Landlords who transferred their property businesses into companies could face unexpected Capital Gains Tax bills. This warning concerns those whose personal or partnership mortgages were repaid using new borrowing taken out by their companies at the time of incorporation.
For many years, this method was widely presented as the conventional process for moving a mortgaged property portfolio into a limited company. Accountants, tax advisers, solicitors, incorporation providers, and mortgage brokers were often involved in these transactions.
A recent First-tier Tribunal judgment has now highlighted a potential problem with the tax treatment. While Incorporation Relief can postpone Capital Gains Tax when a business is transferred for shares, and special HMRC treatment (ESC D32) can ignore existing business debts taken over, repaying an old mortgage with a new company loan may not be treated the same as the company taking over an existing mortgage.
If the old mortgage was replaced rather than taken over, HMRC could argue that part of the incorporation was funded with something other than shares. This could restrict tax relief and potentially make part of the property gain taxable from the date of incorporation.
The Tribunal case involved Property118 and Cotswold Barristers successfully challenging Scheme Reference Numbers imposed by HMRC. The Tribunal cancelled these numbers and did not decide individual tax liabilities. However, it noted that the Property118 incorporation model enabled full Incorporation Relief, which landlords "may not be able to obtain if there was a refinancing."
Mark Alexander, founder of Property118, stated that normal banking practice is not automatically tax-neutral and that paying off an old personal mortgage with a new company loan is not necessarily the same as the company taking over existing debt. He added that landlords followed professional advice and should not be expected to identify technical risks their advisers may not have explained.
Transactions that may require review include those where a personally owned or partnership property business was transferred to a company, existing mortgages were repaid around the incorporation date with new company borrowing, and full Incorporation Relief was claimed without clear documentation explaining why the new financing qualified for relevant HMRC treatment.