Property 118 tax scheme subject to HMRC challenge

Property 118, in association with Cotswold Barristers, market a tax-planning option to individual buy-to-let property landlords (the Property 118 Scheme).

The Property 118 Scheme is a tax-planning option that involves landlords declaring a trust over their buy-to-let rental properties in favour of a newly incorporated company (NewCo). The key steps associated with the Property 118 Scheme include:

• The landlord sets up NewCo and transfers the economic interest in their rental properties to it in exchange for shares in NewCo (without informing any bank with a mortgage over any of the properties).
• Where applicable, NewCo also issues shares to the landlord's children with no initial value.  
• A transfer of economic interest is achieved by declaring a trust, with the landlord remaining titleholder of the properties and Newco taking the economic (or beneficial) interest in the properties.
• Newco provides the funds to make mortgage payments, which continue to be payable by the landlord.

The Property 118 Scheme attempts to:

• Bypass mortgage interest relief restrictions to allow increased deductions for mortgage interest by NewCo.
• Reduce the tax payable on profits generated by the property letting business in the landlord's hands.
• Reduce or avoid Capital Gains Tax (CGT) and Inheritance Tax (IHT) when the properties are sold to NewCo.

Material risks associated with the Property 118 Scheme

There are a number of issues with the Property 118 Scheme. In our view, the scheme is unlikely to achieve the tax savings Property 118 and Cotswold Barristers claim it does.  There are material risks that landlords will incur additional tax.

Based on the information we have seen, material risks associated with the Property 118 Scheme include:

• An upfront incurrence of CGT. The requirements for CGT incorporation relief may not be met.  The trust created under the Property 118 Scheme may give rise to an up-front CGT charge because the landlord retains an interest in the let properties.    
• CGT on any cash or loan amount payable by Newco for the properties. We would expect CGT to have been chargeable on the proportion of any sale consideration that is not shares under a transfer of a business as a going concern.
• A charge to SDLT when the scheme is set up.
• A failure to promptly claim relief for Annual Tax on Enveloped Dwellings (ATED).
• Landlords breaching the terms of any existing mortgage for a failure to disclose the terms of the trust in favour of NewCo.
• HMRC challenging the deductibility of loan interest for Newco.
• HMRC looking to tax landlords on amounts received from Newco to fund mortgage payments.
• Possible immediate IHT consequences linked to the discounted future value of the shares in NewCo. 
• A notification obligation for Property 118 and Cotswold Barristers to HMRC under the DOTAS regime.
• Penalties and interest in relation to the above. 

These risks are real and require immediate and pro-active action from any landlord who has used the Property 118 scheme.

What HMRC says

Since November 2022, HMRC has initiated a letter campaign to buy-to-let landlords who have transferred their property letting business to a company and claimed incorporation relief from CGT . This would include landlords who participated in the Property 118 Scheme.

In these letters, HMRC advises landlords that based on the information they hold too much incorporation relief may have been applied and CGT may be due to HMRC. HMRC urges landlords to check 3 key things, namely:

• If the capital gain arising on incorporation was less than the value of the property business that was transferred to NewCo.
• When calculating the incorporation relief amount claimed, that they claimed the correct amount of relief considering any rent-free interests of dependent relatives and any restrictions that may have applied.
• That the claim to incorporation relief did not include consideration other than shares in exchange for the property letting business e.g. a sum credited to a director's loan account.

HMRC then invited taxpayers to submit a disclosure to HMRC if they think their calculation is incorrect. Where no such disclosure is made, HMRC reserves the right to raise a discovery assessment (under section 29 of the Taxes Management Act 1970) which means HMRC may investigate additional tax years of landlords who participated in buy-to-let schemes.

How can we help?

HMRC is now investigating and challenging aspects of the Property 118 Scheme from as far back as 2017/18.

We understand that clients of Property 118 and Cotswold Barristers may not have been fully alerted to the potential risks associated with the Property 118 Scheme.

We are actively recruiting new members to join a group action against Property 118 and Cotswold Barristers. We are also working with those impacted to help resolve any outstanding issues with HMRC.

By structuring this claim as a group action, we plan to make it affordable and proportionate for you to seek compensation and resolve any outstanding issues with HMRC.

If you would like to join our group action, please get in touch with us by following the "Contact Us" link below or reaching out directly by e-mail or phone to Matthew Sharp and Derek Hill.

Links:

• Fieldfisher Contentious Tax team - recent landmark success
• Property 118 Scheme website
• Less Tax for Landlords Scheme
• HMRC's Guidance on Property Business arrangements involving hybrid partnership