Using An LLP To Bypass Section 24 Revealed As A Huge Tax Scam By HMRC, With Potentially Over £50m To Be Reclaimed

Hello Readers,

Following the Section 24 tax changes, where properties owned in a personal name have the whole rental income taxed and mortgage interest costs claimed back but only up to the basic income tax rate of 20 per cent, I’m sure you will agree that there has been something of a decimation of rental stock.

The data below may not come as a surprise, but it will certainly put the situation into stark contrast, with a net drop of an average of 3% in rental stock each year since 2016 when we compare purchases to sales.

A significant number of landlords have found solace however, in something of a section 24 workaround over the past few years by transferring property into a Limited Liability Company (LLP), however HMRC have just clamped down on the scheme (unsurprisingly).

The scheme was widely promoted by Less Tax for Landlords, who are a high profile firm and so this goes to show you simply can’t be too careful. Ray McCann, a retired senior HMRC inspector and past President of the Chartered Institute of Taxation commented that:

“The Less Tax for Landlords structure is nonsense. It lures clients into what they may think are clever interpretations of the law – but actually LT4L are just plain wrong”

Sadly, for many landlords this could mean total financial ruin at worst or at best, significant fines and penalties. In addition, it could even default mortgages!

I’ve summarised how the workaround claims to have worked and HMRC’s view in the notes below. Please note that these are based on the HMRC press release, which you can read here.

Details of the LLP workaround

Tax specialists have advised that these arrangements aim to minimize tax liability by enabling individual or joint property owners to transfer their properties to a limited liability partnership (LLP) featuring a corporate member. The LLP then distributes profits at its discretion among its members.

By doing this, these schemes claim to achieve the following outcomes:

• Bypass restrictions on mortgage interest relief, enabling larger deductions for mortgage interest expenses
• Lower the tax liability on property business profits
• Decrease Capital Gains Tax owed upon property sales
• Minimize Inheritance Tax obligations in the event of death

Here’s a breakdown of how these arrangements claim to function:

1. The property owners or their family members, or both, establish a limited company.
2. Simultaneously, the property owners create an LLP, designating the limited company as the corporate member.
3. The property owners transfer their properties to the LLP.
4. Members of the LLP, including the property owners and the corporate member, distribute the LLP profits among themselves in a manner that ensures:
   1. The individual members maintain their status as basic rate taxpayers.
   1. Any remaining profits are allocated to the corporate member.
5. The corporate member claims deductions for finance costs, such as mortgage interest, pertaining to the properties.

Landlords are advised that this arrangement results in reduced tax obligations for the following reasons:

• The property transfer to the LLP incurs no immediate tax liability, and the base costs of the properties (the amount used to offset Capital Gains Tax when selling an asset) are adjusted to their market value at the transfer date.
• Property owners maintain their basic rate taxpayer status, thereby avoiding the impact of finance cost restrictions.
• The corporate member can claim full deductions for its share of finance costs, as it is not subject to finance cost restrictions.
• The corporate member is subject to Corporation Tax on its net profit share, rather than facing higher or additional income tax rates that would apply if the profits were allocated to the property owners.
• Calculating the capital gains using the adjusted base cost at the property transfer date results in lower Capital Gains Tax compared to using the original purchase and improvement costs when selling the properties.
• Business Property Relief (BPR) may be applied to a hybrid structure engaged in property rental activities, potentially eliminating Inheritance Tax liability for landlords in case of their demise.

An extremely helpful article on this from Tax Policy Associates explains how much tax is purported to have been saved by individuals using the scheme. You’ll see that the numbers really are significant!

HMRC’s view on the scheme

Here’s the sting in the tail… HMRC have just clamped down on this and earlier in October released their assessment, which is that this arrangement does not work and is classed as tax avoidance.

HMRC’s view of these arrangements is that:

• Mixed member partnership legislation contained in Income Tax (Trading and Other Income) Act 2005, S850C and S850D, which details how excess profits of a corporate member of an LLP are reallocated to individual members
• Disposal of income streams through partnerships anti-avoidance legislation contained within Income Tax Act 2007, Chapter 5AA, S809AAZA, which applies to charge the corporate members’ income on the transferor of the income stream (the landlord)
• Taxation of Chargeable Gains Act 1992 S59A, which treats any dealing in chargeable assets by an LLP as by the individual members — LLPs are transparent for tax purposes so members own a fractional share of assets, and this means the base cost of properties are unchanged following their introduction to the LLP
• A property rental business is likely to be within the exclusions from BPR of ‘making or holding investments’ under the Inheritance Tax Act 1984, s105(3) — the use of the hybrid business model does not change the availability of such relief

This is a big deal and those promoting the workaround are being threatened with an initial penalty of £600 per day for not disclosing and this runs up to a total of £1m!

The scale of the scheme

Less Tax for Landlords (Owned by OCG Accountants Ltd) have registered 440 LLPs since 2016 and with typical savings being £40-£50k per year, as much as £50m in tax may have been avoided through the scheme.

It’s entirely possible that some of these LLPs are genuine, however a skim through indicates that those sampled exist in order to function as the tax workaround.

This may just be the tip of the iceberg, with undoubtedly smaller accountants having followed suit and setting up their own schemes.

My view is that this is simply a reminder of how you need to be ever so careful with your finance and tax planning as the LLP workaround was widely quoted throughout the property investment network.

As HMRC investigates, it will be extremely interesting to watch the cases progressing and undoubtedly we will see more headlines over the coming months and years.

I will endeavour to keep you updated as events unfold and will be interested to hear your thoughts – also, whether you have been caught up in this scheme!

Hasan