New tax returns individual v company

tax relief

New tax returns individual v company

With tax returns now due for 2017-2018, your landlord clients are starting to experience the financial impact of recent tax changes. This is likely to trigger a conversation about whether or not they should consider holding their investment in a limited company, so what are the considerations?

Counting the cost of the changes

In the past, private landlords were able to claim back the interest they paid on their buy to let mortgages on their Income Tax returns and landlords in the higher 40% and 45% tax brackets could also claim tax relief at this higher rate.

However, this tax relief is being phased out over the next four years and from April 2020 tax relief can only be reclaimed at the basic rate (20%).

Here’s an example of what this tax change could mean for a buy to let property worth £150,000 that is rented out for £750 a month and owned by a private landlord in the 40% tax bracket, whose mortgage interest payments are £450 per month.

Before April 2017

  • Annual rental income: £9,000
  • Mortgage interest: £5,400
  • Taxable profit: (£9,000 – £5,400) = £3,600
  • Tax due: (40% of £3,600) = £1,440
  • Net profit: (£3,600 – £1,440) = £2,160

From April 2020

  • Annual rental income: £9,000
  • Mortgage interest: £5,400
  • Taxable profit: (40% of £9,000) = £3,600
  • Mortgage interest relief: (20% of £5,400) = £1,080
  • Tax due: (£3,600 – £1,080) = £2,520
  • Net profit: (£9,000 – £5,400 – £2,520) = £1,080

This is a basic example that doesn’t include other associated costs or account for other considerations in the landlord’s tax return, but it does demonstrate just how significant the changes can be to an investor’s bottom line.

How does becoming a limited company make a difference?

Limited companies pay Corporation Tax, not Income Tax, and by April 2020 Corporation Tax rates will be just 17%.

Using the same example as above, the tax liability if the same buy-to-let property was owned by a limited company in 2020 would be:

  • Annual rental income: £9,000
  • Mortgage interest: £5,400
  • Taxable profit: (£9,000 – £5,400) = £3,600
  • Tax due: (17% of £3,600) = £612
  • Net profit: (£3,600 – £612) = £2,988

In this scenario, the same property is generating almost three times the net profit, just because of the different tax and ownership arrangements.

Things to consider

Owning a buy to let investment with a limited company may be more tax efficient, but there are a number of considerations.

  • Taking an income
  • When a limited company owns the properties, the limited company also owns the profits – so landlords will probably have to pay income tax on any money they’re paid by their limited company.

Limited companies, must keep accounts detailing all income and expenditure, and all purchases using company money must have a demonstrable benefit to the business.

  • Transferring ownership of the properties

When a landlord registers as a limited company, the company must have legal ownership of the properties in the portfolio. They can’t simply transfer them – they must be sold by the landlord to the company, at the market rate.

As such, they may incur several costs in the process – including early repayment fees on any mortgage, Capital Gains Tax, and Stamp Duty.

In addition, any mortgages will also need to be in the name of the limited company, and some buy to let mortgage providers may not allow limited companies to use their services.

  • Selling a property

Limited companies don’t pay Capital Gains Tax, but any increase in the value of a property is viewed as profit when the property is sold, with Corporation Tax due.
Most individuals liable to pay Capital Gains Tax get an annual allowance, (£11,700 in the 2018/2019 tax year) and only pay on gains above this amount, whereas Corporation Tax is payable on the entire profit.

So, for example, assume a buy to let property is sold with a capital gain of £27,000 in 2020, and assume the Capital Gains Tax allowance doesn’t increase between now and then:

  • A basic-rate taxpayer would pay £2,754 (18% of £15,300)
  • A higher-rate taxpayer would pay £4,284 (28% of £15,300)
  • A limited company would pay £4,590 (17% of £27,000)

In these instances, limited companies are worse off. However, this may be reversed on properties with larger capital gains, because the lower rate of Corporation Tax may outweigh the tax-free allowance.

The importance of specialist advice

These considerations demonstrate that every client and every investment is different, and a limited company may not necessarily be the best approach for everyone. It’s important they you understand your client’s individual circumstances and plans, and that you partner with a specialist tax adviser who will be able to talk through their individual position and liabilities.

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