Since George Osbourne changed the rules for landlord tax in 2017 there has been a ‘loophole’ that some have tried to explore.

Most buy-to-let landlords hold their properties personally. So they pay income tax at 40% or 45% on the rental income. Until 2017, their mortgage interest was deductible. George Osborne changed that, replacing interest relief with a 20% credit. 

Although some landlords viewed this as unfair, the purpose was to discourage buy-to-let mortgages. With corporation tax below 25% for a small company and full tax relief for mortgage interest, the obvious move was to hold the properties in a company.

While holding properties in a company seems like a good plan, transferring buy-to-let properties into a company presents challenges. There could be additional costs in capital gains tax (CGT) and stamp duty land tax (SDLT). 

Corporate mortgages tend to be more costly than buy-to-let mortgages, so the potential increase in interest might negate the tax benefits. Advisers warn against prioritising tax savings without considering associated costs.

Some agencies are offering schemes that try to get around this but it’s classed as tax avoidance and we highly recommend keeping away from such schemes.

A Tax Avoidance Scheme example

Landlord X establishes a new company and sells properties to it in exchange for shares. The sale completion is deferred, with X remaining the registered owner, creating a trust where X is the trustee and the company is the beneficiary. This arrangement is undisclosed to the mortgage lender, avoiding potential consent issues. 

The assertion is that creating a trust doesn’t violate X’s mortgage terms, offers CGT benefits through ‘incorporation relief’, and might circumvent SDLT if X and their spouse are deemed partners. 

While X continues to pay the mortgage, the company reimburses him, claiming tax relief. 

This setup is termed a “Smart Company” because the company can issue shares to X’s children, which may increase in value over time but aren’t initially counted in X’s inheritance tax.

Why this doesn’t work in reality

When a property is sold to a company without obtaining consent from the mortgage lender, it likely defaults the mortgage, possibly invalidating building insurance for freehold properties. Such transfers without notifying the lender typically breach mortgage terms. 

X ends up with a higher tax due to receiving taxable indemnity payments without the ability to claim tax relief. This structure could boost the total tax by 50%. 

There is also potential for significant CGT and SDLT upfront, and an annual tax on enveloped dwellings (ATED) return, if overlooked, incurs high penalties. 

We believe this structure is highly problematic and ill-advised. We also believe it is tax avoidance.