Why standalone limited companies are a bad idea and the ‘BTL landlord incorporation bear trap’

Back in 2015 the then Chancellor of the Exchequer (George Osborne) announced proposals to restrict the tax relief that buy to let landlords are entitled to claim on their mortgage interest.

He argued that the measure would “create a more level playing field between those buying a home to let and those buying a home to live in”, although he took the view that the way that this change was being implemented was “proportionate and gradual … because I know that many hard-working people who have saved and invested in property depend on the rental income they get.”.

It was also reported that he wanted to ‘professionalise’ the sector by encouraging private landlords to incorporate their portfolios and be proper businesses wherein they could still offset 100% of their finance costs.

We all now know this measure as S24, and by the time the restriction began to manifest itself in landlords’ tax returns, it was estimated that the Exchequer would be £225m better off in the 2018/19 tax year, £430m in the 2019/20 one, £655m in the 2020/21 tax year and by the time it was fully phased in at the 2021/22 tax year the Treasury would be a whopping £940m better off in that year alone.

At the same time as the Chancellor was taking millions with one hand, he was apparently giving even more back by allowing those buy-to-let landlords who did opt to ‘professionalise’ themselves by becoming standalone limited companies by granting them full deductibility of their finance costs, thus causing the Treasury to lose money in the short-term by doing so.

What no one noticed was that at the same time as George Osborne introduced S24, he brought in another measure which, although on the surface was only aimed at larger Corporates with de minimis interest costs of £2m net (known as the Corporate Interest Restriction), allowed him to hide in plain sight what has become known as the ‘BTL landlord incorporation bear trap’.

For the history buffs amongst us, it was following the end of the Napoleonic War in 1815 that the government of the day wanted to retain income tax in peacetime, which up until then had only been imposed during wartime, to help it reduce the National Debt, which had swelled to over £700m at 1815 values.  A year later, and as a direct result of massive public outcry and lobbying, the government was narrowly defeated on the issue and was forced to abandon it.

By the early 1840s business opinion had moved considerably towards ‘free trade’ and the removal of high protective duties on imports and exports, and Sir Robert Peel, the then Prime Minister, was keen to facilitate this thinking.  In 1842, therefore, he re-introduced income tax at 7d in the pound on incomes over £150, which allowed him to remove import and export duties on more than 700 items.

The reimposition of the tax – this time as a peacetime measure – was only meant to be temporary.  But the increasing cost of government commitments, pushed up by the Crimean War of 1853-56, made this an increasingly remote prospect, and income tax has remained ever since.

Move forward to the present day and change the Napoleonic and Crimean Wars to the COVID-19 pandemic creating an unprecedented national debt of some £271bn, and Free Trade for Brexit, then you can bet your bottom dollar that the money will be clawed back at a premium sooner rather than later when Rishi Sunak finally springs George Osborne’s not so cunningly disguised ‘BTL landlord incorporation bear trap’.

So what does all of that mean in today’s world and why, regardless of whether you are a basic, higher or advanced rate taxpayer, transferring your personally held BTL portfolio into a standalone limited company makes no sense whatsoever.

The Practical Costs

Whilst not in themselves direct costs, being a commercial borrower impacts you in the following ways: –

• incorporation is an all or nothing option, and a virtual one-way street with no economic way back
• significantly reduced choice of lenders and generally higher interest rates
• none are keen on BICTs (Beneficial Interest Company Trusts) as they fundamentally weaken the lender’s ability to pursue the debt
• full personal joint & several guarantees from all the directors and shareholders (if the company goes bust you remain responsible for the debt)
• some lenders will take a debenture (legal charge) over the company’s balance sheet, which restricts your ability to use your director’s loan account if at all
• you’re most likely tied in to the first lender and their appetite for further lending, if any, meaning that each new acquisition or remortgage may need a new lender and a new company with all the associated costs
• if property prices fall, thereby increasing the loan to value beyond the point to which the lender originally agreed, you may have to find the cash difference
• restrictions on what you can borrow for, i.e. remortgage to fund lifestyle.

The Transactional Costs

Moving ownership from your name to a limited company means a change of legal title and thus an almost certain requirement to remortgage or move to a new lender, with associated costs such as: –

• the value of your time (even if you don’t measure it, your time has a monetary value to your business)
• CGT and SDLT if you don’t qualify for S162 Incorporation Relief (HMRC no longer give pre-clearance meaning that you won’t know now until it’s too late, which can be two years off)
• losses cannot be carried forward
• early redemption charges
• brokers fees, lenders fees, legal fees etc
• likely breach of mortgage terms and conditions if using BICTs
• tenancy agreements, insurances, HMO licences and all other contracts
• no realistic/economic way back without re-incurring the above plus no relief from CGT and SDLT.

The Tax Costs (2020/21)

Limited Companies and the individuals within them are taxed up to seven different ways: –

• Corporation Tax (19% but could be uplifted for ‘property/investment’ companies, as was CGT for individuals – the George Osborne incorporation bear trap)
• Capital Gains Tax on personal withdraws of capital resulting from selling assets (up to 28%)
• Directors Loan Account Tax (32.5%) very short duration bridging loans where the money never leaves the conveyancer’s client account(s) and has no obvious commercial purpose is tax avoidance!
• Dividend Tax (7.5%, 32.5%, and 38.1%)
• Income Tax (20%, 40%, 45%, and 60% on the slice between £100,000 and £125,000)
• Employees and Employers NIC (12% and 13.8% respectively)
• Inheritance Tax (40% – ‘investment’ companies, i.e. those that hold residential property for 12-months or more for the sole purpose of collecting rents are fully subject to IHT)
• So called ‘Freezer Shares’ are a one-generation fix and do nothing to solve the current IHT bill.