Law Society warns of another BTL investor tax trap

Under new wording added to the Finance Bill in July BTL investors could be forced to pay income tax as opposed to capital gains tax (CGT) when selling their assets, meaning they could be forced to pay up to 17% more in tax, according to the solicitors’ professional body.

In many instances the CGT rate is much lower than income tax, especially after it was significantly cut in the 2016 Budget.

From April 2016, basic-rate income tax payers pay 18% in CGT on residential property and higher-rate taxpayers are charged 28% CGT.

Income tax on the other hand, which private BTL landlords pay on their rental profits, is currently 40% for anyone earning more than £43,000 a year, rising to 45% for the highest rate payers.

The Law Society said many landlords would automatically assume they would need to pay CGT on their capital earnings from their investment after they sell it.

The problem, it said, was the government had added wording at the report stage of the bill, which was closely based on the existing transactions in land rules – rules to prevent tax avoidance.

The consequence would be that the profit on realisation would be taxed as income rather than as capital gain.

In particular, the Law Society was concerned about the government introducing a “main purpose” test, rather than a “sole or main object” test, which is the test used for the existing transactions in property.

For instance, under one scenario the new rules would be applied where “the main purpose, or one of the main purposes, of acquiring the land was to realise a profit or gain from disposing of the land”.

The Society said: “We consider that there are many situations where this formulation of the test would capture transactions that are uncontroversial investment transactions. In particular, we consider that this formulation of the test could apply to many buy-to-let investors, despite the fact that they are clearly engaged in a property investment business on general principle.”

It explained: “Any buy-to-let investor will assess the overall yield before making an investment decision. In areas of the country with low rental yields, an essential part of the investment proposition is the prospect for capital growth, even if the investor’s intention is to hold the property for the medium to long term.

“Indeed in the current market, and given the low returns on other asset classes, there are few areas where the prospect of capital growth is an immaterial consideration for investors.

“Financially speaking, it is hard to say that the obtaining of that capital growth would not be one of the main purposes of acquiring the land. However, the average buy-to-let investor will have assumed that it will be taxed at capital gains tax rates on ultimate disposal of the property.”

The body criticised the government for the way it changed the text, saying it should have consulted the industry on any changes it intended to implement.

Chief executive Catherine Dixon said: “The way these changes were introduced, in particular without consultation on the draft legislation before it was added to the bill at such a late stage, starts to feel like legislation by stealth.

“If the government did not intend to make a material change, they need to clarify the language in the bill before it is passed. If they are intent on these changes, they should submit them for proper public consultation and legislative scrutiny.”

Parliament is due to debate the issue further next week.