HM Revenue and Customs (HMRC), the UK’s tax authority, is cracking down on buy-to-let landlords. These landlords, who have turned to company structures to mitigate increasing tax burdens, are now in the spotlight for potential underpayment of capital gains tax.
A Nudge from HMRC
HMRC has begun sending advisory letters to landlords who have incorporated their rental businesses in recent years. A letter shared by The Telegraph highlights concerns about excessive incorporation relief claims, potentially leading to insufficient capital gains tax payments. This relief allows postponement of capital gains tax on shares until they are sold.
Understanding the Error
The letters suggest various scenarios that might have led to this tax underpayment. These include situations where the capital gain from shifting to a corporation exceeds the value of the landlord’s business or the shares received.
A Surge in Buy-to-Let Companies
There has been a significant rise in the number of buy-to-let companies. Hamptons, an estate agency, reports a jump to 309,643 by the end of last year, up from 228,743 at the end of 2020. Moreover, Mortgages for Business (MfB) noted that 65% of their January loan applications were from limited company landlords, a sharp increase from 40% in January 2016.
The Appeal of Incorporation
Landlords are attracted to the incorporated business model for its tax benefits. It allows mortgage interest to be offset against income tax, and the tax on gains is generally lower than the standard capital gains tax.
Qualification for Relief
However, not all landlords may meet the criteria for incorporation relief. Chris Norris, from the National Residential Landlords Association, points out the complexity and confusion surrounding the qualification criteria. For instance, landlords must demonstrate at least 20 hours per week of business management, a requirement often overestimated or difficult to prove.
Adding to Landlords’ Challenges
This HMRC move adds pressure to landlords already struggling with regulatory changes and rising mortgage interest rates. The average two-year fixed rate for buy-to-let mortgages is around 6.0%, according to Moneyfacts. Savills reports a significant drop in landlord profitability, with gross rent yields falling below 4%, a low not seen since 2007.
The Impact of Tax Changes
Christopher Springett, a partner at Evelyn Partners, highlights how recent tax changes have pushed some landlords into post-tax losses. Misleading advice and “too-good-to-be-true” schemes have exacerbated these challenges.
The Perils of Poor Advice
Since George Osborne’s tax changes, there’s been considerable confusion about the optimal property business structure. Norris notes that many landlords, in haste, opted for incorporation without proper advice, leading some into dubious tax schemes.
Dan Neidle, founder of Tax Policy Associates, offers guidance for those receiving HMRC’s letter:
- Do not ignore the letter.
- Avoid returning to advisers who promoted tax-saving schemes.
- Consult with a regular tax adviser before responding to HMRC.
HMRC clarifies that their aim isn’t to deny incorporation relief but to correct its improper application.
HMRC’s Stance
A HMRC spokesperson described the letters as routine, aimed at ensuring correct tax compliance. Each year, thousands of such reminders are sent across various tax areas, with most people paying the correct amount on time.
In summary, the HMRC is intensifying its scrutiny of buy-to-let landlords, particularly those who have switched to company structures. Landlords are advised to review their tax positions, seek professional advice, and respond appropriately to HMRC’s inquiries to avoid potential legal and financial complications.