benefit from lower corporation tax rates, fully deductible mortgage interest, limited liability protection, and effective inheritance tax planning.
Retaining undistributed profits within the company allows for financial stability and tax planning options. However, transferring properties to a limited company comes with tax implications such as Capital Gains Tax and Stamp Duty Land Tax. To mitigate these taxes, partnership incorporation relief can be utilised. By transferring the partnership business to a limited company in exchange for shares, one can take advantage of incorporation relief and potential stamp duty land tax relief. It is essential to seek professional advice and ensure the legitimacy of the partnership when considering these transfers.
If you are a sole trader or in a partnership and are considering to transfer property business into limited company, it is crucial to understand the benefits, challenges, and tax implications involved. Consult with a tax advisor or professional to assess your specific situation and determine the best course of action.
Looking for trusted property accountants and tax advisors? Look no further! At UK Property Accountants, we specialise in serving landlords, investors, and property businesses.
Optimise your finances and make informed decisions with proper tax planning and professional advice. Contact us now!
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