Buy to Let Property Owners and Freelance Contractors may find forming a limited company could be a viable strategy to save tax under the new Government, as they prepare to increase Capital Gains Tax and dilute strict rules for the self-employed.

The Queen’s speech announced the Governments proposals to change personal tax and pensions laws over the coming months. Proposals to raise capital gains tax (CGT) rates, bring them more line with income tax rates, with the exception of the upper limit which is expected to be 40%, rather than the 50% rate applied to income tax.

Despite this gloom and doom significant tax savings may be available through establishing a limited company through which to operate as a free lancer (sometimes known as a Contractor or Interim Executive) to avoid the 50p income tax rate or to shelter buy-to-let investments from the rise in CGT.

Increasing numbers of professionals are opting to become consultants or freelancers, shying away from traditional employment to minimise personal income tax. This transition will be encouraged by the government’s agreement to review IR35, which was introduced to prevent workers from forming personal service companies to avoid national insurance and income tax.Top of Form

IR35 allows HM Revenue & Customs (HMRC) to apply a number of tests to determine if the workers drawings should be treated as a dividend or be taxed at the higher rates associated with a salary. For example, an employed person with a salary of £150,000 will left with £92,220 after income tax and national insurance (NIC) after April. If the same person formed their own limited company and drew their monies in the most tax efficient manner the same gross earnings of £150,000 would be reduced to  £99,929 after tax, providing a saving of £7,709.

A small down side associated with this strategy is the application of Capital Gains Tax to the sale of the company at some point. However, the chancellor, George Osborne, is expected announce the continuation of entrepreneur relief for trading companies, which allows the proceeds of trading companies to be taxed for capital gains at 10% with a ceiling of £2m.

Limited companies also provide the additional benefit of the division of income between a husband and wife. In such a case both husband and wife would own shares in the company. Couples, even  adult children (this could be useful if the child is at University) and grandparents (this is not as useful due to the personal tax code allocated to pensioners), can apply their personal allowance to a salary paid to them by the company.

It should be noted that the HMRC have for some time sort to tighten down on this practice. Whilst so far they have not been able to do this, some feel that it is only a matter of time until the law is drafted to achieve this. Even with this caveat it appears as if we have another tax year before new legislation is adopted.

The formation of a limited company to shelter property assets for Buy to Let Investors could also be a profitable tax saving strategy to defend against rises in CGT, which is set to rise. This is only feasible if you intend to drop to the basic tax band before drawing the money out of the company.

If you own Buy to Let property yourself you will pay income tax at the marginal rate on any rental profit you make which could be as much as  50%. Any capital gain will be currently taxed at 18% (post the budget on 22nd June this will rise to 40%), less any capital gains allowance you may be entitled to.

However, if the property is owned through a limited company, the tax on any capital gain will be taxed at between 21 to 28%, with rental profits taxed at the same percentage rate.

Higher rate taxpayers will have to pay tax twice to draw money making the strategy unfeasible. However, if you reframe from drawing money until you drop to the basic personal tax bracket, possibly upon retirement, you will be taxed at 28% overall. You will have to restrict income to within the basic (currently 20%) rate band (£37,400) per year.

There is a small potential draw back as stamp duty must be paid if you transfer a property you already own into your company. However, presently those properties worth less than £250,000 are exempt from stamp duty until 2011.

There are some additional possible down sides to consider before adopting this strategy. Financing property has become difficult, since the credit crunch, and at times almost impossible for those who cannot prove their income. If you did decide to go freelance you may want to consider remortgaging beforehand. A good independent mortgage broker could possibly be able to smooth any mortgage application.  

There is a degree of complexity in forming and operating a limited company to ensure that it is tax efficient. Returns are required for both Companies House and HMRC. Moore Hill Accountants would be happy to support anyone wanting either to make the move for their property portfolio or to operate as a freelance contractor. Those wishing to operate as freelance contractors should also discuss with us the advantages that VAT registration can provide for them, in as much as it will allow them to claim back the VAT on items purchased for businesses purposes..