His Majesty's Revenue and Customs (HMRC) has acknowledged the existence of a scheme that is currently being promoted as a tax planning option available to individual landlords for structuring their property businesses.
This scheme, sometimes referred to as a hybrid business model, makes the following claims:
- It allows for the circumvention of restrictions on mortgage interest relief, thereby enabling greater deductions for mortgage interest.
- It reduces the tax liability on profits generated by the property business.
- It minimizes Capital Gains Tax obligations when properties are sold.
- It lessens Inheritance Tax liabilities upon the landlord's demise.
- However, HMRC's official stance is that this scheme is ineffective. They have requested that we inform our readers that individuals who employ these arrangements may find themselves liable for more taxes than they initially sought to avoid. Additionally, they may face interest charges, penalties, and substantial fees for using such schemes.
Official Statement from HMRC:
How the Scheme Claims to Operate:
The scheme aims to reduce tax burdens by allowing individual or joint property landlords to transfer their properties to a limited liability partnership (LLP) with a corporate member. The LLP then allocates profits to its members at its discretion.
The claimed operational process of this scheme is as follows:
- Individual landlords or their family members establish a limited company.
- Concurrently, the individual landlords establish an LLP alongside the limited company, with the limited company acting as the corporate member.
- The individual landlords then transfer their properties to the LLP.
- The members of the LLP, which include the individual landlords and the corporate member, allocate the LLP's profits to themselves based on their discretion. This allocation ensures that:
Individual members maintain their status as basic rate taxpayers.
Any remaining profits are assigned to the corporate member. - The corporate member claims deductions for finance costs, including mortgage interest, related to the properties.
Landlords are advised that this arrangement results in reduced tax liabilities for the following reasons:
- The transaction concerning the transfer of properties to the LLP incurs no upfront tax costs, and the base costs of the properties (the amount that can be offset against the sale price for Capital Gains Tax calculations) are adjusted to their market value at the transfer date for Capital Gains Tax purposes.
- The landlords continue to be basic rate taxpayers, meaning they are not affected by finance cost restrictions.
- The corporate member can claim full deductions for its share of finance costs, as finance cost restrictions do not apply to it.
- The corporate member is subject to Corporation Tax on its net profit share, rather than higher or additional income tax rates that would apply if the profits were allocated to the landlords.
- Calculating the capital gain using the uplifted base cost at the transfer date to the LLP reduces the Capital Gains Tax liability compared to using the original purchase and improvement costs if the properties are sold.
- Business Property Relief (BPR) may be claimed for a hybrid structure engaged in a property rental business, resulting in no Inheritance Tax liability if the landlords pass away.
HMRC's Perspective on the Scheme:
HMRC's view is that this scheme is ineffective, primarily because it falls under the following categories:
- It is subject to mixed member partnership legislation as outlined in the Income Tax (Trading and Other Income) Act 2005, Sections 850C and 850D, which details how excess profits of a corporate member of an LLP are reallocated to individual members.
- It is affected by anti-avoidance legislation concerning the disposal of income streams through partnerships, as stipulated in the Income Tax Act 2007, Chapter 5AA, Section 809AAZA, which applies to tax the corporate member's income on the transferor of the income stream (i.e., the landlord).
- The Taxation of Chargeable Gains Act 1992, Section 59A, treats any dealings in chargeable assets by an LLP as if they were conducted by the individual members. LLPs are considered transparent for tax purposes, meaning that members have fractional ownership of assets. Consequently, this does not change the base cost of properties following their transfer to the LLP.
- A property rental business is likely to fall under the exclusions from Business Property Relief (BPR) concerning 'making or holding investments' under the Inheritance Tax Act 1984, Section 105(3). The use of the hybrid business model does not alter the availability of such relief.
What to Do if You're Employing This Scheme:
If you believe you are currently involved in this scheme and wish to discontinue it, HMRC is here to assist you. HMRC offers various forms of support to help you rectify your tax situation or avoid becoming ensnared in such schemes in the first place.
If you are using this scheme or similar arrangements, HMRC strongly advises you to terminate your involvement and settle your tax matters. You can initiate this process by contacting HMRC via email at spotlight63@hmrc.gov.uk, and they will provide you with further instructions.
Individuals concerned about the schemes they are presently using should also consider the following steps:
- Seek independent professional tax advice.
- Consult tax charities such as TaxAid for guidance. More information about the TaxAid helpline can be found on the TaxAid website.
Implications for Scheme Promoters:
Promoters of this scheme must adhere to the Disclosure of Tax Avoidance Schemes (DOTAS) legislation, ensuring that they disclose the arrangements they are promoting to HMRC.
Promoters may incur penalties if they fail to disclose a scheme to HMRC within five days of making it available or implementing it. The initial penalty can be as high as £600 per day. If this is deemed insufficient as a deterrent, promoters may be subject to penalties of up to £1 million.
HMRC reserves the right to publish information about tax avoidance schemes they are aware of, as well as the individuals involved in supplying and promoting these schemes.
HMRC will pursue anyone who promotes or enables tax avoidance, including employing the enablers penalty regime against those who design, sell, or enable the use of abusive tax avoidance arrangements that are later defeated by HMRC.
Additionally, HMRC will utilize its powers under the Promoters of Tax Avoidance Schemes regime against those who continue to promote tax avoidance schemes.
Reporting a Scheme:
If you come across tax avoidance arrangements, schemes, or individuals offering them, you can report them to HMRC using our online form for reporting tax fraud or avoidance. You have the option to submit this form anonymously and are not required to provide your name, address, or email.
Alternatively, if you cannot use the online form, you can contact HMRC by phone to report tax fraud or avoidance.
Article from: https://propertyindustryeye.com/hmrc-tax-avoidance-scheme-marketed-to-property-landlords/