HMRC has warned landlords to stop using a promoted tax avoidance scheme that claims to reduce property tax bills by bypassing mortgage interest relief restrictions.
The arrangement, described as a hybrid business model, is being marketed as a way for landlords to restructure their property businesses and increase mortgage interest deductions. HMRC says the scheme does not work and could leave landlords facing extra tax, interest, penalties and professional fees.
The warning was issued in HMRC’s latest tax avoidance Spotlight 63a. Landlords already using the arrangement are being urged to seek independent advice and exit the scheme as soon as possible.
How the scheme is promoted
The scheme involves transferring properties into a limited liability partnership (LLP) with a corporate member. Profits are then distributed among the LLP members at their discretion.
Promoters claim this structure can reduce tax because the transfer of properties to the LLP does not create an immediate tax charge. They also argue that the corporate member is entitled to a notional return on its “capital contribution”, meaning profits do not need to be reallocated under the mixed member partnership rules.
Another selling point is that the corporate member can supposedly claim a full deduction for its share of finance costs, because mortgage interest relief restrictions do not apply to companies in the same way as they apply to individual landlords.
Under the promoted arrangement, the corporate member pays corporation tax on its share of net profits. This can appear attractive because corporation tax rates may be lower than the higher and additional income tax rates of 40% and 45% that often apply to individual landlords.
HMRC’s position is clear: the arrangement breaches tax rules and should not be used.
Why HMRC says it fails
HMRC says the scheme falls foul of the mixed-member partnership rules. Under sections 850C and 850D of the Income Tax (Trading and Other Income) Act 2005, excess profits allocated to the corporate member can be reallocated to the individual landlords.
In HMRC’s view, the corporate member’s supposed capital contribution does not count as a genuine contribution for these purposes. As a result, profits routed to the company can still be treated as the landlords’ income.
HMRC also points to section 809AAZA of the Income Tax Act 2007. This anti-avoidance rule means that, even if a landlord transfers rental income to another person or structure, that income can still be treated as the landlord’s own income.
The tax authority has also reminded landlords that stamp duty land tax may apply when properties are transferred, and again when profit shares change. That could create further costs for landlords who were expecting a tax saving.
What should landlords do now?
Landlords involved in this type of arrangement should speak to an independent tax adviser or accountant as soon as possible. HMRC has said it can support taxpayers who want to leave the scheme and get their affairs back on track.
Those who continue to use the arrangement could face HMRC enquiries, additional tax assessments, interest and penalties. In some cases, the final cost may exceed the tax the landlord hoped to avoid.
Promoters of non-compliant tax avoidance schemes also face serious consequences. HMRC can issue fines of up to £1m for running illegal or non-compliant arrangements.
HMRC’s message to landlords is blunt: this scheme does not work, and anyone already caught up in it should act quickly.
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