{"id":11487,"date":"2023-09-22T15:00:22","date_gmt":"2023-09-22T14:00:22","guid":{"rendered":"https:\/\/www.taxpolicy.org.uk\/?p=11487"},"modified":"2024-01-22T21:05:22","modified_gmt":"2024-01-22T21:05:22","slug":"amazing","status":"publish","type":"post","link":"https:\/\/heacham.neidles.com\/2023\/09\/22\/amazing\/","title":{"rendered":"The “amazing opportunity” from Property118 to avoid tax, and its amazingly bad consequences"},"content":{"rendered":"\n

Since our original report<\/a>, we’ve received numerous reports of clients’ and advisers’ experiences with Property118. This short report explains one new element – the artificial creation of a “director loan” which can be used by landlords to take profits from their business free from income tax. <\/em><\/strong><\/p>\n\n\n\n

It’s an artificial tax avoidance scheme which doesn’t work, and any landlord using it will incur large tax liabilities and penalties. The scheme should have been disclosed to HMRC under the “DOTAS” rules, but wasn’t – Property118 potentially face penalties of up to \u00a31m.<\/em><\/strong><\/p>\n\n\n\n

UPDATE 13 October 2023: since we wrote this report we’ve discovered more about the precise details of this scheme, which means that the description and analysis below is both inaccurate and too kind. We’ll keep this here, but our updated full description of the scheme is here<\/a>.<\/strong><\/p>\n\n\n

The sales pitch<\/h2>\n\n\n

Here’s the sales pitch from Property118:<\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

We’ve redacted the figure to protect our source, but it’s a large six figure sum. <\/p>\n\n\n\n

Here’s their explanation:<\/p>\n\n\n\n

\"Directors<\/figure>\n\n\n\n

This just one example from the many we’ve received – it’s a standardised structure. Property118 even set out the details themselves here<\/a>.<\/p>\n\n\n

What’s going on?<\/h2>\n\n\n

When a company makes a profit, it pays corporation tax. If it then pays the profit to its shareholders as a dividend, they pay tax on that. But if it can use the profit to repay a loan from the shareholders then they don’t pay tax on the loan repayment.<\/p>\n\n\n\n

Standard (and legitimate) tax planning on incorporation takes advantage of that. In the standard approach, the landlord sells property to the newly incorporated company in return for (1) shares, (2) assumption of mortgage debt, and (3) a “loan note”1<\/a><\/sup>Why a loan note and not a loan? Because, conceptually, the company is then giving something (the loan note) as part of the purchase price for the properties. In part because the tax treatment for the company is more certain, as a loan note is clearly a “loan relationship” for tax purposes, and simply leaving money on account may not be<\/span> (or similar) issued by the company to the landlord. Future profits can be used to repay the loan note.<\/p>\n\n\n\n

That is uncontroversial, but has the disadvantage that the sale of the property to the company will be subject to capital gains tax. <\/p>\n\n\n\n

Property118 think they’ve found a way to avoid the capital gains tax and<\/strong> extract profits by a tax-free loan repayment.<\/p>\n\n\n\n

Here’s an example. Let’s take a landlord who owns properties worth \u00a31m and has a mortgage of \u00a3500k.<\/p>\n\n\n\n

Step 1: <\/strong>Landlord takes out a two week bridge loan of \u00a3450k. The money never actually goes to the landlord – it’s held in a solicitor’s client account<\/a>. The solicitor undertakes to the lender that the money will never leave that account (so the arrangement is risk-free for the lender):<\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

Step 2:<\/strong> Landlord incorporates a new company. The company buys the rental properties, and in return issues \u00a350k of shares to the landlord, and agrees to assume responsibility for the \u00a3500k mortgage and the \u00a3450k bridge loan (under a “novation”). Note that the \u00a3450k advanced under the bridge loan stays with the landlord (in the solicitor’s client account):2<\/a><\/sup>As explained in our original report, the transfer of the property is actually effected using a trust rather than a normal legal transfer, to avoid having to obtain the consent of the lender. The mortgage loan isn’t novated, but the company agrees to indemnify the landlord for the payments under the mortgage. The trust causes a number of serious legal and tax complications, not least triggering a mortgage default. However, to keep this example clear, we’ll ignore the trust in this report.<\/span><\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

Step 3: <\/strong>Two weeks later, the landlord makes a \u00a3450k “director loan” to his company, using the \u00a3450k advanced under the bridge loan in step 1 (but the \u00a3450k again stays in the solicitor client account – these are just accounting entries):<\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

Step 4: <\/strong>The company immediately uses the \u00a3450k to “repay” the bridge loan. “Repay” is in quotes, because the bridge loan money never left the solicitor’s client account:<\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

The outcome of all this:<\/p>\n\n\n\n

\"\"<\/figure>\n\n\n\n

A \u00a3450k “director loan” has been magicked<\/a> into existence, despite the landlord never having had the \u00a3450k, and certainly never having lent any real money to the company. \u00a3450k just sat in a solicitor’s client account for two weeks. The only money that really moved was \u00a39,000 – the fees Property118 and the bridge lender received for arranging the structure.<\/p>\n\n\n

The intended consequences<\/h2>\n\n\n

There are two intended consequences:<\/p>\n\n\n\n