A group of advisers has warned that limited company buy-to let might be the next big mis-selling scandal to rock the mortgage industry.
The warning has been inssued in the wake of research revealing that clients using limited companies to take out buy-to-let loans paid significantly more than personal borrowers.
The study, by mortgage broker Private Finance, showed the higher rates for limited company borrowing means some investors could see their income shrink by £1,000 a year compared to personal borrowers.
Limited company buy-to-let lending has grown in popularity thanks to the changes to mortgage interest tax relief, which kicked in earlier this year.
Previously landlords could claim 100% mortgage interest tax relief based on their marginal rate of Income Tax, but new rules being phased in from April will see this being scaled back.
The shakeup means, by 2020 tax will charged on all income and all landlords will get a 20% tax credit instead, which will impact profits for those taxed at the higher and additional rate.
However, these rules don’t apply to buy-to-let landlords converting to a limited company structure, plus profits are subject to lower Corporation Tax rather than Income Tax.
Currently, limited company landlords can subtract mortgage interest costs from their rental income before calculating how much Corporation Tax is due.
Not for everyone
However, not everyone will benefit from using a limited company to protect profits from the government’s tax clampdown on landlords.
Private Finance research reveals a limited company borrower can expect to pay 3.4% for a two-year fixed rate at 75% loan-to-value, compared to 1.92% for a landlord borrowing in their own name.
So a landlord earning £46,010 annually (£35,000 base salary plus £11,010 in rental income) will have £36,194 in take-home income if purchasing as an individual after tax and mortgage costs.
If the same landlord purchased through a limited company, they would earn £34,825 in take home income – which is £1,369 less.
The main reason for the lower take-home amount for the limited company route is the higher mortgage costs – which add £2,147 a year to the limited company borrower’s bill.
Private Finance research reveals that typically landlords with multiple properties can benefit from converting to a limited company structure, with four being the magic number.
So, the same landlord earning £35,000 a year with four rental properties earning £11,010 each would take home £49,374 per year after tax and costs. If those properties were owned through a limited company structure, the earnings rise slightly to £49,644.
Overall the larger the portfolio, the greater the incentive to move to a limited company structure, according to the research.
But the firm warns that this rule of thumb only applies to acquiring new buy to let properties.
If you already have a number of properties and want to repurchase them via a company there are much greater costs to consider like Stamp Duty and Capital Gains, that wipe out the advantage of a limited company strategy for most.
A landlord with five rental properties earning £90,050 in total, would have £53,768 in take-home pay compared to £54,584 through a limited company. However, after CGT this is reduced to £49,663, a loss of £4,000 a year under the company structure.
Oliver Marley, mortgage adviser and head of research at Independent James, told FT Adviser that the number of mortgage advisers pushing landlords to getting limited company status could be the next mis-selling scandal.
He said: “We have lots of advisers saying it is tax efficient, but they are not accountants,” he added. “I have heard a few advisers saying it is better for tax purposes.
“Limited company interest rates are normally higher and fees are higher. The way interest rates are at the moment it is a balance between the amount of tax and interest, and when we have looked at scenarios, they are not too far away from each other.”
Marley also warned that limited company borrowers could be impacted by further changes to government policy, taking a further financial hit.
“There is nothing really set to say that just because you have purchased a property using a limited company, the government are not going to change tax for limited companies. They could change it any day.”
Meanwhile, Ruth Whitehead from Ruth Whitehead Associates in London said that, while the scale of limited company buy-to-let mis-selling would be smaller than PPI, the principle was the same.
She told the FT Adviser: “It is a very litigious world we live in, and anyone who thought they had been short-changed would try to claim money back from them.
“I had a client try to sue me for arranging a buy-to-let mortgage rather than a residential one – but it was a buy-to-let property, and he already had a residential mortgage. He tried to sue me because the interest rate was higher.”
What to do if you've been mis-sold
If you think you’ve been mis-sold a limited company buy-to-let mortgage or received bad advice about switching to a limited company structure, you can complain.
If you are unhappy with the response you can take your complaint to the Financial Ombudsman Service.