HMRC clamps down on landlord tax avoidance scheme

Sara White, Editor, Business & Accountancy Daily. Croner.

Landlords using a scheme to reduce tax by distorting mortgage interest relief rules warned by HMRC to stop using schemes as tax avoidance.

HMRC has raised the alert about a tax scheme being promoted to landlords as a way to structure their property businesses and reduce their tax bills.

The hybrid business model arrangement claims to bypass mortgage interest relief restrictions, allowing increased deductions for mortgage interest, and reduce the amount of tax payable on profits from their property business.

But this breaches tax rules and is high risk in HMRC’s view. ‘This scheme does not work. Landlords who use these arrangements could end up paying more tax than they tried to avoid, along with interest, penalties and high fees,’ stressed HMRC.

The schemes are intended to help landlords avoid tax by transferring their properties to a limited liability partnership (LLP) which has a corporate member. Profits are then distributed among members of the LLP at their discretion.

Landlords are told that this arrangement will reduce their tax because transferring properties to the LLP does not trigger an immediate tax charge as the corporate member is said to be entitled to a notional return on its ‘capital contribution’, meaning profits do not need to be reallocated under the mixed member partnership rules.

The sellers of these avoidance schemes claim the ‘corporate member can claim full deduction for its share of finance costs as restrictions do not apply’.

Under the landlord scheme the corporate member pays corporation tax on its net profit share, instead of paying the higher or additional income tax rates at 40% or 45%, which would normally apply to landlords if profits had been allocated to them.

But HMRC says this breaks tax rules and is advising anyone involved in the scheme should extricate themselves as quickly as possible.

In particular, it breaches the mixed member partnership legislation because sections 850C and 850D of Income Tax (Trading and Other Income) Act 2005 (ITTOIA) means excess profits allocated to the corporate member are reallocated to the landlords. As a result this means this does ‘not count as a genuine capital contribution by the corporate member’, HMRC stressed.

In terms of stark anti-avoidance rules, s809AAZA of Income Tax Act 2007 (ITA 2007)  applies to landlords. HMRC stated: ‘Even if a landlord transfers their rental income to another person or structure, that income is treated as the landlord’s own income.’

The note also reminds landlords that ‘stamp duty land tax (SDLT) will apply to these transfers and when profit shares change’.

The warning was issued in the latest HMRC tax avoidance Spotlight 63a, and landlords are advised to discuss the implications of their use of the scheme with their tax advisers or accountants at the earliest opportunity to avoid punitive action by HMRC, including the risk of officers opening a tax inquiry.

‘If you think you’re already involved in this arrangement and want to get out, HMRC can help. HMRC offers a range of support to get you back on track or avoid being caught out in the first place,’ HMRC stated.

Taking independent advice first is highly recommended if any landlord has become embroiled in this type of tax avoidance scheme.

Scheme promoters face fines of up to £1m from HMRC for running non compliant, illegal tax avoidance schemes.

HMRC guidance, Property business arrangements involving hybrid partnerships and indemnities (Spotlight 63a)