The obvious advantages of incorporation are lower than income tax corporation tax rates (set to fall even further in future), the continued tax relief on mortgage interest for companies (now restricted and eventually denied to private landlords), and much more flexibility regarding the timing of the extraction of profits and hence more tax planning opportunities, with the added benefit of a £5,000 extraction tax free in the form of dividends.
However, transferring properties to a limited company has a number of tax consequences on incorporation.
Capital gains tax
Like any transfer of assets between connected parties, the transaction is deemed to have taken place at market value (MV), hence the transfer of properties from a private landlord to his/her newly incorporated company will create taxable capital gain on the landlord.
Availability of capital gains tax reliefs
The recently introduced lower capital gains rates of 10% and 20%, the entrepreneur’s relief and gift relief are not available on incorporation of a rental property business.
However, incorporation relief is likely to be available in the following circumstances:
- The rental activity is a business. This condition is met as long as the property is let on commercial terms and the activity carried out in connection with the letting is at a level typical of business, rather than a passive holding of investments (please see the relevant tax case below).
- Consideration is wholly or partly in shares (if partly, incorporation relief is available only on the proportion of the gain attributable to the share consideration). The assumption by the company of some or all debt outstanding, such as mortgages or loans to do with the letting business, is not taken to be cash consideration, so does not restrict the application of incorporation relief (statutory concession D32).
- The business is transferred as a going concern.
The relief is also available to partners where the whole business of the partnership is transferred to a limited company.
The consequence of incorporation relief is that the cost base of its shares for capital gains tax purposes is reduced by the amount of the gain relieved on incorporation, hence deferring the tax liability until the company is sold. In theory, if the company is never sold, capital gains tax will be deferred indefinitely.
Incorporation relief applies automatically, so is not claimed. If incorporation relief is not beneficial, it can be disclaimed. This is highlighted in Elizabeth Moyne Ramsey v HMRC  UKUT 266.
Transfer of properties from an individual to a company
No special relief is available for property transferred on the incorporation of an individual proprietor’s existing business.
SDLT arises on the MV of the properties transferred (s53, FA 2003), irrespective of consideration actually paid. For companies, for transactions completed on or after 1 April 2016 on which contracts were exchanged after 25 November 2015, SDLT at higher rates (3% surcharge) apply if the chargeable consideration is £40,000 or more and where the dwelling is not subject to a lease with more than 21 years left to run.
In the event that the properties transferred to the company are short leaseholds (granted for 21 years or less), multiple dwelling relief (MDR) can reduce SDLT. If MDR is claimed, higher SDLT rates apply for the purposes of the calculation and at least two dwellings need to be transferred. The total SDLT payable is calculated on the mean consideration using the relevant higher SDLT rates multiplied by the number of dwellings. The actual SDLT payable is the higher of that amount, and 1% of the total consideration.
If the portfolio transferred is made of at least six dwellings, the company can choose whether to pay SDLT at the higher rates and apply MDR, or treat the properties as non-residential and apply relevant rates applicable to non-residential properties, but without MDR.
Transfer of properties from a partnership to a company
Companies incorporated from a partnership may significantly reduce or eradicate its SDLT bill altogether, thanks to special rules granting SLDT exemption in transactions between a partnership and persons connected with the partnership (Part 3 Schedule 15 FA 2003).
Applying CTA 2010, s1122, an individual who is a partner in a partnership, and a company controlled by that same individual, are connected parties.
Essentially, as long as the controlling shareholder(s) of the company created on the partnership’s incorporation have held all of the interest in the partnership before incorporation (taking into account the individual’s share in the partnership and any of his/her relatives who were also partners), the company will escape SDLT.
However, if an individual now holding majority of shares in the company has been in partnership with unrelated individuals, it is only a proportion of the share consideration issued by the company for the properties of the partnership which will escape SDLT.
Considering the complications of incorporation, some of which are discussed above, is it worth it?
A detailed comparison of tax costs impacting an incorporated vs unincorporated business throughout its life is deserving of much extended page space than available here.
However, tax impacts alone should not determine the final decision on incorporation or otherwise. Practical considerations, such as a lender’s consent to move properties to a company, potential need for refinancing following incorporation, its cost and additional bank requirements (such as personal guarantees demanded of shareholders), are likely to influence the final decision.