In this article Richard Gray, Barrister of Elysium Law considers the tax reliefs available as well as the evidential and anti-avoidance issues to be considered when incorporating a property portfolio into a Company. The article takes not only a brief look at case law but considers the advisors retainer and the practical steps to be taken with the client when undertaking such work.
Much has been written about the incorporation of a property portfolio from a partnership into a limited company.
It is important to remember that the whole transaction consists of two elements
(i) Incorporation of a business; and
(ii) Transfer of the partnership
Clients (and sometimes their advisors) confuse the two, but each is a separate and distinct consideration.
To a considerable extent, each is fact specific and based upon evidence, which the advisor and their clients should be able to refer to should the claim for Roll-over Relief be challenged by HMRC and/or the issue of the existence of a partnership, is also called into question.
The Legislation -Rollover Relief Taxation to Chargeable Gains Act 1992
162 Roll-over relief on transfer of business
(1) This section shall apply for the purposes of this Act where a person who is not a company transfers to a company a business as a going concern, together with the whole assets of the business, or together with the whole of those assets other than cash, and the business is so transferred wholly or partly in exchange for shares issued by the company to the person transferring the business.
The legislation does not define the term ‘business’ and largely as one may know, the matter is dealt with in case law and by the evidence produced by the taxpayer as to the carrying on of a business should there be a challenge for the relief claimed. The classic case is that of Elisabeth Moyne Ramsay v HMRC (but again, there is no defining one size fits all factual scenario) and the issue is therefore fact specific to each case. Records of any business activity should be capable of being produced if required and by all persons within the business.
Further examples can be found in case law but be advised, that HMRC will not give non-statutory clearance on this point. It is down to the taxpayer and perhaps the advisor to formulate the case and be able to meet any anticipated challenge from HMRC.
Invariably, the accountant/advisor will know the client, but it is important that in drafting the retainer letter, the advisor should attribute the ultimate responsibility to the client, if possible, as to the facts of how the enterprise was run, which should be recorded in a comprehensive file note and sent by detailed letter to the client for confirmation and signature.
Be aware however, that in drafting the retainer, the incorporation will have been brought about possibly upon the accountant’s advice and unless seeking independent advice such as from Counsel, the accountant/advisor should really acquaint themselves with the facts and give the client a full explanation of the cases on the point if necessary. Please also be aware that the client will invariably be a consumer and any attempt to limit or exclude liability must be considered in the light of Part 2 of the Consumer Rights Act 2015. In a case where there is a large claim for such relief, it may be advisable to seek advice from Counsel and instruct Counsel to draft the appropriate retainer letter.
Debt/Equity – Point to remember
Rollover relief can be claimed only where the equity in the properties is more than the Capital Gain. It is important that clients understand the debt/equity position. Whilst acting for them during their business they should have made full disclosure as to any re-mortgaging of the properties and what they have done with the money acquired. If that money has been removed from the portfolio and spent on anything outside of it, then the incorporation may not be possible unless the debt is repaid prior to incorporation or regardless of withdrawal, there is still enough equity in the properties. Again, use a simple analogy such as re-mortgaging for a new private residence. In a removal situation the gain will be more than the equity in all probability, but the client should set the facts down and then undertake the calculation. Remember, that the information given relies upon the accuracy of the client. Therefore, the retainer letter should exclude any liability for the information given. An example of the calculation is given in HMRC manual CG65740.
Partnerships and SDLT relief
Partnership as transferor
Given that the consideration is for shares then the payment of SDLT will be calculated on the value of the shares.
Section 53 of the Finance Act 2003 and the Market Value Rule
53 Deemed market value where transaction involves connected company
(1) This section applies where the purchaser is a company and—
(a) the vendor is connected with the purchaser, or
(b) some or all of the consideration for the transaction consists of the issue or transfer of shares in a company with which the vendor is connected.
(1A) The chargeable consideration for the transaction shall be taken to be not less than—
(a) the market value of the subject-matter of the transaction as at the effective date of the transaction.
(4) Where this section applies paragraph 1 of Schedule 3 (exemption of transactions for which there is no chargeable consideration) does not apply.
But this section has effect subject to any other provision affording exemption or relief from stamp duty land tax.
Where there is a transfer at Market Value to a connected Company an SDLT charge will therefore arise.
FA2003, Schedule 15, para 18 onwards applies to the transfer of a chargeable interest from either a Partnership or an LLP and will apply upon an incorporation where the existing business is operated through a Partnership or LLP.
The calculation at para 20 (“Transfer Of Chargeable Interest from a Partnership: Sum of The Lower Proportions”) provides that the chargeable consideration will be equal to the % of the income rights changing hands applied to the market value of the property.
The shares should be issued in proportion to the partnership income.
SDLT relief will not be available if shares are issued disproportionately to the capital in the partnership.
It appears that HMRC accept that FA2003, Schedule 15 takes effect in priority to the market value rule in s53 of the Finance Act 2003. This means that no SDLT would be chargeable if the transfer came from a partnership or limited partnership providing that the steps in paragraphs 18-22 of Schedule 15, are followed. Again, the existence of a partnership is a matter for the individual client, and one cannot simply undertake a ‘one size fits all’ approach.
Of note is paragraph 17A of Schedule 15. Essentially, if value is removed from the partnership within 3 years of land being transferred to it, where there was no SDLT or reduced SDLT by a partner or connected person then paragraph 17A operates to produce a charge. However, incorporation does not remove the property and Schedule 17 will not apply.
Two points of importance also must be recognised:
- This rule appears to be an anomaly in the legislation in that partners are favoured in this way. In that respect a partnership deed should be in existence, or the accounts treated as partnership accounts. One cannot retrospectively draw up partnership accounts if they have not been operated in this way previously.
- Partnership and Co-ownership are NOT the same. There must be evidence of one partner being able to bind another and a separate bank account being operated. All must agree to share profits and losses.
There are two cases with which the advisor should be familiar.
As to the existence of a business and a partnership one needs to refer to the case of SC Properties and Another v Commissioners for HM Revenue & Customs.
For the purpose of this article, we propose to concentrate upon the partnership issue that arose in the case. The Partnership itself was not registered with HMRC until February 2019, which was long after the property transactions which were the subject of the tax dispute had occurred. Whilst the appellants (but strangely not one of the partners Mrs Cooke who did not give evidence) argued that the partnership occurred in 2014, HMRC rejected this. Whilst Partnership accounts were prepared for 2015-2017, and a Partnership return was filed for 2017 HMRC argued that on the facts there was no business (there being no mention of a partnership) and that neither Section 162 nor Schedule 15 applied.
As far as the existence of a partnership is concerned guidance was had by reference to the case of Burnett v Barker  3332(Ch)
This case calls very much into question certain assumptions that advisors make when looking at the question of the existence of a partnership. Whilst this case was not on the point of the SDLT relief that is often sought, it nevertheless discloses interesting issues set out in the Partnership Act 1890.
Section 1(1) of the Partnership Act 1890 provides:
Definition of partnership
1. (1) Partnership is the relation which subsists between persons carrying on a business in common with a view of profit.
From the statutory definition it appears that before a partnership can be said to exist, three conditions must be satisfied, i.e. there must be:
(1) a business;
(2) which is carried on by two or more persons in common;
(3) with “a view of profit”
Section 2 of the Partnership Act 1890 sets out certain rules for determining the existence of a partnership:
Rules for determining existence of partnership
2. In determining whether a partnership does or does not exist regard shall be had to the following rules:
(1) Joint tenancy, tenancy in common, joint property, common property or part ownership does not of itself create a partnership as to anything so held or owned, whether the tenants or owners do or do not share any profits made by the use thereof.
(2) The sharing of gross returns does not of itself create a partnership, whether the persons sharing such returns have or have not a joint or common right or interest in any property from which or from the use of which the returns are derived.
(3) The receipt by a person of a share of the profits of a business is prima facie evidence that he is a partner in the business, but the receipt of such a share, or of a payment contingent on or varying with the profits of a business does not of itself make him a partner in the business;
For the sake of completeness, we have set out paragraphs 40-42 of the judgment and advisers should bare this in mind when advising clients.
- With one exception (the receipt of a share of profits), the above rules are formulated as negative propositions and merely establish the evidential weight to be attached where the particular facts of a case precisely duplicate those set out in the section. However, it will rarely, if ever, be possible to divorce those facts from the surrounding circumstances so as to permit the statutory rules to be applied in their pure form. Fundamentally, in determining the existence of a partnership, regard must be paid to the true contract and intention of the parties as appearing from the whole facts of the case (Lindley & Banks, para 5-03).
- There is some further guidance about the evidence required to prove a partnership in Lindley & Banks, Chapter 7 and in particular the types of ‘usual’ evidence relied on in para 7-23 etc including (so far as likely to be relevant here): accounts (draft or final); advertisements; agreements and other documents; bills, circulars and invoices; brochures; conduct; holding out; joint bank accounts; joint property; letters and memoranda; meetings; profit share; tax returns; use of property; wages; and witnesses.
- Although conduct is clearly relevant, it will not be determinative, particularly if it can be demonstrated that there was actually no intention to create a partnership. As to witness evidence (which is also relied on) – a witness may be asked whether named individuals compose the firm.
In light of this judgment, it may once again be advisable to go to specialist Counsel for advice especially where the reliefs sought are large, and Counsel can then advise if appropriate upon the collation of evidence. Our suggestion would be to obtain statements of truth from the Clients with exhibits in the form set out as required by the FTT (Elysium law can assist in this respect) and obtain further evidence such as that mentioned above. Above all, read and consider Section 2 (1) and (2) above and once again go through PIM1030 with the clients.
In summary, the reliefs available to people who carry on a property business partnership are significant, but a thorough process must be undertaken with the clients before incorporation takes place.
Points to remember
- Is there a business and can this be evidenced by facts if required?
- Is there a Partnership? NOTE: Co-Ownership is not the same. Again, can this be evidenced by the partnership accounts, any partnership agreement, any stationery in the name of the partnership used by the partners for correspondence?
- If in doubt, get a further opinion from Counsel and ask what evidence is required including statements of truth from the clients.
- Go through PIM1030 and the Partnership Act.
- Clarify what the debt/equity position is and get this certified by the clients in clear terms.
Anti-avoidance rules are set out in the Finance Act 2003 Sch 15 para 17A.
Paragraph 17A imposes a charge to SDLT if, during the three years after a para 10 transfer of land to a partnership, the transferor or a partner connected with the transferor:
(i) Withdraws money or money’s worth from the partnership (other than income profit);
(ii) Reduces their interest in the partnership share; or
(iii) Ceases to be a partner. This would include the withdrawal of capital from the capital account and the repayment of a partner’s loan.
Does incorporation constitute a withdrawal for these purposes?
Some ask whether an incorporation is to be treated as a ‘withdrawal’ for the purposes of para 17A
The answer is no. A withdrawal is only a qualifying event if it is coupled with a partner withdrawing capital from his account, reducing his interest in the partnership
Further Anti-Avoidance provisions
Of further interest is Section 75A of the Finance Act 2003
This may be relevant where the following takes place:
- Property investor operates as a sole trader or joint owner with A.N. Other;
- A Partnership or LLP is formalised; and
- Sometime afterwards this Partnership is ‘converted’ to NewCo
Without any of the anti-avoidance provisions, and assuming this was the genuine substance of the transaction, then an SDLT charge could be avoided.
Clearly, the planning could fall within the generality of s75A given that:
- The property Investor (V) will dispose of a chargeable interest and NewCo (P) will acquire it;
- Subject to the precise definition of ‘transaction’, a transaction [the partnership and the incorporation] is involved in connection with the disposal and acquisition (“the scheme transactions”); and
- 3. the amounts of stamp duty land tax payable in respect of the scheme transactions would be less than the amount that would be payable on a notional land transaction effecting the acquisition of V’s chargeable interest by P on its disposal by V.
One question, highlighted above, is whether we have a scheme transaction. This is defined at s75A (3) which provides a (non-exhaustive) list of ‘transactions. The incorporation process would not fall within the definitions of a scheme transaction.
A question would therefore be whether, assuming that the Partnership had been in place for a reasonable period, and was being genuinely operated as a partnership, there is a realistic danger that HMRC would invoke 75A?
Whilst I am aware, that HMRC is seeking to apply this section more aggressively than it has historically done so in relation to SDLT planning arrangements, I do not believe that there is a real risk of HMRC making a successful attack. This section needs to be carefully reviewed with the client however before incorporation takes place.
In conclusion property incorporation can be very useful in many circumstances but clearly each and every aspect of it both as to the calculations and principles of the existence of the business and as a separate consideration the partnership must be carefully considered.
If you require further advice on incorporations relief or require assistance, then please call us on 0151 328 1968 or visit our website www.elysium-law.com.
 Ramsay v HMRC  UKUT 0236 (UTT).
 Partnership includes LLP
 See paragraphs 10-12 of Schedule 15
 See HMRC guidance at PIM1030 which SHOULD be read and gone through with the client.