Over the weekend, Rishi Sunak has leaked plans for sweeping tax hikes to two British newspapers, the Telegraph and The Sunday Times. This is in part a response to the consultation on capital gains tax earlier in the Summer. The proposals are required to plug a hole in British finances estimated to be between 20bn and 30bn left by coronavirus.
The sharp 5% rise in corporation tax to 24% will bring it back to a level not seen since 2012. Historically, a “Small Rate Profit Limit” which from 1994 to 2015 was set at £300,000 created two tiers of tax rate based on profits with a gradual increase in rate from the small rate to the full rate.
The hope is that any rises in corporation tax will mirror this historical system of corporation tax. A blanket rise in the rate would result in a strong tax justification for operation as an unincorporated business rather than a company. This is because there is little tax difference between the two structures as it stands. The resultant disruption of disincorporation will be unwelcomed for small businesses and contractors, many of whom are trying to get back up and running after lockdown.
Capital gains tax
The other proposal was an increase in capital gains tax. The leaked report targets owners of residential property which is not exempted by principal private residence relief. This will mainly be landlords and owners of secondary property. A reduction in supply of rental property could bring about rises in rent at a time when the unemployment impact of lockdown is most sharply experienced - by the least well off.
The idea is to make gains taxable at the same marginal rate as income. This was broadly the system of tax in the UK from 1988 to 5 April 2008.
The final proposal, which affects tax relief on private pension contributions is possibly the least prudent. The consequences of disincentivising pension saving could be to increase the dependence of an ageing population upon the state.
A competitive advantage gained in the UK through less severe fiscal measures should be considered by the Revenue as an alternative strategy for debt reduction.
Likely the proposal will be effective from 6 April 2021 and so there is still time to increase pension contributions prior to that date.
For landlords and other property owners contemplating a sale, the following months could be opportune while demand is supported by a stamp duty holiday.
For contractors and other small business owners it is too soon to recommend moving the business out of a company. The announcement will almost certainly come in the Autumn Budget and there will probably be time to prepare arrangements ahead of the introduction of any new rules. It is likely that- in the current climate- the Treasury will seek to deaden the impact of any shock measures.
Many buy-to-let landlords purchased property in their own names or jointly with a spouse at a time when there was no restriction on the deduction of mortgage interest. At the point of purchase, the tax case was usually tipped in favour of private ownership. However, changes in cash flow requirements and in regulation has lent more credit to the proposition of using a corporation vehicle for the property. Bringing the discussion up to date, this article examines the case for transferring a property to take benefit from the stamp duty holiday.
Capital gains tax on transfer of property into a company
Leaving aside the tax implications of private ownership as compared with property ownership through a company, many existing landlords are put off by the proposal of transaction costs. The transfer is treated as a disposal for capital gains tax purposes and an acquisition for stamp duty purposes.
With London values moving little if anything since the referendum, the capital gains tax implication could be negligible. If the property used to be a former residence there could be a case for banking any PPR relief before it is further eroded over time. Principal private residence relief is so much of the gain as relates to the period in which the property was occupied. Therefore, the percentage time in which the property was the owner’s home reduces over time. Consequently, the tax-free portion of the gain reduces with every month that the landlord does not occupy the property. This is particularly punitive where prices are static or falling. At least in a rising market the amount of tax relief, in real terms, tends to rise.
Stamp duty on company purchasing property from a landlord
Stamp duty land tax (SDLT) on acquisition by the company is a further disincentive for landlords to transfer their existing stock into company ownership. However, this tax barrier is liifted by a stamp duty holiday, as announced by the chancellor, on properties with a value up to £500,000. The 0% rate of SDLT applies to purchases of residential properties between 8 July 2020 and 31 March 2021 inclusive.
In London, many ‘accidental landlords’ who let the first flat they bought will be well placed to benefit from the holiday.
Pitfalls of capital gains tax on eventual disposal
The main drawback to having a property in the company is the ‘double tax charge.’ When the property is eventually disposed of by the company, any gain would be subject to corporation tax. The rate of corporation tax is currently 19%. Extraction of that gain by the shareholder would be again taxed at 20%. The rate of 20% applies to the extent that the shareholder is a higher rate taxpayer. This is because shareholders of a property investment company are not eligible for entrepreneur’s relief.
Therefore, the landlord would be liable to personal tax at 20% profits after corporation tax. The CGT of 20% applied to post tax profits of 81% gives a resultant rate of 16.2%. The overall capital gains tax rate of 35.2% applies to disposal of investment property in a company. This compares to a tax rate of 28% on disposal of the property which is not transferred into a company.
Tax savings on mortgage interest
There is a restriction on the deduction of mortgage interest from taxable profits. From 2020-21, only 20% of mortgage interest is available as a tax reducer. By contrast, mortgage interest can be deducted from company profits in full. The mortgage interest reduces both corporation tax and income tax, because it lowers funds that would otherwise treated as dividends.
To the extent that the landlord does not have other dividend income, the dividend allowance of £2,000 would be available to further reduce income tax exposure. Where the landlord shares household bills, for instance with a spouse or other cohabitee, it could be practical to add that person as a shareholder and further extend the £2,000 annual exemption from income tax. To the extent one shareholder is a higher rate taxpayer, the dividend of £2,000 would otherwise be taxed at 32.5% or £650. Further savings could be achieved within the limit of one shareholder being a basic rate taxpayer and the other not.
The shareholder could also consider accumulating funds in the company to be extracted as a capital gains on disposal of the company. This strategy carries a cash flow penalty but brings about eventual savings of 10% personal tax.
A prospective landlord weighing up a transfer of property should consider the increase in annual accounting cost associated with operating the investment via a company. Coman & Co provides fixed fee pricing for a limited company.
The tax points outlined in this paper are based on current rates. The Chancellor has ordered a review of capital gains tax. In general, where tax planning spans more than one tax year the rates above can change. Once issue to consider is that the tax regime for properties owned by companies could change, and market conditions (or tenancy agreements) may be such that it is not possible to close the company in time to escape any such changes.
Where the landlord owns more than one property, consider one company per property. The reason is that cash from any capital gains can be extracted without having to sell both properties. Accounting costs will increase incrementally with the number of companies used.
Where the strategy is to reinvest rather than to extract cash for other purposes, a company carries the additional benefit that the capital gains tax is limited to corporation tax.
A company is better suited to property that is expected to have high yield but less capital appreciation. History shows that prestige locations, for instance in London, tend to outperform in times of growth. Holiday lets, houses in multiple occupation, bedsits, student accommodation and Airbnb tend to produce higher yields. Where the proposition is closer to a bed and breakfast or hotel there is even the possibility of keeping entrepreneur’s relief intact which adds to the tax case for a corporate structure.
A company could be better suited to a consortium type arrangement where a greater portion of each member’s share is below the dividend allowance.
Company owned property could lend itself well to the passing of wealth down the family line or among family members. The company provides a mechanism for ownership portions to be changed without affecting the land title. The tax permutations widen with the number of members involved.
Tax advisory service
Coman & Co can estimate the tax impact of different scenarios with which to inform decision making in this area. Some basic forecasting can be carried out for no additional charge.
The Chancellor has commissioned a review of Capital Gains Tax from the Office of Tax Simplification. While nothing has been confirmed, the expectation is that the government’s tax take is on the up. Costs to the UK economy of Cov19 has left the UK with a deficit well above pre-lockdown expectations. Estimates for the 2020-21 budget deficit vary widely. The office for budget responsibility forecasts around 300 billion pounds. The highest since 1945.
Having a manifesto pledge of no rises in income tax, VAT and national insurance, it is near inevitable that outcome of the review be increases in capital gains tax. The nil rate band for inheritance tax has not increased since 2009-10 and has therefore been saddled by hefty fiscal drag. The rate of tax of 40% already leaves many estates in London and the South with selling the family home.
Two Budgets have been scheduled this year. Announcements about capital gains tax are likely in the Autumn Budget. Possible reforms are surmised below.
The largest group concerned will be landlords letting their prior residence. Reform would reduce the population of ‘accidental landlords.’ This type of landlord opts to let rather than sell property when moving home. The practice was commonplace during the period of rapid rises in property prices, especially in the UK’s hotspots, and prior to tax reforms targeted at landlords. In recent years, the trend is to increase regulation on landlords about pressure on government to make housing more affordable. With the average age of first-time buyers rising and the pound at historic lows there is sufficient pent up demand to support changes to PPR.
Deemed periods of occupation
The final deemed period of occupation has been reduced twice recently: from 36 months to 18 months on 6 April 2014 and again to 9 months on 6 April 2019. The benefit of a further reduction would unlikely be outweighed by the hassle it would put to house movers. The relief is intended to accommodate the situation where a homeowner temporarily holds two properties to facilitate moving or due to a setback in the disposal of the former home.
A further deemed period covers temporary periods of absence, for instance where the homeowner is seconded elsewhere or otherwise unable to live in their home, such as due to jailtime. It excludes any period in which the individual had another property that qualified as a PPR. It is also a requirement that there is an actual period of occupation both before and after the period of absence. While the deemed period of absence is capped at four years for individuals relocating within the UK, there is no time limit for overseas workers. With an increasingly globalised workforce, this regulation could be regarded as out of date. Following the Budget, the concession could be significantly reformed or simply scrapped.
An increase in basic and mainstream rates (from 10 percent and 20 percent, respectively.) As recently as 2007/08 capital gains tax was charged at the highest rate of income tax, which at the time was 40%;
Entrepreneurs' relief for contractors
Rumours about a scrapping of the relief were circulation following a consultation prior to the 2018 Budget. Instead the relief was reformed with the minimum holding period extended to two years. Recent government focus on entrepreneur’s relief suggest that it is on the radar. Removal of entrepreneur’s relief would have significant ramifications for contractors who have accumulated funds in their business as a form of long term tax planning.
Rebasing for non-resident property owners
Non-residents are currently exposed to capital gains tax about appreciation in their residential property assets since 6 April 2019. This contrast with UK residents who are subject to gains accruing over the entire period of ownership. Rebasing allows non-residents to gain considerable reduction in exposure to CGT as compared to a UK resident.
Consequently, an emigrant can obtain a capital gains tax free uplift in value of their asset by rebasing. This would be applicable, for instance, on buy to let property. Unlike the old rules, rebasing is not disapplied for temporary non-residents. Therefore, an individual could move for a contract of employment lasting a year, dispose of their property while non-resident and return to the UK avoiding considerable taxation.
By contrast, a non-resident who purchases a property prior to 5 April 2019 and moves to the UK after 6 April 2019 cannot re-base. An immigrant could face a substantial tax ‘penalty’ on moving to the UK. Property owners, as such likely to be wealthier on average, are discouraged from residing in the UK because of existing legislation.
Regulation should adjust to an increasing mobile and globalised population, to tax assets in the country in which these assets are located rather than the country in which the person finds themselves resident on the date of disposal.
The use of market valuation is impractical and open to abuse as compared to transaction values recorded with the land registry. The system relies on valuers commissioned by the property owner. Property owners who leave the UK may not have been aware of their future residency at 6 April 2019. Justifiably, this group would not have had a revaluation at 6th April 2019 and will rely retrospective valuations which have even less inherent reliability.
Pension and ISAs
Pensions have already been speculated upon a likely area that The Chancellor will turn to plug the financial hole left by lockdown. The exclusion of certain assets from pension funds would limit the tax shelter. Commercial property is an obvious example. A requirement for pension funds to rebase property would be easier to enforce than a rebasing directed at individuals. With high street values depressed, the longer-term potential for government revenue would be enhanced. Classic cars, racing horses, gold bullion and various other exempt assets classes could be brought into charge, although the effect on budget deficit would be comparatively minor.
Typically in a Budget, certain taxes take effect immediately, most tend to come into force from the tax year following that of the Budget, some reforms are phased in or scheduled further into the future. Changes that take effect on Budget day tend to relate to indirect taxes, VAT, stamp duty and other levies.
Likely there will be time to make changes before 6 April 2021. A benefit could be achieved by bringing forward a charge to capital gains tax, so that gains are released in 2020-21. Post-tax proceeds from asset transfers will be affected both by fiscal policy and the effect that policy holds over values. Where house prices are concerned a short-term advantage could be gained by incentives created in the market by the stamp duty holiday.
The Stamp Duty Land Tax threshold will be temporarily increased with effect from today and until 31 March 2021. The value at which residential property is taxed will be rise from £125,000 to £500,000 during this holiday period. This was an attempt to address the reported 50% slump in house transfers throughout May.
Green Homes Grant
Starting in September landlords and homeowners will be able to apply for a grant to make their homes more energy efficient. The grant will be used to cover two thirds of the cost of works up to £5,000 per household. Certain low-income households will obtain a higher grant of the full cost up to £10,000. The funds can be used on insulation, double glazing, energy efficient doors and the like.
Job Retention Bonus Programme
The government put in place an incentive for employers to retain staff after furlough ends. The Treasury will pay employers a £1,000 grant per employee who is still employed on 31 January 2021. It is a requirement that the employee has been earnings at least the monthly lower earnings limit of £550 on average between the end of the Coronavirus Job Retention Scheme (30 November 2020) and 31 January 2021.
Eat Out to Help Out
Throughout August 2020, every Monday, Tuesday and Wednesday, the government is offering an incentive for people to eat out. Restaurants will be able to obtain a subsidy for 50% of food costs capped at £10 per person. Participating diners in the UK can obtain the grant for eat-in meals and non-alcoholic drinks. The claim is made weekly and paid within five days.
Reduced rate VAT for hospitality
The rate of VAT within the hospitality sector will reduce from 20% to just 5%. Lower rates will apply to food and non-alcoholic drinks from eateries, accommodation from hotels and B&Bs and attractions such as zoos, theme parks and cinemas. The VAT cut will operate from Wednesday 15th July until 12th January 2021.
As a consequence of lockdown, long term unemployment is a higher risk for 16-24 year olds on Universal Credit. The government will therefore cover the cost of hiring individuals in this group for up to six months. The subsidy is up to the national minimum wage for the first 25 hours per week and any related national insurance on those wages.
In a related move, the government has pledged to subsidise the cost of training new employees. An employer will receive a grant for each new trainee hired between August and January. The grant is £2,000 per trainee aged between 16 and 24 and £1,500 per trainee aged over 25.
Announced yesterday, the Chancellor has extended self-employment income support scheme (SEISS) and furlough of employees until October. The extension, according to Mr Sunak, makes the UK government covid response “amongst the most generous in the world.”
The initial SEISS covered self-employment for the three months to 30 June. Applications for this grant will remain open until 13 July 2020. Further information can be found in the summary on Self-Employed Income Support Scheme. By way of recap the grant is 80% of three months’ profits, subject to a limit of £2,500 a month.
As second grant will be available from August in which self-employed individuals will be able to claim 70% of profit for an average three months. The payment will be subject to a monthly limit of £2,250. This equates to an overall limit of £6,750 for the three month period.
Employers are able to obtain support for the cost of paying their staff who are not able to work because of the enforced lockdown conditions. However, the government plan will relax the lockdown in stages and alongside those measures taper grants. Currently, employers can reclaim 80% of the salary of any employees who have not been able to work due to Covid. The reimbursement is capped at £2,500 a month; however, the state will also fund employers NIC and pension obligations related to furloughed pay.
That coronavirus job retention scheme will continue in June and July 2020. It is hoped that with continued falls in the rate of infection more will return to work and in tandem the number furloughed will decline.
From August, the government will no longer cover employers’ NIC and nor help towards paying for occupational pensions.
In September, the government will help towards only 70% of the pay for furloughed employees and will reduce the cap to £2,187.50. Employers will be expected to pay the additional 10% of salary.
From October, an employer of a furloughed staff member will only receive compensation of 60% of their pay. The reimbursement amount is to be capped at £1,875. Until 1 September any top up of pay beyond the government reimbursement is voluntary. In September and October, the 10% and 20% payments will be a statutory requirement.