If you have a large portfolio (because that could be seen as business) then this might be possible but not if you only have a single property (or if its a small portfolio).
Forming a partnership has been seen as milestone on the route to incorporation, incorporation will mean that Section 24 interest restrictions don’t apply, which can save substantial amounts of tax.
Incorporation Tax Relief
The Ramsey case set out a basis for incorporation tax
Mrs Ramsey carried out the following activities
- Mr & Mrs Ramsey personally met potential tenants
- Mrs Ramsey check the quarterly electric bills
- Mrs Ramsey arranged insurance
- Mrs Ramsey arranged and attended to maintenance issues (drains)
- Mrs Ramsey and her son maintained the garages and cleared rubbish
- Mrs Ramsey dealt with post
- Mrs Ramsey dealt with fire regulation issues
- Mrs Ramsey arranged for a fence to be erected
- Mrs Ramsey created a flower bed
- Shrubs were pruned and leaves swept
- The parking area was cleared of weeds
- The flag stones were bleached
- Communal areas were vacuumed
- Security checks were carried out
- She took rubbish to tip
- She cleaned vacant flats
- she helped elderly tenants with utilities
This work equated to at least 20 hours per week and Mrs Ramsey had no other employment.
It is because she did the work herself that her property investment was considered a ‘Business’ and eligible for Incorporation Tax Relief.
Partnerships have special rules on SDLT relating to incorporation.
The rules on SDLT for Partnerships are in the Finance Act 2003 Schedule 15 and amendments in the Finance Act 2006 Schedule 24.
It is complicated but essentially it comes down to the following formulae
MV x (100 – sum of lower proportions (SLP))%
What this means is that if the land being put into the partnership is effectively retained by the transferor-partner (or persons connected with the transferor) after the transaction, you basically end up with:
MV x (100-100) = £0
So a husband and wife partnership owning 50% each could transfer the property to a company for 50% of the shares each and in theory there would be no SDLT charge.
What’s the problem for small portfolios
Take a look this tax question of the week My VIP Tax Team question of the week: Finance Costs Restriction (cronertaxwise.com)
Two of my clients, a married couple, have jointly held residential investment property. The husband is a higher rate taxpayer and the wife is a basic rate taxpayer and they would like to change the allocation of the property income. They do not want to change their 50/50 capital interest so have decided to form a general partnership to take advantage of exception C within ITA 2007 S836 to the assumption they are beneficially entitled to the income in equal shares. Their property portfolio is mortgaged. As the husband has income from other sources, he has fully utilised relief for all finance costs attributed to him. The wife has cumulative unrelieved finance costs, due to her personal allowance mitigating her tax liability on the property income. Can those unrelieved finance costs be carried forward and relieved against tax liabilities on property income from the partnership?Alexandra Fielding – Croner 4/5/22
There are two issues you raise which need to be addressed.
The first is the formation of a partnership to enable more of the property income to be allocated to the wife.
Although, as you say, a partnership means the assumed 50/50 income entitlement of s836 ITA 2007 does not apply, this is not the end of the matter. A non-commercial allocation of profits within a partnership is still within the settlement legislation of s624 ITTOIA 2005 and can apply to all partnerships and LLPs. This is a view confirmed by HMRC at TSEM4215.
The allocation of more of the profits to the wife without a corresponding increase in her share of partnership equity simply to avoid income tax would be caught by the settlement legislation. The exception in s626 ITTOIA 2005 for transfers between spouse/civil partners would not apply as this would be “wholly or substantially a right to income” without a corresponding transfer of partnership equity. If the couple’s particular rental properties require personal involvement of time and effort and such work is only carried out by the wife, or most of it is carried out by the wife, then it may be possible to commercially justify a greater share of the partnership profits to be allocated to the wife. How much would depend on the time spent and the nature of the work undertaken.
I would add that whether the particular rental properties constitute a “business” that meets the requirements of the Partnership Act 1890 depends on the facts involved. Although not an issue actively pursued by HMRC at the moment, there is a published view from HMRC at PM131800 which states:
The letting of jointly owned property does not normally constitute a partnership. Most cases will fall short of the degree of business organisation needed to constitute a business. The provision of significant additional services in return for payment may be an indicator of such business organisation.
The second issue relates to the unrelieved finance costs.
The rules to determine the entitlement to relief of non-deductible costs of a dwelling-related loan for an individual are contained within ITTOIA 2005 S274A and S274AA. Section 274A(3) tells us the relievable amount for a tax year is the total of the individual’s current-year restricted finance costs (if any) for that year in respect of that business and the unrelieved individual’s brought-forward restricted finance costs (if any) for that year in respect of that business.
The legislation restricts the tax reduction for finance costs so that a reduction can only be made against the income tax liability on the same property business to which the finance costs relate.
Although the properties and the individuals carrying on the letting activities will remain the same after the partnership is formed, for income tax purposes the partnership property business is a separate property business to that previously carried on by the individuals (ITTOIA 2005 S859(2)). This rule pre-dates the finance costs restriction and is covered by HMRC at PIM1030.
Therefore, unrelieved dwelling-related loan costs accumulated by the wife will be lost on the formation of the general partnership.
Whilst the wife’s only source of income is property income, she may continue to accumulate unrelieved finance costs. Your clients may want to consider allocating more of the underlying ownership of the property to the wife or transferring other income producing assets to utilise her personal allowance to maximise finance cost tax reductions.
Form 17 – Joint Ownership Proportions
For jointly owned property Form 17 and Declarations of Trust can be used to change the split of ownership.
When you make a declaration it must apply equally to ownership and income and a couple must be married or civil partners, you can’t be separated or divorced or joint tenants.
Form 17 is used to make the declaration
You can use this form to declare a beneficial interest if you hold property jointly and:
• you actually own the property in unequal shares, and
• you are entitled to the income arising in proportion to those shares, and
• you want to be taxed on that basis.
Form 17 must be submitted with in 60 days of completion, in addition a Declaration of Trust is likely to be required.
If there is a change, even a minor change, after submitting the Form 17 it will be invalid and revert to 50/50.
If the property is held in a single name it may be possible to use a declaration of trust to confirm joint beneficial interest.
Income Tax and Capital Gains Tax will be be based on the beneficial interest in the property, so if one spouse is a higher rate tax payer and the other a lower rate tax payer changing the proportion of ownership could have a significant tax advantage.