Many landlords hold their properties personally. This means that income received on rental properties is charged at income tax rates of up to 45%. When the property is sold capital gains tax (CGT) is chargeable at up to 28%.
In contrast, rental income profits and gains in a company are charged to corporation tax at a maximum of 21% and, where a property is sold by a company, an indexation allowance is given to reduce any taxable gain it makes on the sale.
However, in order to access the more favourable tax treatment provided by corporate ownership, it is necessary to transfer the rental properties into the company, which normally triggers a CGT charge. Whilst there are provisions deferring a tax charge on the transfer of assets to a company, these only apply where the asset is a business asset rather than an investment asset.
Generally, a rental property is seen as an investment asset and not a business asset unless it is furnished holiday accommodation where it is then treated as a business and therefore CGT deferral can apply.
The recent case of Ramsay v HMRC considered whether or not a personally owned rental property could be treated as a business asset for CGT purposes. If it was a business asset then the transfer of the property into the company would not trigger a CGT charge but, if it was an investment asset, it would.
In this case the taxpayer, Mrs Ramsay, owned a building divided into 10 flats, of which 5 were occupied. She transferred the building to a new company in exchange for the company issuing shares to her.
The case was first heard by the First Tier Tribunal which, in arriving at its decision, relied on previous judgments which considered the meaning of business in the context of national insurance and inheritance tax. It thought the key factor in deciding whether rental income is a business is the nature and type of extra services a landlord provides (for example repairs, redecoration, etc) and, in particular, whether the activities involved are over and above those required in a normal property rental activity. In its view Mrs Ramsay did not provide enough extra services to make her property activities count as a business for capital gains.
The Upper Tribunal judge took a different view. He said that the scale of operations was the proper test. In his view, provided the degree of activity was more than what would normally be undertaken by a passive property investor, this was sufficient to constitute a business for the purposes of the CGT legislation.
For any landlords thinking of incorporating their business in order to access the lower rates of corporation tax, this case represents an important opportunity. However, for those landlords who own only a few properties, one would have to consider carefully whether their activities are sufficient to constitute a business for CGT purposes. It would also be necessary to take into account the stamp duty land tax cost and the cost of any incorporation, although it may be possible to take steps to mitigate this cost.