Property118: a tax avoidance scheme for buy-to-let landlords that defaults their mortgage and increases their tax bill

Property118 is an unregulated adviser which works in a “joint venture” with a barristers chambers called Cotswold Barristers. They promote a tax avoidance scheme aimed at buy-to-let landlords. But nobody involved appears to have any tax qualifications and in our view the scheme fails spectacularly.

This report explains the scheme, and explains why in our view, and that of the mortgage lenders’ industry body, it is likely to default the landlord’s mortgage. We also set out a detailed analysis of the serious tax problems with the structure. We are going into more technical detail than usual given the widespread promotion of this scheme in the market. Anyone who has entered into these arrangements should seek independent advice.

UPDATE: 16 September. Property118 have responded to this report. Despite having two months notice of our findings, their response contains no response to any of the points we’ve made, just assertions that their structure is fully compliant, and that HMRC and lenders have never challenged it. As we note below, we doubt the structure has ever been properly disclosed to HMRC or lenders. Now HMRC and lenders is aware of the structure we expect challenges over the coming months and years.

UPDATE: 22 September. We’ve a further report on another aspect of Property118’s planning.

UPDATE: 5 October. See also our report on Less Tax for Landlords. A different scheme, but with some commonalities; in many senses an even worse scheme than Property118’s.

UPDATE: 24 October. Mark Smith of Cotswold Barristers published a response on the s162 point, but one which does not address the key problem with the structure. We’ve updated the text below.

UPDATE: 9 November. The analysis below is of the structure Property118 intended to implement. Our review of their actual documentation reveals several critical implementation failings which means the actual position of their clients is likely significantly different, and significantly worse. We analyse this here. This means that much of what follows below is likely academic.

The sales pitch

Most buy-to-let landlords hold their properties personally. So they pay income tax at 40% or 45% on the rental income. Until 2017, their mortgage interest was deductible, meaning a result something like this:

George Osborne changed that, replacing interest relief with a 20% credit. That makes a big difference:

Many landlords view this as unfair, because the £2,400 tax is more than their £2,000 net income (although the purpose of the rules was expressly to discourage buy-to-let mortgages, so this rather punitive outcome is actually the point).

The obvious move is to hold the properties in a company. Corporation tax is less – below 25%, for a small company¹The rate is 19% for profits under £50,000, with a “catch-up rate” of 26.5% on profits up to £250,000, so that the overall effective rate smoothly transitions into the full rate of 25% and companies get full tax relief for mortgage interest.²Obviously you will want to get the money out at some point, but being able to defer and roll up low-taxed income is valuable in itself

But it’s not easy for a buy-to-let landlord to move their properties into a company. There can be capital gains tax and stamp duty land tax (SDLT) on the way in. And – most seriously – the mortgage lender won’t allow the existing individual mortgage to move to a company. You could get a new mortgage, but mortgages for companies are significantly more expensive than buy-to-let mortgages. ³Because a landlord can walk away from a company in a way that they cannot walk away from a personal mortgage

Advisers therefore frequently caution clients that the increased interest cost of moving properties to a company can easily exceed the tax saving. It’s often a mistake to be over-focused on tax savings.

The Property118 solution

Wouldn’t it be wonderful if you had all the tax benefits of moving to a company, but could keep your existing bargain-price mortgage?

Property118 say you can, with what they call the Substantial Incorporation Structure:

• The landlord – let’s call him X – sets up a new company (which I’ll call the Company), and sells the properties to it, getting shares in return
• But “completion” of the sale is deferred – X remains the registered owner of the properties. A trust is created, with the landlord as trustee, and the company as beneficiary.
• This is invisible to the world – and to the mortgage lender. So X doesn’t ask the mortgage lender for consent, or even tell the mortgage lender about it.
• Property118 claim that, because the transaction creates a trust, it’s not a breach of X’s mortgage.
• They claim that “incorporation relief” applies so there’s no capital gains tax.
• Often they say that X and their spouse were in a partnership, so SDLT partnership rules apply and there’s no SDLT to pay either.
• X continues to make mortgage payments to the lender but, behind the scenes, the Company agrees to reimburse/indemnify X. The Company claims tax relief for those payments. So – claim Property118 – it’s just as good as if the Company had borrowed itself.
• But it’s better – because they say this isn’t just a company – it’s a “Smart Company“. The idea is that the Company issues shares to X’s children which supposedly have no initial value, but will grow in value over time. So future increase in the value of the property portfolio will fall outside X’s inheritance tax estate.

The end result is that, by signing a piece of paper, X gets a dramatically better tax result with no downside:⁴We have established this is their structure from published information on the Property118 and Cotswold Barristers websites (e.g. this brochure, and here, here, here, and here) as well as copies of their advice we received from our sources.

What actually happens – the short version

The structure doesn’t work.

The sale likely puts the mortgage into default. The mortgage terms usually require consent for the sale to the Company, and that wasn’t obtained.

We asked UK Finance, the trade association for mortgage lenders, and they said:

“Transferring ownership of a property into a trust without informing your lender and seeking their consent would most likely be a breach of a mortgage’s terms and conditions.”

The tax will also go badly wrong.

Property118 have forgotten that X is still there, still paying £8k to the bank, but now receiving £8k of new income in the form of the indemnity payments. Those indemnity payments are fully taxable, but the bank interest isn’t deductible for him (because X no longer has a property business; he has no basis to claim any tax relief).⁵This is perhaps the most likely of a number of possibilities, all discussed further below

So the structure increases the overall tax bill by 50%.

It gets worse. There is potentially also a large up-front tax hit of a large amount of CGT and SDLT when the structure is established. That could amount to hundreds of thousands of pounds.

And then an ongoing requirement to file an annual tax on enveloped dwellings (ATED) return, which is easily missed – failure to file creates late-filing penalties of £1,600 per year.

In our opinion this structure is a disaster.

We’ve set out the legal analysis of these issues in detail below.⁶In the interests of concision, we don’t go into one somewhat difficult point: the effect of a sale when that sale is prohibited by another contract (the mortgage). The Don King v Warren case is general authority for the proposition that such a sale will still be effective in equity, and we expect that will be the case here. However the issues are not straightforward; and if we’re wrong, and the sale is not effective in equity, then essentially nothing has happened from a tax perspective, and it’s as if the transaction never happened. No tax benefit, but also none of the unfortunate results we go into below.

Is this tax avoidance?

Yes.

The “Substantial Incorporation Structure” has no benefit to the landlord other than (supposedly) saving tax. It will therefore be regarded as tax avoidance by a number of statutory anti-avoidance rules, which will potentially negate the tax benefits (if there are any, which there probably aren’t).

This is by contrast with a normal incorporation, which absolutely does have other benefits for the landlord. In particular, it segregates legal liability: if the landlord is sued by the lender or by a tenant, then if the properties are held in a company, that liability will normally not attach to the landlord personally. A normal incorporation is not usually tax avoidance, even if it has tax benefits.

However, the substantial incorporation structure does not achieve legal segregation. As far as the lender, the tenants, and the world are concerned, the landlord remains personally the owner of the properties and therefore as a legal matter remains personally liable.⁷ the landlord may be able to recover from the company under the indemnity, but if the companies’ assets are insufficient, the landlord will remain on the hook. There are, therefore, no liability advantages from the substantial incorporation structure, compared to, if the landlord just held the properties personally.

Property118 and Cotswold Barristers

Property118 and Cotswold Barristers often charge fees of over £40,000 to relatively small landlords earning less than £100k/year. They’re set up to get referrals from other websites, paying £2,000 for a click that results in new business – meaning that they’re widely promoted by other firms (for example here).

For £40,000 you could expect to instruct a well-known accounting or law firm, staffed by qualified tax lawyers/accountants.

But neither Property118 nor Cotswold Barristers appear to have any members or employees with tax qualifications or experience. Property118 is entirely unregulated. I had a very confusing exchange of emails with Mark Alexander, head of Property118, in which he didn’t appear to have even heard of the two main tax qualifications: ATT and CTA.⁸In an earlier (and unrelated) LinkedIn discussion, Mark Smith, head of Cotswold Barristers, hadn’t heard of the term “tax set” – i.e. he was unaware that there were specialist tax barristers’ chambers.

The head of Cotswold Barristers, Mark Smith⁹Not to be confused with Mark Smith, the respected extradition barrister., is a generalist whose practice ranges from business law, to tax, to criminal defence work, to private prosecutions (including one where he was suspended by a month by the Bar Standards Board for acting negligently and “failing to act with reasonable competence“). His profiles in 2017 and 2020 don’t include tax in his areas of practice.

Barristers chambers usually list their members – the members being the whole point of the chambers. Cotswold Barristers is unusual in not doing this. It did at one point – and included as part of its team a fake barrister with a dubious past who was jailed for conning a dying woman out of her life savings. There is no suggestion that Cotswold Barristers was aware of his actions, but Cotswold Barristers does appear to have been responsible for listing him as part of its team.

Property118 and professional standards

Property118 say this to clients:¹⁰This is from a document they sent to a client a few months ago

The reference to “delegated authority” is strange. The claim that a non-barrister could be bound by Bar professional standards and be subject to the Bar Standards Board has perplexed all of the barristers we’ve spoken to.

We put this to Mark Smith of Cotswold Barristers. He said:

“Barristers must disclose, to the BSB and clients, any associations they have with people or entities in their provision of legal services. This is a code of conduct requirement. This was complied with at the outset of our relationship with Property 118 (P118). It has recently (Jan-Mar 2023) been re-examined by the BSB as part of a routine audit of Cotswold Barristers (CB) following an update of the BSB’s Transparency Rules. We had correspondence with the BSB about this, and they were and are satisfied our association is compliant. We did review the wording relating to ‘delegated authority’ at that point, as it was ambiguous. P118 has since amended this portion of their materials, so it makes it clear their consultants only work under delegation when the client has engaged with CB. Again, so long as it is made clear to the client, and the barrister is ultimately responsible, sub-contracting of work is permitted under the Code of Conduct.”

We don’t see an ambiguity: we think the claim that Property118 are bound by Bar professional standards, and subject to the BSB, is false. We asked Mr Smith to explain this claim, and he did not respond.

We’re writing to the Bar Standards Board to see if they can cast any light on these issues. We are also asking them to look into the wider question of why Cotswold Barristers are giving legal and tax advice that is obviously wrong.

Professional indemnity insurance

Property118 say that their barristers’ professional indemnity insurance means their clients are “shielded from financial risk”:

That’s not at all how professional indemnity insurance works. If the tax structure turns out to be the disaster we think it is, and the client wants to recover their loss, they have to successfully sue the barrister for negligence. That’s never a straightforward undertaking; not least because the barrister would presumably deny causation on the basis that you would have followed Property118’s advice even if Cotswold Barristers hadn’t been involved. And Property118 aren’t regulated, are unlikely to have any insurance, and probably aren’t good for the money (its owner lives in Malta).

The mortgage problem

Property118 say their structure is “fully compliant for mortgage purposes”:

However this appears to rely significantly on not telling lenders that their security has become the subject of a trust:

We asked UK Finance, the representative body for mortgage lenders, what they thought of the structure. They said:

“If someone wishes to transfer ownership of a buy to let property they should contact their lender to discuss whether this is permitted under the terms of any mortgage on the property. Transferring ownership of a property into a trust without informing your lender and seeking their consent would most likely be a breach of a mortgage’s terms and conditions.”

We believe UK Finance are clearly right on this. But even we didn’t agree, we’d suggest that it’s not a good idea to enter into a structure which your lender believes most likely breaches the terms of your mortgage.

Property118 and Cotswold Barristers seem to be in denial. They tell their clients:

The idea a lender can’t require repayment of a mortgage when it is in default is very strange. The 2016 Court of Appeal case they cite concerned whether a lender could require repayment of a mortgage when there was no default. We don’t understand how Property118 can make this claim when their own founder was the claimant in the case.

The problem with the trust

Property118 do seem aware there could be an issue with declaring a trust that shifts beneficial ownership to a company without telling the mortgage lender. They say:

There’s a similar theme on the Property118 website:

Is this an accurate reflection of most mortgage T&Cs?

One of our team undertook a very fast and incomplete review of major mortgage lender BTL T&Cs, carried out in about one hour.¹¹Caveat: our team only had English expertise; the law is different in Scotland and Northern Ireland and therefore none of the analysis in this section applies to it; however given that Property118’s English lawyers get the English law position wrong, it would be optimistic to assume that they have the Scots and Northern Irish position right

She found specific prohibitions in Investec:

And Clydesdale:

So the specific claim there are only two lenders with prohibitions is false.

But the larger problem is more basic. This is the key claim made by property118 (highlighted in blue):

The “Barrister-At-Law” will be Mark Smith of Cotswold Barristers. He takes the same approach: “as a matter of law, unless it says specifically in the terms and conditions [that] you can’t do it, then you can”.

This is not how English law security documentation works. The mortgage terms don’t need to have a specific prohibition on declaring a trust. All that’s required – and this is common – is to simply prohibit the sale or transfer of the property, and define “property” so it includes all interests, meaning the beneficial interests that would be transferred by a trust.

Here’s NatWest:

Or The Mortgage Works (aka Nationwide):

Other lenders have a general transfer of ownership prohibition which is drafted broadly enough to capture trusts and sales of beneficial interest. For example, TSB:

After undertaking this review, we spoke to a series of experienced real estate finance lawyers, who act for lenders and borrowers on everything from small domestic conveyancing transactions to the largest commercial real estate transactions. It was their unanimous view that, one way or another, a trust would be prohibited by most and possibly all mortgage T&Cs.

We put this point to Property118 and Cotswold Barristers, and specifically gave one of these mortgage terms as an example. They declined to explain their position as a legal matter, instead asserting that large conveyancing companies agreed with them, and that no bank had ever raised the point. That, again, does not answer the question. The large conveyancing firms are built to handle straightforward conveyancing at scale, not to answer technical queries on unusual trust arrangements. Mortgage lenders will not raise the point unless they become aware of it. Until now, we don’t believe they were. However, we briefed the mortgage lenders’ representative body, UK Finance, on the structure, and their view is now clear:

“Transferring ownership of a property into a trust without informing your lender and seeking their consent would most likely be a breach of a mortgage’s terms and conditions.”

It is therefore reasonably clear that entering into this arrangement without the consent of the lender likely defaults the mortgage.¹²The original version of this report also discussed the potential for the trust to invalidate the buildings insurance of freehold property, which would be another mortgage default. Our was undertaken by insurance specialists but has been questioned by others with expertise in insurance law. This report is intended to reflect a consensus view of relevant experts, and therefore (given there is at least some doubt as to the position) we have removed that text. The general point about mortgage defaults (for both freehold and leasehold property) remains, and it is this point that UK Finance are referring to.

Legal and tax analysis – capital gain

X probably has a large latent capital gain in the properties. For example, if X’s acquisition cost of the portfolio was £4m, and X sold it now for current market value of £8m, X would have a £4m capital gain, and pay £1.12m CGT.

But Property118 claim their Substantial Incorporation Structure means that CGT incorporation relief applies.

That would have two very nice outcomes for X. First, there’s no CGT at all to pay on the transfer to the Company. Second, the capital gain is “rolled over” into the shares in the Company, so that any sale of the shares is subject to CGT broadly as if X had held them all along. The latent capital gain of the properties themselves is eliminated – the properties are “rebased” to current market value. So if the Company sold the properties for £8m, there would be zero tax to pay.

However, there is considerable doubt whether incorporation relief will apply.

The legislation requires that “the whole of the assets of the business” move to the Company. And that’s not happening¹³An additional problem is that the liabilities of the business are not being transferred; rather they are being covered by an indemnity from the Company, and that means the consideration does not just consist of shares (which s162 requires). On the face of it, that prevents incorporation relief applying. There is an HMRC concession that HMRC do not take this point (ESC D32). That is very convenient (and necessary) for the Substantial Incorporation structure. But two important niggles: (1) there is no technical basis for ESC D32 and therefore, following the Wilkinson case, it’s unclear how HMRC can continue to apply it, and (2) a taxpayer engaged in tax avoidance cannot rely upon any HMRC concession or published practice (a point HMRC go out of their way to stress in their guidance).

The problem here is that legal title in the properties is being left behind. This is not some minor legal formality; legal title over real estate has reality and value to it. You can’t borrow without legal title. You can’t refinance. You can’t sell. In many “bare trust” cases this is a distinction without a difference, because the beneficiary can call for legal title at any time. Here they cannot, because the consent of the mortgage lender would be required. The Company’s inability to acquire legal title is a real constraint on its business – and that demonstrates that it did not in fact acquire the “whole assets of the business”.¹⁴Similar issues may arise with other assets of the business which are staying put as a legal matter but (presumably) purportedly being assigned in equity: e.g. buildings insurance policies, tenancy agreements, letting agent agreements, the right to recovery of . The legal title that is being left behind is an asset, and not a valueless one. A business that only has equitable title to the core elements of its business is not the same as a normal business. A landlord is also subject to a large number of regulatory requirements around deposit protection, fire safety, etc – and these obligations will remain with the landlord as legal owner.

Another way of putting the same point is that there is no transfer of a “business as a going concern”, just an economic transfer under a trust. The “business” is operated by the person with the legal title, as it’s that person who has all the dealings with the tenant, bank, service providers, etc. This “business” isn’t moving at all.

So our view is that incorporation relief likely does not apply.¹⁵Cotswold Barristers’ response was that there was a deemed CGT disposal of legal and beneficial title day one, and so the whole assets of the company were deemed to be transferred. We don’t think that’s defensible. Section 28 is a rule which sets the time of a disposal for CGT purposes. It is not some wider deeming rule which deems an asset to have been actually transferred on a different date. Incorporation relief refers to “transfer” (the legal/commercial concept) and not “disposal” (the CGT concept). This is therefore a misreading of section 28. The courts have always held that deeming rules should be restricted to their statutory purpose.) UPDATE: Property118’s own KC ended up agreeing with us on this point

(In many cases there will also be doubt as to whether X’s activity as a landlord is enough to constitute a “business”.¹⁶See the Elizabeth Ramsay case, and HMRC commentary here.)

UPDATE: Mark Smith finally published a specific response to this point on 20 October 2023. He makes the obvious point that capital gains tax normally looks to beneficial ownership, not legal ownership, when considering whether a disposal has been made. But section 162 is not looking at whether a CGT disposal has been made – it uses the terms “whole assets of the business” and “transfers… a business as a going concern”. We read these as factual tests. And, factually, significant elements of the business remain with the landlord. Only the landlord can deal with the lender, the tenants, letting agents, and other contractual parties. The business of the company is very different – it’s just a passive investor. We made this point above; Mr Smith does not attempt to respond to it.

Mr Smith again makes the claim that HMRC have accepted the position. This would only be relevant if the true nature of the structure was disclosed to HMRC, and the s162 point above specifically drawn to HMRC’s attention. We doubt that is the case, but even if it was, it would only provide comfort to the taxpayers specifically covered by that correspondence. HMRC would not be bound for other Property118 clients.

There is therefore, as ever, no substitute for properly considering the legal position.

Legal analysis – SDLT

On the face of it, SDLT¹⁷or the equivalent devolved taxes if one or more of the properties is in Scotland or Wales is due on the transfer of the properties by X to the Company, on the full market value at a marginal rate of up to 15%.¹⁸That’s including the 3% surcharge for purchases of dwellings by companies. In some cases we would also need to add the 2% increased rate for non-resident transactions. That’s potentially a huge up-front cost. There’s a relief for partnerships incorporating, but not for individuals incorporating.

In many cases, SDLT would make the Substantial Incorporation Structure uneconomic, with a large up-front tax cost. Here’s the Property118/Cotswold Barristers solution:

It’s to claim that, where a husband and wife run a property rental business together, in fact they’ve always been a partnership, and partnership relief is available. They do this, even in cases where there was no partnership agreement, no partnership tax returns, and no extraneous evidence of any kind that a partnership existed. Technically that does not make it impossible that there was a partnership – it’s a question of fact. But the recent SC Properties case shows just how difficult is to establish a partnership in such circumstances – and the burden of proof is on the taxpayer. It is usual for a married couple to manage their financial affairs together, but that does not normally mean there is a partnership in the legal sense. Relations between spouses are very different from the business relations of partners in a partnership.¹⁹Section 2(1) of the Partnership Act 1890 is clear that joint ownership is not enough, and sharing profits is not enough. It’s the relationship between the parties that is key. This is something that Smith and Property118 appear to overlook.

If SDLT were payable (because the properties are not partnership property), then interest and penalties for late filing would be due. Although multiple dwellings relief would usually be available to reduce the SDLT charge, this relief is unavailable if it is not claimed in a return or an amendment to a return. And an SDLT return cannot be amended more than one year after the filing date for the transfer. If any of the properties were occupied by X or his relatives (or not held for a qualifying business purpose) the SDLT rate on that property would be 15%.²⁰Plus the 2% increased rates for non-resident transactions, if applicable).

In our view, it will only be in rare cases that this strategy succeeds, and SDLT relief applies – and HMRC guidance suggests that HMRC are likely to contest the point.²¹There may be other potential attacks on the “retrospective partnership” strategy using anti-avoidance legislation and principles

Finally, although no annual tax on enveloped dwelling (ATED) would be payable to the extent that the properties are let out to third parties, ATED relief must be claimed. It is unclear to us if Property 118 advise their clients to file ATED returns (our sources have not seen such advice). Failure to file triggers late-filing penalties of up to £1,600 per return per year. For companies that used these arrangements over five years ago, it might come as quite a shock that they are liable to £8,000 of penalties even though no ATED is due.

Legal and tax analysis – taxation of the interest payments

Property118 and Cotswold Barristers say:

They make a slightly different claim in the video below: that the “legal owner continues to make mortgage payments (as nominee of the beneficiary) and claims the payments back from the beneficiary as out of pocket expenses, which are tax free.”

But that is not right at all. X, the legal owner, is not the “agent” or “nominee” of the Company under the loan – X remains the borrower under the loan in their own right. You cannot declare a trust over obligations. What is actually happening is that the Company is making indemnity payments to X, which pays the mortgage lender (and this is the case as a legal matter even if, as I suspect, there are never any cash payments from the Company to X). X therefore remains taxable.

When we look at the actual legal and tax analysis that follows from this, the entire structure falls apart.

Deductibility of interest payments for the Company

Mark Smith says in this video that the payment is “deductible in accordance with normal corporation tax principles”. That’s not correct.

The corporation tax treatment of debt is governed by the loan relationship rules in Part 5 of Corporation Tax Act 2009. For these rules to apply, the Company must have a “loan relationship”, for which it has to be “standing in the position of debtor under a money debt” which must “arise from a transaction for the lending of money“. But the Company doesn’t have a money debt and never borrowed any money – it’s just making indemnity payments. There is only one loan, and that was from the mortgage lender to X – and it’s still there.²²The obvious way to test the loan relationship point is to ask whether the Company can be sued by the mortgage lender; the obvious answer is that it cannot. Note that whether there is a “loan relationship” or not is a legal test, not an accounting test – even if the accounts here show the Company as party to a loan, it won’t have a loan relationship

So the Company doesn’t have a loan relationship and will not achieve a deduction under the loan relationship rules.²³One correspondent raised a plausible argument to the contrary: condition C in s330A CTA 2009 applies on the basis that there was a “transaction which [had] the effect of transferring to the company all or part of the risk or reward” of the mortgage (this is not an argument Property118 has made; there is no evidence they are aware of any of the provisions of the loan relationships rules). We are, however, doubtful that an indemnity has that effect – it is cashflows which are (economically) transferred, not risk/reward. An indemnity is economically and legally distinct from defeasance. Financing cost indemnities are often seen on commercial transactions, and the idea s330A applies to such arrangements would be novel. It is, furthermore, unclear if X would benefit even if s330A applied. It seems likely that the main purposes of the arrangement are to enable the Company to obtain a tax advantage; on that bass, s455C would apply to deny the deduction

It might achieve a deduction under the general rules for a company carrying on a UK property business. That requires the indemnity payments to be recognised in the accounts and for the indemnity payments to be regarded from a tax perspective as income of the property business and not as further consideration for the capital transaction of the original acquisition of the beneficial interest. We don’t think either is a straightforward point. ²⁴A better argument Property118 could make is that the company doesn’t need a deduction for the indemnity payment, because under the trust it’s only entitled to the net rent (after mortgage payments are made). That, however, is contrary to the nature of a bare trust – see e.g. the HMRC guidance here

So it cannot be assumed that the Company will achieve a deduction for its indemnity payments. If it doesn’t, we are in a worst-case scenario for X which looks like this:

More than doubling X’s original £2,400 tax bill. Not a good result.

Even if the Company does achieve a deduction, the result is still worse than the original £2,400 of tax:

We put this point to Cotswold Barristers. They asserted that the payment was deductible but were unable to explain how or why.

Taxability of indemnity payments

We can immediately dismiss the explanation in the video – that X is receiving tax-free out-of-pocket expenses. That would be the case if the loan had been entered into by X as trustee for the Company. But it wasn’t – the loan was simply entered into by X and X alone, and the trust can’t change that). The payments X makes to the lender are not trust expenses – they’re X’s personal expenses. And no agreement X signs with the Company can change this – you can’t transfer an obligation, or create a trust over an obligation.

That’s a big problem. X no longer has a property business (because he is a mere trustee). So X has zero basis for claiming a deduction on the interest he pays the bank. But he is now receiving a stream of indemnity payments under a legal obligation. They will be taxable (perhaps as “annual payments“, perhaps as “miscellaneous income“). That creates a large tax charge for X – it’s the worst-case outcome we show above.

We see only one potential counter-argument: to say that the indemnity payments actually form part of the consideration for the original sale,²⁵Property118’s actual implementation is unclear. We have seen some documentation which states that the indemnity payments are consideration (which we expect is the intended outcome). However we have also seen a legal advice note from Mark Smith in which he says that the consideration is the issue of shares equal to the market value of the property (i.e. with no deduction for the debt) – we do not know if this was a on-off mistake, or reflects a general confusion as to the legal character of the transaction and so are capital and not revenue items. If so, and the original sale was exempt from CGT, then there’s no additional tax to pay; but the consequence of this argument is that the Company absolutely won’t get a tax deduction for its indemnity payments (because they must be capital payments too). That results in this, which we think is the best-case outcome of the Substantial Incorporation Structure:

Note that the best-case outcome here (which we’d expect HMRC to resist) is still worse than the original £2,400 tax bill. You’d have been better off doing nothing.

Or, if the original sale was subject to CGT then probably²⁶“Probably” because we think the uncertainty as to how long the mortgage will remain in place probably makes the stream of indemnity payments “unascertainable future consideration”, charged to CGT when each payment is made. But there’s a risk that, at least in some cases, it’s not unascertainable (for example, if the mortgage doesn’t have long to run). In that case, the stream of indemnity payments would have to be calculated and added to the original disposal consideration, with no discount applied – potentially a really bad result each indemnity payment is subject to CGT at 28%, resulting in this bad-but-not-quite-worst-case outcome:

We put this point to Cotswold Barristers. They were unable to explain why the indemnity receipts weren’t taxable, but said that HMRC had never raised the point. We expect that is because the issue has never been properly disclosed to HMRC.

Back in 2019, Mark Smith gave a mystifying explanation in this video:

“Finance costs accrue to the beneficiary, the company pays the expense of running the mortgage and it’s deductible on normal corporation tax principles. You don’t even have to change your direct debit or standing order payments, because you are allowed to receive the money for the mortgage repayments from the company as their agent without it being taxable in your hands, as long as at some point it flows through the company books, the company bank account, it’s only taxable by the company. You only receive the money as their agent, you make the payment as the company’s agent. And there’s a fallback position. Even if HMRC tried to tax you on it, you only pay tax at trustee rates, which basically washes out any impact of having to pay tax on it because you get the tax credit back again at 20% basic rate.”

This is gobbledygook. The individual is not the company’s agent when making mortgage payments – the individual entered into the mortgage as principal. The mortgage doesn’t form part of the trust – you can’t declare a trust over an obligation. The trust rate (and associated credit rules) apply to settlements, not bare/simple trusts – they cannot apply to this structure (and if the arrangement was a settlement there would be an array of other consequences, mostly adverse).

Legal and tax analysis – inheritance tax

Cotswold Barristers send clients materials presenting them with extraordinarily large (and unrealistic) inheritance tax calculations. We’ve seen one projecting that a client’s portfolio of under £10m would be worth £200m in ten years’ time, so with a potential inheritance tax bill of £80m. This is, at best, sharp practice and, at worst, misselling.

They say that the advantage of their Smart Company solution is that:

So you say the property portfolio is currently worth £10m, and issue shares which are worth the value of the portfolio minus £10m. Those shares are therefore worth £0 today (you claim), and you can give the shares to your children with no inheritance tax or capital gains consequences. But if the portfolio did become worth £200m in ten years’ time, the shares would be worth £190m. More magic.

The flaw in this is that the shares plainly aren’t actually worth £0 when created. It’s easy to test this: would they sell them to Tax Policy Associates for £1,000? That’s a fantastic deal for them, if the shares are really worth nothing. But obviously, nobody would take up that offer – because there’s a large expected capital appreciation embedded in the value of the shares. And that’s the tax conclusion too: the shares have a large current value equal to the discounted expected capital appreciation. We’re aware of two cases where shares of this kind have been litigated, and the contention that the shares were valueless failed (with, in one case, the Tribunal actually giving the shares a seven-figure value).

That means this structure probably has immediate inheritance tax and capital gains tax consequences (possibly also consequences under the “employment related securities” rules).

A further twist:

Cotswold Barristers and Property118 often advise putting these shares in a discretionary trust. We’ve seen them recommend “Creation of a Discretionary Trust controlled by you via a Letter of Wishes to shelter all future capital growth in the portfolio from Inheritance Tax”.

A “discretionary trust controlled by you” isn’t a trust – it’s a sham.

And another twist:

Part of the idea seems to be that shares are being created for children, so they can receive dividends and pay less tax than the parents (because of their allowances and lower tax rates). But there are specific rules that stop this.

DOTAS

Given that the main (and perhaps sole) purpose of Property118’s scheme is tax avoidance, it seems likely that their structures should be registered with HMRC under DOTAS – the rules requiring disclosure of tax avoidance schemes.

Cotswold Barristers told us that HMRC considered this point in 2021 and did not take it forward.

We would query if Cotswold Barristers made HMRC aware of the size of their fees. A “premium fee” (being a fee which is more than the time value of the work carried out) is one of the hallmarks which can trigger DOTAS.

Another DOTAS “hallmark” is where it is reasonable to expect a promoter would wish an element of the arrangements to be kept confidential from any other promoter. Property118 sent us correspondence refusing to explain elements of their structure, because it was “valuable intellectual property”. That may amount to an (accidental) admission that the confidentiality hallmark applies.

The “standardised tax product” hallmark may apply as well. Property118 boast about their “suite of documentation”.

Failure to comply with DOTAS can result in fines of up to £1m.

More strange Property118 advice

The Property118 website has other examples of tax planning that raises alarm bells, because it has no reasonable prospect of success. We’ll mention just two examples:

Capital gains value shifting

The capital gains tax avoidance below ignores the existence of a specific anti-avoidance rule:

An entirely artificial step is used to reduce the capital value of the shares, and then immediately re-inflate it. There are very longstanding rules to counter such “value-shifting” transactions (as well as a plethora of other statutory rules, plus common law anti-avoidance principles).

The structure as presented in our view has no reasonable prospect of success.

UPDATE 22 September: after this report was published we found more details of this scheme, and it turns out to be rather different from the description above, and much worse. We’ve written a short analysis of this here.

SDLT avoidance

This page suggests that SDLT can be reduced when acquiring a “house in multiple occupation” (HMO), i.e. where many people have separate bedrooms but there is one front door and usually one living room. The idea is that “multiple dwellings relief” applies. (There is similar advice in this video)

That is, however, wrong – MDR applies only where there are separate dwellings, and a bedroom is not a dwelling. That was fairly obvious when the page was written in 2020. It is more obvious now, as an Upper Tier Tribunal has ruled on the point.²⁷There is also a technical problem with the claim on this page, which Sean Randall (an experienced SDLT adviser and Chair of the Stamp Taxes Practitioners Group) explained here – with an unconvincing response from Property118.

What if you’ve entered into a Property118 scheme?

We would strongly suggest you seek advice from an independent tax professional, in particular a tax lawyer or an accountant who is a member of a regulated tax body (e.g. ACCA, ATT, CIOT, ICAEW, ICAS or STEP). Given the potential for a mortgage default, we would also suggest you urgently seek advice from a solicitor experienced with trusts and mortgages/real estate finance (e.g. a member of STEP).

We would advise against approaching Property118 given the obvious potential for a conflict of interest.

Property118 and Cotswold Barristers’ response to this article

It is common practice to give the subject of a report or investigation 24 hours to respond. The response we received from Property118 was unusual in several respects. We set it out below in full.

The initial response was a request from the CEO of Cotswold Barristers to join a recorded Zoom call: “Why won’t you come on video and ask your questions? The public deserve to make their own assessment”.

Property118 then failed to respond to any of the technical questions we asked.

Cotswold Barristers responded, but leant very heavily on the claim that their approach has been accepted by HMRC and other accounting firms. We are sceptical that full disclosure was ever made to HMRC; if you approach HMRC for a clearance but don’t mention all the facts, or all the technical issues relevant to the clearance, then any clearance you get cannot be relied upon.²⁸The leading case here is R v Inland Revenue Commissioners, ex p. MFK Underwriting Agencies Ltd, which held that a taxpayer must “put all his cards face upwards on the table”. And HMRC clearances can never be relied upon where there is tax avoidance.

The final response was a vague legal threat: “Your continued blackmail is noted and our response to any damages caused to our businesses by your future actions will be dealt with accordingly.”

In the interests of transparency, we set out the correspondence in full below. The thumbnails should expand when you click on them. Alternatively, the correspondence can be downloaded as a PDF here.

Our original query:

The initial response from Property118, including HMRC correspondence²⁹Which had a peculiar feature; however given that it could identify the client, we are not publishing it, customer testimonials, a complaint about the timescale and a vague legal threat:

The clerk/CEO of Cotswolds Chambers responded by suggesting a recorded Zoom call, because that’s “what the public would expect in 2023”:

We then received a letter from Mark Smith. This responds to our queries about the unusual relationship between Property118 and Cotswolds Barristers by referring to a recent BSB audit (discussed further above). Mr Smith responds to our CGT incorporation relief criticism by misunderstanding the s28 deeming rule; otherwise there is little in the way of technical content. For the most part, the response is “no one else has complained“:

We asked for a specific response to the technical points we had made:

Smith asks for two weeks to respond to our email. When we say that’s not realistic, and these are points they should already know the answers to, Mark Alexander sends a somewhat intemperate response:

Then a more detailed response, with a long list of people he works with (names redacted out of fairness to the individuals):

And finally a vague legal threat and accusation of blackmail::

Many thanks to G and S for bringing this to our attention. Thanks to J, T, F and BM for their help with the mortgage aspects, as well as UK Finance. Thanks to E for trust law expertise, T for insurance law input, H, S and O for the barrister conduct issues, A and Sean Randall for the specialist SDLT input, and C for advice on the direct tax/indemnity point. Thanks to Pete Miller, who wrote on the incorporation relief point three months ago, and independently reached the same conclusion as us. Pete and Sean also kindly reviewed a draft of this report, and provided invaluable feedback. J kindly provided some technical corrections after the initial version of this report was published. And thanks to Ray McCann (former senior HMRC inspector and past President of the Chartered Institute of Taxation).

We rely upon the goodwill and expertise of a large number of tax professionals, only some of whom we can name. As ever, Tax Policy Associates takes sole responsibility for the contents of this report.

Landlord image by rawpixel.com on Freepik. House image by new7ducks on Freepik. Bank image by Freepik – Flaticon

• 1
  The rate is 19% for profits under £50,000, with a “catch-up rate” of 26.5% on profits up to £250,000, so that the overall effective rate smoothly transitions into the full rate of 25%
• 2
  Obviously you will want to get the money out at some point, but being able to defer and roll up low-taxed income is valuable in itself
• 3
  Because a landlord can walk away from a company in a way that they cannot walk away from a personal mortgage
• 4
  We have established this is their structure from published information on the Property118 and Cotswold Barristers websites (e.g. this brochure, and here, here, here, and here) as well as copies of their advice we received from our sources.
• 5
  This is perhaps the most likely of a number of possibilities, all discussed further below
• 6
  In the interests of concision, we don’t go into one somewhat difficult point: the effect of a sale when that sale is prohibited by another contract (the mortgage). The Don King v Warren case is general authority for the proposition that such a sale will still be effective in equity, and we expect that will be the case here. However the issues are not straightforward; and if we’re wrong, and the sale is not effective in equity, then essentially nothing has happened from a tax perspective, and it’s as if the transaction never happened. No tax benefit, but also none of the unfortunate results we go into below.
• 7
  the landlord may be able to recover from the company under the indemnity, but if the companies’ assets are insufficient, the landlord will remain on the hook. There are, therefore, no liability advantages from the substantial incorporation structure, compared to, if the landlord just held the properties personally.
• 8
  In an earlier (and unrelated) LinkedIn discussion, Mark Smith, head of Cotswold Barristers, hadn’t heard of the term “tax set” – i.e. he was unaware that there were specialist tax barristers’ chambers.
• 9
  Not to be confused with Mark Smith, the respected extradition barrister.
• 10
  This is from a document they sent to a client a few months ago
• 11
  Caveat: our team only had English expertise; the law is different in Scotland and Northern Ireland and therefore none of the analysis in this section applies to it; however given that Property118’s English lawyers get the English law position wrong, it would be optimistic to assume that they have the Scots and Northern Irish position right
• 12
  The original version of this report also discussed the potential for the trust to invalidate the buildings insurance of freehold property, which would be another mortgage default. Our was undertaken by insurance specialists but has been questioned by others with expertise in insurance law. This report is intended to reflect a consensus view of relevant experts, and therefore (given there is at least some doubt as to the position) we have removed that text. The general point about mortgage defaults (for both freehold and leasehold property) remains, and it is this point that UK Finance are referring to.
• 13
  An additional problem is that the liabilities of the business are not being transferred; rather they are being covered by an indemnity from the Company, and that means the consideration does not just consist of shares (which s162 requires). On the face of it, that prevents incorporation relief applying. There is an HMRC concession that HMRC do not take this point (ESC D32). That is very convenient (and necessary) for the Substantial Incorporation structure. But two important niggles: (1) there is no technical basis for ESC D32 and therefore, following the Wilkinson case, it’s unclear how HMRC can continue to apply it, and (2) a taxpayer engaged in tax avoidance cannot rely upon any HMRC concession or published practice (a point HMRC go out of their way to stress in their guidance).
• 14
  Similar issues may arise with other assets of the business which are staying put as a legal matter but (presumably) purportedly being assigned in equity: e.g. buildings insurance policies, tenancy agreements, letting agent agreements, the right to recovery of . The legal title that is being left behind is an asset, and not a valueless one. A business that only has equitable title to the core elements of its business is not the same as a normal business. A landlord is also subject to a large number of regulatory requirements around deposit protection, fire safety, etc – and these obligations will remain with the landlord as legal owner.
• 15
  Cotswold Barristers’ response was that there was a deemed CGT disposal of legal and beneficial title day one, and so the whole assets of the company were deemed to be transferred. We don’t think that’s defensible. Section 28 is a rule which sets the time of a disposal for CGT purposes. It is not some wider deeming rule which deems an asset to have been actually transferred on a different date. Incorporation relief refers to “transfer” (the legal/commercial concept) and not “disposal” (the CGT concept). This is therefore a misreading of section 28. The courts have always held that deeming rules should be restricted to their statutory purpose.) UPDATE: Property118’s own KC ended up agreeing with us on this point
• 16
  See the Elizabeth Ramsay case, and HMRC commentary here.
• 17
  or the equivalent devolved taxes if one or more of the properties is in Scotland or Wales
• 18
  That’s including the 3% surcharge for purchases of dwellings by companies. In some cases we would also need to add the 2% increased rate for non-resident transactions.
• 19
  Section 2(1) of the Partnership Act 1890 is clear that joint ownership is not enough, and sharing profits is not enough. It’s the relationship between the parties that is key. This is something that Smith and Property118 appear to overlook.
• 20
  Plus the 2% increased rates for non-resident transactions, if applicable).
• 21
  There may be other potential attacks on the “retrospective partnership” strategy using anti-avoidance legislation and principles
• 22
  The obvious way to test the loan relationship point is to ask whether the Company can be sued by the mortgage lender; the obvious answer is that it cannot. Note that whether there is a “loan relationship” or not is a legal test, not an accounting test – even if the accounts here show the Company as party to a loan, it won’t have a loan relationship
• 23
  One correspondent raised a plausible argument to the contrary: condition C in s330A CTA 2009 applies on the basis that there was a “transaction which [had] the effect of transferring to the company all or part of the risk or reward” of the mortgage (this is not an argument Property118 has made; there is no evidence they are aware of any of the provisions of the loan relationships rules). We are, however, doubtful that an indemnity has that effect – it is cashflows which are (economically) transferred, not risk/reward. An indemnity is economically and legally distinct from defeasance. Financing cost indemnities are often seen on commercial transactions, and the idea s330A applies to such arrangements would be novel. It is, furthermore, unclear if X would benefit even if s330A applied. It seems likely that the main purposes of the arrangement are to enable the Company to obtain a tax advantage; on that bass, s455C would apply to deny the deduction
• 24
  A better argument Property118 could make is that the company doesn’t need a deduction for the indemnity payment, because under the trust it’s only entitled to the net rent (after mortgage payments are made). That, however, is contrary to the nature of a bare trust – see e.g. the HMRC guidance here
• 25
  Property118’s actual implementation is unclear. We have seen some documentation which states that the indemnity payments are consideration (which we expect is the intended outcome). However we have also seen a legal advice note from Mark Smith in which he says that the consideration is the issue of shares equal to the market value of the property (i.e. with no deduction for the debt) – we do not know if this was a on-off mistake, or reflects a general confusion as to the legal character of the transaction
• 26
  “Probably” because we think the uncertainty as to how long the mortgage will remain in place probably makes the stream of indemnity payments “unascertainable future consideration”, charged to CGT when each payment is made. But there’s a risk that, at least in some cases, it’s not unascertainable (for example, if the mortgage doesn’t have long to run). In that case, the stream of indemnity payments would have to be calculated and added to the original disposal consideration, with no discount applied – potentially a really bad result
• 27
  There is also a technical problem with the claim on this page, which Sean Randall (an experienced SDLT adviser and Chair of the Stamp Taxes Practitioners Group) explained here – with an unconvincing response from Property118.
• 28
  The leading case here is R v Inland Revenue Commissioners, ex p. MFK Underwriting Agencies Ltd, which held that a taxpayer must “put all his cards face upwards on the table”.
• 29
  Which had a peculiar feature; however given that it could identify the client, we are not publishing it