2021 was a record year for the number of companies set up to hold buy-to-let properties. According to Companies House, a total of 47,400 buy-to-let companies were incorporated across the country – almost twice the number in 2017.

A lot of this rise has been attributed to the removal of mortgage interest tax relief in April 2020, as landlords sought ways to repair the damage this caused to their finances.

While the immediate shock to the buy-to-let sector has passed, the original justification provided by this change for setting up a company to hold a rental property or a number of such properties remains. Whereas previously landlords could claim mortgage interest tax relief, now they receive a tax credit based on 20% of their mortgage interest payments. Landlords must also declare the income used to pay the mortgage on their tax return, pushing some into a higher income tax bracket.

The question of tax

In contrast, where a property is held within a company rather than in the name of an individual, corporation tax rather than income tax applies, with the former being charged on profits. With the rate of corporation tax currently at 19% compared to income tax rates of 20%, 40% and 45% depending on a person’s income, there remains a significant tax advantage in incorporation, especially for higher rate taxpayers. Perhaps even more so than previously, given that income tax thresholds have been frozen until April 2026, pushing more people into higher tax bracket. That said, the rise in the rate of corporation tax to 25% from 1 April 2023 will reduce this tax advantage.

Corporation tax is not the only tax buy-to-let landlords need to consider. Dividend tax is also applicable on any dividends paid above a certain level to shareholders of a buy-to-let company. Currently, the Annual Allowance before tax on dividend income is payable is £2,000. In April 2022, dividend tax rates were raised by 1.25 percentage points to pay for the social care levy. This took it to 8.75% for basic rate taxpayers, 33.75% for higher rate taxpayers and 39.35% for additional rate taxpayers, making incorporation less financially attractive than before.

It is important to note, however, that dividend tax is only paid on profits drawn. If there is no need for these funds, the money can remain in the business.

In practice, in order to reduce the tax liability, company directors often pay themselves through a combination of salary and dividends.

Another potential option could be paying a salary to a member of the family – typically this would be a spouse/civil partner, but it could be another family member such as a child at university. This could allow you to increase the amount of cash withdrawn from the company while reducing the company’s tax bill. However, to qualify as a deduction for allowable expenses against the company’s tax on its profits, any salary must be for real work done and the payment realistic. This also maximises the use of the Annual Personal Allowances. A note of caution, careful attention must be paid to avoid being caught by ‘settlements legislation’. Please speak to a financial or tax adviser for more details.

Another possibility might be to pay dividends to a family member. However, it is important to note that in order to do so, they need to be a shareholder. A further possible tax advantage of setting up a limited company is that in some cases it can mean exemption from Inheritance Tax (IHT). This is because of what is known as Business Property Relief (BPR). For more details on this and the tax implications of setting up a company, please speak to a financial adviser, accountant, or other suitably qualified professional.

Don’t forget the paperwork

Anyone considering setting up a company to hold a buy-to-let property needs to be aware of the practicalities such as the time spent on paperwork and administration as well as the legal requirements.

These include keeping accounting records and other details of the company and filing company returns. You will also need to register the company with Companies House. Referring to the Gov.uk site, this can usually be done online within 24 hours and only costs £12. Depending on the complexity and size of the company it may be necessary to employ an accountant or bookkeeper.

Finally, transferring an existing buy-to-let property held in your own name into a limited company requires you to sell that property to the limited company. This is not straightforward and incurs costs. These costs can include stamp duty, higher stamp duty on additional dwellings and capital gains tax if the market price is higher than the original price. There may also be finance costs associated with a company applying for a buy-to-let mortgage, as well as legal fees. Setting up a limited company before you purchase a buy-to-let property will also incur costs.

Conclusion

Setting up a limited company to hold a buy-to-let property or properties continues to have financial benefits for landlords over holding such a property or properties in their own name. This is especially the case for higher rate taxpayers and those that have several properties. That said, the way companies are taxed is significantly different to the way individuals are taxed, while the potential tax planning opportunities can be involved and complicated.

Any decision needs to be taken in the round and will of course be based on an individual’s circumstances and those of their family. For these reasons and the complexities that may be involved, it is highly advisable to first speak to a financial adviser, or other professional with specialist knowledge of this area.