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Written by: Kate Aitchison

Kate Aitchison

Director, Private Client Tax

Incorporating a problem?

The incorporation of property businesses has been increasingly popular since the restriction of tax relief on mortgage interest for higher and additional rate taxpayers. Where a bona fide property business is being carried out, a tax efficient incorporation can often take place without incurring a capital gains tax (CGT) charge by relying on incorporation relief.

For the relief to apply, all the assets of the business (apart from cash) must be transferred to the company in exchange for shares. Whilst cash is the only asset which can be left out, the taxpayer can also leave out some or all of the business’s liabilities to the company without compromising the relief.

However, care must be taken where liabilities are transferred to the new company. HMRC regard the transfer of debt as additional consideration and may therefore restrict the availability of incorporation relief. However, a statutory concession (ESC D32) may apply to prevent this tax issue where, broadly, the liabilities transferred are the same in the hands of the individual as in the new company, i.e. the liability is taken over.  

Due to the difficulty of the rules and practical complications of undertaking an incorporation of a property business, many may not fully appreciate how debts should be transferred to a company as part of this process and may inadvertently fail to meet the criteria set by HMRC. As lenders have set more restrictive lending criteria, lenders may insist that the new company takes out a new mortgage, which is then used by the individual shareholders to clear their existing loans. Whilst in practical terms the end position looks no different to a legal novation of the debt, the payment of cash could constitute non-share consideration for the business. Any element of non-share consideration could restrict the relief available and give rise to a capital gains tax charge.

Whilst this looks like semantics, it could have a significant impact on portfolios which are heavily geared and where individuals have not engaged to obtain specific tax advice. In broad strokes, there could be a significant undisclosed capital gain taxable at 28% and a non-filing issue where this has not been reported to HMRC.

There are potentially a number of landlords who have relied on receiving this relief without understanding the full implications of the lending structure, leaving them with a potentially significant, unreported and unintended liability. Those looking at undertaking this planning now need to tread with caution.

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