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The imposition (or not) of tax has often been used as a tool for achieving economic and social change. But it now seems that tax is increasingly being used in an even more blatant way to influence the social and economic development of the UK housing market.
It is readily acknowledged that there is a shortage of affordable housing in the UK. As house prices continue to rise steadily, increasing numbers of people are being priced out of the housing market. This is particularly apparent when you look at falling home ownership levels amongst the under 40s. The reasons given for this unrelenting trend include a physical shortage of housing and the proliferation of buy-to-let landlords. The solution would therefore seem to be to encourage the former and discourage the latter. So it is that the last few years have seen the introduction of higher rates of stamp duty land tax (SDLT) for transactions that the Government wishes to curb and lower rates of SDLT (stemming from a change in calculation method) for those that it wants to encourage.
For those just starting out on the housing ladder these changes are to their benefit because it has lowered the overall SDLT cost and, over time, it is projected that there will be a drop in the number of buy-to-let landlords thereby freeing up more properties at the lower end of the housing market.
However, for those wanting to invest in property to rent (or even just to hold as a second property or holiday home) from 1st April 2016 there will be an additional 3% SDLT cost. This means that the entire consideration will be subject to SDLT at the following rates on a progressive basis:
It is intended that this additional upfront cost will discourage many individuals from investing in buy-to-let properties. But there may also be an unintended side effect in that those who cannot afford to purchase their first home without parental financial assistance may suddenly find parents are less willing or able to assist. This is because many parents, in lending money to their children to purchase their first home, will choose to protect their interest in the inevitably large sums of money lent by being registered as a co-owner. But the changes due to come in from April 2016 will mean that as a result of protecting their interest through co-ownership, the parents will incur the additional 3% stamp duty because it would be classed as a second property.
Industry is lobbying the UK Government to introduce into the draft legislation an exemption for parents being registered as co-owners where the child occupies the property, but at the time of writing there has been no indication of whether this will be included in the final legislation. The irony is that by introducing a measure intended to increase the number of young families purchasing their own home, the Government may inadvertently decrease the number.
Another uncertainty with the additional 3% SDLT charge is that we do not know yet whether this will apply only to individuals, partnerships and trusts, or whether it will impact on companies as well. The Autumn Statement 2015 at which the 3% was announced, expressly referred to individuals. However, whilst the subsequent consultation paper referred to individuals throughout, it did include an express reference to considering whether the additional charge should apply to companies; and if it did whether there should be an exemption for companies with a significant investment in UK property (which was suggested as 15+ properties or possibly by reference to property value). At the time of writing there is no clear indication of which way the legislation will go; we simply have to wait until 16 March 2016 for the draft legislation to be published.
As well as the increased SDLT cost for purchasing a second property, for individuals there will also be a restriction on the deductibility of interest costs which is to be phased in from April 2017. By April 2020 interest relief will only be available at the basic income tax rate of 20%; effectively cutting in half the amount of tax relief available for interest costs on loans for buy-to-let properties.
So should the aspiring buy-to-let landlord set up a company to operate the letting business through? If using a company the full interest deductibility will continue to be available and, depending upon the draft legislation, there may also be an exemption from the additional 3% SDLT charge for companies (albeit it may be attached to the requirement for there to be a significant property investment whether in terms of numbers or in terms of property value).
But as you might expect, simply incorporating your property rental business is not the tax panacea that it first appears. Although the interest deduction is given in full to companies it will be at the corporation tax rate, which at present is 20%; no different from the basic rate of income tax. This in itself is not a particular disadvantage, since the tax paid by the company will be 20%; but you then need to consider that at some point you will want to extract the profits from the company. The profit extraction will create a second tier of personal tax cost, either as income tax on a dividend or as capital gains tax on disposing of the company. Overall you would end up paying more tax. That is not to say that using a corporate structure is a “no go” for everyone; there will be some circumstances when it is more advantageous to use a company. Each individual set of circumstances is different, which is why seeking professional advice can be advantageous in the long run; it can help you to find the ownership arrangements that are the most suitable for you and can stop you falling foul of the tax anti-avoidance measures that are many and varied.
For example, if you are considering setting up a company to hold the residential property you need to consider whether you will be purchasing properties with a market value of £500,000 or more, or which are likely to fall into the category with the passage of time or following refurbishment works. This is because there was a set of tax anti-avoidance measures introduced to discourage the use of companies as holders of residential property where that property was to be occupied by the shareholders (or persons connected with them). One such measure is a punitive 15% SDLT rate on the acquisition of residential property by a company. In addition there is also an Annual Tax on Enveloped Dwellings (ATED); which as the name suggests is a yearly tax charge for as long as the property is owned by the company.
The only way to avoid these tax charges is to come within one of the exemptions, the most commonly used of which is that the property forms part of a property letting business and is not available to the shareholders (or persons connected to them) to occupy. Since this exemption exists you may therefore ask why the need to mention these anti-avoidance measures; but it is important to be aware of them in case your personal circumstances change such that either you or another family member ends up needing to occupy one of the rental properties. There is also the matter of remembering to submit an additional annual filing to HMRC in order to claim the property rental relief from the ATED charge.