Spotlight 63: Property Tax Hybrid Partnership Scheme

What is Spotlight 63?

In recent months, HMRC has shined a light on several schemes they have deemed to be tax avoidance. Within this exposure, Spotlight 63 has lit up a storm in the world of property tax. HMRC claim that buy-to-let (BTL) individual landlords using ‘hybrid business models’, have been avoiding paying tax on their property income.

HMRC state that individuals employing such schemes have benefited from tax avoidance. It is HMRCs belief that the hybrid partnership structure has allowed landlords to:

• bypass mortgage interest relief restrictions allowing increased deductions for mortgage interest
• reduce the tax payable on profits generated by the property business
• reduce Capital Gains Tax payable when properties are sold
• reduce Inheritance Tax payable on death

(Please see HMRCs ‘Property business arrangements involving hybrid partnerships (Spotlight 63)’ for more information: https://www.gov.uk/guidance/property-business-arrangements-involving-hybrid-partnerships-spotlight-63)

HMRC is firm with their position that these types of arrangements simply do not work.

Who are ‘Less Tax 4 Landlords’?

Less Tax 4 Landlords describe themselves as a specialist multi-disciplinary consultancy helping landlords optimise their property portfolio.

Basically, these landlords have bought into a structure that allows them to shift their business to a body corporate. This allows landlords to claim relief on their mortgage interest, while simultaneously avoiding the usual commercial or tax disadvantages associated with such a move.

How does the scheme claim to work?

A ‘Letter of Trust’ effectively transfers beneficial ownership of the property portfolio to a newly established LLP, which then incorporates the property assets into its Balance Sheet.

The LLP comprises the individuals and a Limited Company as members. The rental business now operates within the LLP, with all profit and loss recorded by the LLP. Each year, the LLP generates accounts and files a tax return, distributing profits to the Limited Company member.

The Limited Company member records its share of profits from the LLP in its own profit and loss statement, offsetting any mortgage interest costs against this profit. Corporation Tax is subsequently paid on the net profit. LT4L claim that transferring Beneficial Ownership into the LLP results in an increase in the Capital Gains Tax base cost for the assets now held on the LLP Balance Sheet. Furthermore, LT4L contends that structuring the property rental business through a hybrid entity like this provides members with Business Relief for Inheritance Tax (IHT) purposes, exempting the value of their equity in the LLP from IHT.

Why it Doesn’t Work

The Letter of Trust is not a Deed. We believe it’s defective and therefore it would be possible to state that no transfer of beneficial ownership has taken place. That logic would mean that consequently, the accounting and tax returns from day one for all parties need restating and refiling.

Any transfer of Beneficial Ownership would require approval from mortgage lenders. To date, there’s no indication that lenders have been consulted or informed about any interest transfer.

The FA 2014 introduced a Targeted Anti Avoidance Rule (TAAR) targeting hybrid partnerships, altering the taxation of deemed “excessive profits” assigned to the Limited Company member (referred to as the Corporate Partner). This scheme overlooks the impact of TAAR, potentially leading HMRC to view the profit allocated to the Corporate Partner as excessive and redirect it to individual LLP members.

It is our view that claiming mortgage interest relief in the Corporate Partner lacks a legal basis in tax law. While direct loan acquisition by the Corporate Partner would permit interest cost claims, this hasn’t occurred in most cases, thus negating the Corporate Partner’s eligibility for such expense claims. Consequently, the Corporation Tax payable by the Corporate Partner is likely understated. Additionally, the Corporate Partner shouldn’t be eligible for any partnership profits initially.

Contrary to the assertion, there’s no capital gains tax (CGT) uplift in value upon asset introduction to an LLP. According to accounting rules, assets are to be booked at market value, with no alteration to the CGT base cost.

The IHT status of a member’s equity in this property business structure doesn’t qualify for Business Relief. Asset values remain within the taxpayer’s estate for IHT purposes.

How WTT can help

WTT can quickly assess the extent of the repairs needed to rectify your tax affairs. We will try and reach a fixed price for the repair, once we know the extent of what is needed.