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UPDATED 21 July 2024: Bhattacharya filed a DMCA takedown notice to try to remove this video from the internet. US fair use and UK fair dealing rules means it’s not going anywhere.

UPDATED 20 July 2024: in early 2024, HMRC notified Property118 that this was a tax avoidance scheme that should have been disclosed under DOTAS. Property118 continued to market the scheme, and as a consequence HMRC issued a stop notice on 18 July 2024.

UPDATED 1pm on 13 October 2023 with comment from HSBC UK

Here’s “property guru” and YouTuber Ranjan Bhattacharya promoting the Property118 tax avoidance scheme:¹

Part of the Property118 scheme involves the landlord borrowing under a “bridge loan” for a few hours, with the money moving swiftly between three different bank accounts all controlled by the lender. The claim is that this magically avoids £100k+ of tax for the landlord.

But what kind of lender would facilitate such a scheme?

Who owns Avocado Properties Ltd?

Rajan Bhattacharya.

If what Property118 says is true, Avocado has made hundreds of such loans, charging a 1% fee each time. So Mr Bhattacharya has been paid more than £500k for facilitating the scheme.

His failure to disclose that in his promotional videos is startling – a breach of Advertising Standards Association guidance and YouTube’s own rules. But that’s the least of it.

When HMRC challenge the arrangement, which we expect they will, the landlords involved will potentially have to pay hundreds of thousands of pounds in tax, interest and penalties.

And Property118 and Mr Bhattacharya’s companies could be liable for fines of up to £1m for failing to disclose the scheme to HMRC.

The short summary above doesn’t do justice to how brazen the scheme is – full details are below.

Why hasn’t HMRC challenged the scheme yet?

Because Property118 tell their clients not to mention the bridge loan when they file their self assessment return:²

Actually the business is sold for shares PLUS the assumption of the bridge loan (and other liabilities). Property118 surely know this, because their own documents say it. We expect they also know that the assumption of liabilities is highly relevant to incorporation relief, particularly when tax avoidance is involved. But they provide clients with disclosure that ensures HMRC don’t find out.³

The scheme

When a company makes a profit, it pays corporation tax. If it then pays the profit to its shareholders as a dividend, they pay tax on that. But if it can use the profit to repay a loan from the shareholders then they don’t pay tax on the loan repayment.

Standard (and legitimate) tax planning on incorporation takes advantage of that. In the standard approach, the landlord sells property to the newly incorporated company in return for (1) shares, (2) assumption of mortgage debt, and (3) a “loan note”⁴ (or similar) issued by the company to the landlord. Future profits can be used to repay the loan note.

That is uncontroversial, but has the disadvantage that the sale of the property to the company will be subject to capital gains tax.

Property118 think they’ve found a way to avoid the capital gains tax and extract profits by a tax-free loan repayment.⁵

An example: let’s take a landlord who owns properties worth £1m, has a mortgage of £500k, and wishes to transfer the properties to a newly incorporated company.⁶

Step 1 – The loan

Avocado Properties Limited lends £450k to the landlord. So, on paper, the arrangement looks like this:

In reality, the money actually goes from Avocado Properties Limited to an HSBC bank account held by Fab Lets (London) LLP, a company owned by Mr Bhattacharya, held on escrow for the landlord. The landlord never gets the £450k.

Here’s what Property118 tell their clients about Avocado Properties Limited:

I am pleased to confirm I have now submitted your bridging finance application to our preferred lender and that:

• • • Your application matches their lending criteria perfectly
    • Their processes and documentation have been compliance checked by Cotswold Barristers
    • We have a 100% success record with this lender
    • We have completed hundreds of loans with this lender

And here’s what they say about Fab Lets (London) LLP:

This is another of Ranjan’s companies and was originally purposed as a property management business, so it has the correct structures to securely create and manage clients’ accounts in a fully compliant, insured and ring-fenced manner.

The reality:

• Avocado Properties Limited is not a regulated lender, despite apparently making hundreds of loans to individuals.⁷
• Fab Lets (London) LLP is not regulated to act as an escrow agent, despite apparently having a significant escrow business.⁸
• As far as we are aware, Fab Lets (London) LLP has no insurance that would cover this arrangement.⁹ There is no evidence of any “ring-fencing”. Why did Property118 claim otherwise?
• There may also be a breach of HSBC’s account terms.

There are obvious questions as to the regulatory propriety of these arrangements, but that is not our expertise. We will leave such matters to regulatory lawyers and the FCA. The remainder of this report will focus on tax.¹⁰

HSBC has now seen this report. A spokesperson for HSBC UK told us:

“HSBC has zero tolerance for the facilitation of tax avoidance schemes using HSBC products and services.”

Our assumption is/was that HSBC had no knowledge or involvement in the scheme.

Step 2 – Novation 

Immediately after the bridge loan, the landlord’s new company buys the rental properties. In return, the company issues £50k of shares to the landlord, and agrees to assume responsibility for the £500k mortgage and the £450k bridge loan (under a “novation”).

In theory, it’s this:

In practice, nothing happens, and no money moves.

Step 3 – Director loan

The landlord now makes a £450k “director loan” to his company, using the £450k advanced under the bridge loan in step 1:

In practice, Fab Lets (London) LLP transfers the cash from the first HSBC bank account (supposedly held on escrow for the landlord), and moves it into a second HSBC bank account (but now supposedly held on escrow for the company).

Back in the real world, the landlord isn’t lending £450k, because the landlord never really had £450k.

Step 4 – Repayment

Immediately afterwards – this is all happening on the same day – the company uses the £450k to “repay” the bridge loan. In theory:

In practice, Fab Lets (London) LLP returns the £450k to Avocado Properties Ltd. The money never left Mr Bhattacharya’s control.

The intended consequences

There are four intended consequences:

• The company now magically owes £450k to the landlord under the “director loan”, despite the landlord never having £450k and the company never receiving £450k. The next £450k of profit made by the company can be paid to the landlord as a repayment of the “loan” – and the landlord won’t be taxed on it. That’s saved/avoided up to £177k of tax.¹¹
• Incorporation relief applies so there is no capital gains tax, thanks to the HMRC concession that allows a company to assume liabilities of the business.
• Rajan Bhattacharya has made £5,250¹² for moving £450k between three bank accounts in the course of one day. If Property118 have really “completed hundreds of loans with this lender” then Mr Bhattacharya has made well over £500k in total.¹³
• Property118 has made a £4,500 “arrangement fee”.

The actual consequence – a large CGT hit

When a landlord incorporates their property rental business, an important and legitimate part of the tax planning is ensuring “incorporation relief” applies to prevent an immediate capital gains tax hit on moving the properties into the company.

That requires (amongst other conditions) that the property is sold in consideration for shares in the company, and only for shares.

By concession, HMRC also permit the company to take over business liabilities of the landlord:

In the Property118 scheme, the bridge loan is taken over by the company; but the problem is that it’s not a “business liability” of the landlord. It barely exists at all, and certainly isn’t used for the landlord’s business.

Oh, and HMRC expressly say that this concession can’t be used for tax avoidance:

So incorporation relief is DOA. Not “it’s doubtful the relief applies” or “some would question whether the relief applies”. We see no reasonable basis for believing incorporation relief applies to the assumption of debt in such circumstances. That means a large up-front capital gains tax hit for the landlord, probably around £130k on the numbers in the example above.¹⁴

If the bridge loan had been properly disclosed to HMRC we expect that HMRC would have raised this point. However, Property118 tell their clients not to mention it:

We asked Property118 why they do this. They didn’t respond, so we have to speculate. Our view is that no reasonable adviser would advise a client to mis-describe a transaction to HMRC. Best case, it’s carelessness, for which penalties apply. Worst case, it’s deliberate and concealed, and we are into serious penalties. We still believe Property118 are incompetent rather than dishonest… but if we are wrong, and this is dishonesty, then we get into criminal tax fraud territory.

Another consequence – the “director loan” isn’t a loan

This is an artificial tax avoidance structure. The bridge loan is taken immediately prior to incorporation for no purpose other than tax avoidance. Money is then moved in a predetermined circle for no purpose other than tax avoidance, and achieves no result other than tax avoidance. The bridge loan doesn’t even exist for a whole day. Structures of this kind have been repeatedly struck down by the courts over the last 25 years.¹⁵

So the question is: despite that artificiality, can the director loan be used to facilitate tax-free profit-extraction in the same way as the “loan note” in the standard version of the structure?

There are several ways this could be viewed:¹⁶

• Realistically, the bridge loan did nothing and can be disregarded – but the director loan can still be viewed as part of the consideration for the sale of the property. In other words, if we step back and ignore the silly intermediate steps, the landlord sold the property to the company for consideration comprising: shares, the assumption of the mortgage debt, and another £450k which remains outstanding as a director loan. In this scenario it’s clear CGT incorporation relief fails. But future profits can be paid out on the director loan without suffering income tax. The structure failed to achieve its CGT aim, but did achieve the basic planning aim of the standard structure… in a much more complicated way and at much greater expense for the landlord.
• The bridge loan didn’t exist and neither did the director loan. So future profits can’t be paid out on it, and the structure fails completely. This seems a harsh result. Can HMRC really say the director loan exists enough to kill CGT incorporation relief, but not enough to shield future profits from income tax on dividends? HMRC has a history of running such harsh “double tax” arguments when attacking tax avoidance schemes, but not always successfully.

The consequence of failing to disclose to HMRC

Most tax avoidance schemes are required to be disclosed to HMRC under the “DOTAS” rules. The idea is that a promoter who comes up with a scheme has to disclose it to HMRC. HMRC will then give them a “scheme reference number”, which they have to give to clients, and those clients have to put on their tax return. The expected HMRC response is to challenge the scheme and pursue the taxpayers for the tax.

For this reason, promoters of tax avoidance schemes typically don’t disclose, even though they should. This is often on the basis of tenuous legal and factual arguments, to which the courts have given short shrift¹⁷. One recent example was Less Tax for Landlords, who were adamant their structure was “not a scheme” and so not disclosable. HMRC disagreed.

It is, therefore, unsurprising that the Property118 structure has not been disclosed under DOTAS. In our view, it clearly should have been. The structure has the main purpose of avoiding tax – indeed that’s its sole purpose. The high fees charged by Property118 and Mr Bhattacharya are the kind of “premium fee” that triggers disclosure¹⁸

The failure to disclose means Property118 may be liable for penalties of up to £1m. It also means that HMRC could have up to 20 years to challenge the landlord’s tax position.

Mr Bhattacharya’s companies may also be liable as “promoters”, as their role administering the transaction may make them a “relevant business”. HMRC say:

How do Property118 defend the structure?

We asked Mr Bhattacharya and Property118 for comment; neither responded.

In the advice note Property118 sends to clients, they refer to HMRC guidance in the “Business Income Manual”. Advisers questioning the structure have received the same explanation. But that guidance is irrelevant – it relates to when a company can claim an interest deduction for a loan taken by the company to fund a withdrawal of capital by its shareholders. It has nothing to do with creating a “director loan” out of nothing, and nothing to do with circular tax avoidance transactions.

Property118 have also assured advisers that HMRC have accepted the structure in numerous cases. We are highly doubtful that the true nature of the structure was ever explained to HMRC (and, as noted above, Property118 appear to advise against providing an explanation). Any clearance, or enquiry closure, obtained on the basis of incomplete disclosure is worthless.

These two responses are typical of Property118 and other avoidance scheme promoters. Little or no reference is ever made to the law, and certainly never to tax avoidance caselaw. Instead, HMRC guidance is quoted out of context, and clients are assured that nothing has ever gone wrong in the past, whilst success is (apparently) assured by never revealing the full details to HMRC.

When and if Property118 and Mr Bhattacharya do respond, we will gladly correct any factual or legal errors they identify.

What if you’ve implemented this structure?

We would strongly suggest you seek advice from an independent tax professional, in particular a tax lawyer or an accountant who is a member of a regulated tax body (e.g. ACCA, ATT, CIOT, ICAEW, ICAS or STEP).

If it appears you will suffer a financial loss from the scheme, you may wish to also approach a lawyer with a record of bringing claims against tax avoidance scheme promoters.¹⁹

We would advise against approaching Property118 given the obvious conflict of interest.

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Thanks to accountants and tax advisers across the country for telling us about their experiences with Property118, as well as the clients who contacted us directly. Thanks again to all the many advisers who’ve worked with us on these issues.

Landlord image by rawpixel.com on Freepik. Bank image by Freepik – Flaticon

Video © Ranjan Bhattacharya and Property118 Limited, and reproduced here in the public interest and for purposes of criticism and review.

Property118 is an unregulated adviser which works in a “joint venture” with a barristers chambers called Cotswold Barristers. They promote a tax avoidance scheme aimed at buy-to-let landlords. But nobody involved appears to have any tax qualifications and in our view the scheme fails spectacularly.

This report explains the scheme, and explains why in our view, and that of the mortgage lenders’ industry body, it is likely to default the landlord’s mortgage. We also set out a detailed analysis of the serious tax problems with the structure. We are going into more technical detail than usual given the widespread promotion of this scheme in the market. Anyone who has entered into these arrangements should seek independent advice.

UPDATE: 16 September. Property118 have responded to this report. Despite having two months’ notice of our findings, their response contains no response to any of the points we’ve made, just assertions that their structure is fully compliant, and that HMRC and lenders have never challenged it. As we note below, we doubt the structure has ever been properly disclosed to HMRC or lenders. Now HMRC and lenders is aware of the structure we expect challenges over the coming months and years.

UPDATE: 22 September. We’ve a further report on another aspect of Property118’s planning.

UPDATE: 5 October. See also our report on Less Tax for Landlords. A different scheme, but with some commonalities; in many senses an even worse scheme than Property118’s.

UPDATE: 24 October. Mark Smith of Cotswold Barristers published a response on the s162 point, but one which does not address the key problem with the structure. We’ve updated the text below.

UPDATE: 9 November. The analysis below is of the structure Property118 intended to implement. Our review of their actual documentation reveals several critical implementation failings which means the actual position of their clients is likely significantly different, and significantly worse. We analyse this here. This means that much of what follows below is likely academic.

UPDATE: July 2024: HMRC have issued a “stop notice” making it a criminal offence for Property118 to continue to promote the structure.

The sales pitch

Most buy-to-let landlords hold their properties personally. So they pay income tax at 40% or 45% on the rental income. Until 2017, their mortgage interest was deductible, meaning a result something like this:

George Osborne changed that, replacing interest relief with a 20% credit. That makes a big difference:

Many landlords view this as unfair, because the £2,400 tax is more than their £2,000 net income (although the purpose of the rules was expressly to discourage buy-to-let mortgages, so this rather punitive outcome is actually the point).

The obvious move is to hold the properties in a company. Corporation tax is less – below 25%, for a small company¹ and companies get full tax relief for mortgage interest.²

But it’s not easy for a buy-to-let landlord to move their properties into a company. There can be capital gains tax and stamp duty land tax (SDLT) on the way in. And – most seriously – the mortgage lender won’t allow the existing individual mortgage to move to a company. You could get a new mortgage, but mortgages for companies are significantly more expensive than buy-to-let mortgages. ³

Advisers therefore frequently caution clients that the increased interest cost of moving properties to a company can easily exceed the tax saving. It’s often a mistake to be over-focused on tax savings.

The Property118 solution

Wouldn’t it be wonderful if you had all the tax benefits of moving to a company, but could keep your existing bargain-price mortgage?

Property118 say you can, with what they call the Substantial Incorporation Structure:

• The landlord – let’s call him X – sets up a new company (which I’ll call the Company), and sells the properties to it, getting shares in return
• But “completion” of the sale is deferred – X remains the registered owner of the properties. A trust is created, with the landlord as trustee, and the company as beneficiary.
• This is invisible to the world – and to the mortgage lender. So X doesn’t ask the mortgage lender for consent, or even tell the mortgage lender about it.
• Property118 claim that, because the transaction creates a trust, it’s not a breach of X’s mortgage.
• They claim that “incorporation relief” applies so there’s no capital gains tax.
• Often they say that X and their spouse were in a partnership, so SDLT partnership rules apply and there’s no SDLT to pay either.
• X continues to make mortgage payments to the lender but, behind the scenes, the Company agrees to reimburse/indemnify X. The Company claims tax relief for those payments. So – claim Property118 – it’s just as good as if the Company had borrowed itself.
• But it’s better – because they say this isn’t just a company – it’s a “Smart Company“. The idea is that the Company issues shares to X’s children which supposedly have no initial value, but will grow in value over time. So future increase in the value of the property portfolio will fall outside X’s inheritance tax estate.

The end result is that, by signing a piece of paper, X gets a dramatically better tax result with no downside:⁴

What actually happens – the short version

The structure doesn’t work.

The sale likely puts the mortgage into default. The mortgage terms usually require consent for the sale to the Company, and that wasn’t obtained.

We asked UK Finance, the trade association for mortgage lenders, and they said:

“Transferring ownership of a property into a trust without informing your lender and seeking their consent would most likely be a breach of a mortgage’s terms and conditions.”

The tax will also go badly wrong.

Property118 have forgotten that X is still there, still paying £8k to the bank, but now receiving £8k of new income in the form of the indemnity payments. Those indemnity payments are fully taxable, but the bank interest isn’t deductible for him (because X no longer has a property business; he has no basis to claim any tax relief).⁵

So the structure increases the overall tax bill by 50%.

It gets worse. There is potentially also a large up-front tax hit of a large amount of CGT and SDLT when the structure is established. That could amount to hundreds of thousands of pounds.

And then an ongoing requirement to file an annual tax on enveloped dwellings (ATED) return, which is easily missed – failure to file creates late-filing penalties of £1,600 per year.

In our opinion this structure is a disaster.

We’ve set out the legal analysis of these issues in detail below.⁶

Is this tax avoidance?

Yes.

The “Substantial Incorporation Structure” has no benefit to the landlord other than (supposedly) saving tax. It will therefore be regarded as tax avoidance by a number of statutory anti-avoidance rules, which will potentially negate the tax benefits (if there are any, which there probably aren’t).

This is by contrast with a normal incorporation, which absolutely does have other benefits for the landlord. In particular, it segregates legal liability: if the landlord is sued by the lender or by a tenant, then if the properties are held in a company, that liability will normally not attach to the landlord personally. A normal incorporation is not usually tax avoidance, even if it has tax benefits.

However, the substantial incorporation structure does not achieve legal segregation. As far as the lender, the tenants, and the world are concerned, the landlord remains personally the owner of the properties and therefore as a legal matter remains personally liable.⁷

Property118 and Cotswold Barristers

Property118 and Cotswold Barristers often charge fees of over £40,000 to relatively small landlords earning less than £100k/year. They’re set up to get referrals from other websites, paying £2,000 for a click that results in new business – meaning that they’re widely promoted by other firms (for example here).

For £40,000 you could expect to instruct a well-known accounting or law firm, staffed by qualified tax lawyers/accountants.

But neither Property118 nor Cotswold Barristers appear to have any members or employees with tax qualifications or experience. Property118 is entirely unregulated. I had a very confusing exchange of emails with Mark Alexander, head of Property118, in which he didn’t appear to have even heard of the two main tax qualifications: ATT and CTA.⁸

The head of Cotswold Barristers, Mark Smith⁹, is a generalist whose practice ranges from business law, to tax, to criminal defence work, to private prosecutions (including one where he was suspended by a month by the Bar Standards Board for acting negligently and “failing to act with reasonable competence“). His profiles in 2017 and 2020 don’t include tax in his areas of practice.

Barristers chambers usually list their members – the members being the whole point of the chambers. Cotswold Barristers is unusual in not doing this. It did at one point – and included as part of its team a fake barrister with a dubious past who was jailed for conning a dying woman out of her life savings. There is no suggestion that Cotswold Barristers was aware of his actions, but Cotswold Barristers does appear to have been responsible for listing him as part of its team.

Property118 and professional standards

Property118 say this to clients:¹⁰

The reference to “delegated authority” is strange. The claim that a non-barrister could be bound by Bar professional standards and be subject to the Bar Standards Board has perplexed all of the barristers we’ve spoken to.

We put this to Mark Smith of Cotswold Barristers. He said:

“Barristers must disclose, to the BSB and clients, any associations they have with people or entities in their provision of legal services. This is a code of conduct requirement. This was complied with at the outset of our relationship with Property 118 (P118). It has recently (Jan-Mar 2023) been re-examined by the BSB as part of a routine audit of Cotswold Barristers (CB) following an update of the BSB’s Transparency Rules. We had correspondence with the BSB about this, and they were and are satisfied our association is compliant. We did review the wording relating to ‘delegated authority’ at that point, as it was ambiguous. P118 has since amended this portion of their materials, so it makes it clear their consultants only work under delegation when the client has engaged with CB. Again, so long as it is made clear to the client, and the barrister is ultimately responsible, sub-contracting of work is permitted under the Code of Conduct.”

We don’t see an ambiguity: we think the claim that Property118 are bound by Bar professional standards, and subject to the BSB, is false. We asked Mr Smith to explain this claim, and he did not respond.

We’re writing to the Bar Standards Board to see if they can cast any light on these issues. We are also asking them to look into the wider question of why Cotswold Barristers are giving legal and tax advice that is obviously wrong.

Professional indemnity insurance

Property118 say that their barristers’ professional indemnity insurance means their clients are “shielded from financial risk”:

That’s not at all how professional indemnity insurance works. If the tax structure turns out to be the disaster we think it is, and the client wants to recover their loss, they have to successfully sue the barrister for negligence. That’s never a straightforward undertaking; not least because the barrister would presumably deny causation on the basis that you would have followed Property118’s advice even if Cotswold Barristers hadn’t been involved. And Property118 aren’t regulated, are unlikely to have any insurance, and probably aren’t good for the money (its owner lives in Malta).

The mortgage problem

Property118 say their structure is “fully compliant for mortgage purposes”:

However this appears to rely significantly on not telling lenders that their security has become the subject of a trust:

We asked UK Finance, the representative body for mortgage lenders, what they thought of the structure. They said:

“If someone wishes to transfer ownership of a buy to let property they should contact their lender to discuss whether this is permitted under the terms of any mortgage on the property. Transferring ownership of a property into a trust without informing your lender and seeking their consent would most likely be a breach of a mortgage’s terms and conditions.”

We believe UK Finance are clearly right on this. But even we didn’t agree, we’d suggest that it’s not a good idea to enter into a structure which your lender believes most likely breaches the terms of your mortgage.

Property118 and Cotswold Barristers seem to be in denial. They tell their clients:

The idea a lender can’t require repayment of a mortgage when it is in default is very strange. The 2016 Court of Appeal case they cite concerned whether a lender could require repayment of a mortgage when there was no default. We don’t understand how Property118 can make this claim when their own founder was the claimant in the case.

The problem with the trust

Property118 do seem aware there could be an issue with declaring a trust that shifts beneficial ownership to a company without telling the mortgage lender. They say:

There’s a similar theme on the Property118 website:

Is this an accurate reflection of most mortgage T&Cs?

One of our team undertook a very fast and incomplete review of major mortgage lender BTL T&Cs, carried out in about one hour.¹¹

She found specific prohibitions in Investec:

And Clydesdale:

So the specific claim there are only two lenders with prohibitions is false.

But the larger problem is more basic. This is the key claim made by property118 (highlighted in blue):

The “Barrister-At-Law” will be Mark Smith of Cotswold Barristers. He takes the same approach: “as a matter of law, unless it says specifically in the terms and conditions [that] you can’t do it, then you can”.

This is not how English law security documentation works. The mortgage terms don’t need to have a specific prohibition on declaring a trust. All that’s required – and this is common – is to simply prohibit the sale or transfer of the property, and define “property” so it includes all interests, meaning the beneficial interests that would be transferred by a trust.

Here’s NatWest:

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Or The Mortgage Works (aka Nationwide):

Other lenders have a general transfer of ownership prohibition which is drafted broadly enough to capture trusts and sales of beneficial interest. For example, TSB:

After undertaking this review, we spoke to a series of experienced real estate finance lawyers, who act for lenders and borrowers on everything from small domestic conveyancing transactions to the largest commercial real estate transactions. It was their unanimous view that, one way or another, a trust would be prohibited by most and possibly all mortgage T&Cs.

We put this point to Property118 and Cotswold Barristers, and specifically gave one of these mortgage terms as an example. They declined to explain their position as a legal matter, instead asserting that large conveyancing companies agreed with them, and that no bank had ever raised the point. That, again, does not answer the question. The large conveyancing firms are built to handle straightforward conveyancing at scale, not to answer technical queries on unusual trust arrangements. Mortgage lenders will not raise the point unless they become aware of it. Until now, we don’t believe they were. However, we briefed the mortgage lenders’ representative body, UK Finance, on the structure, and their view is now clear:

“Transferring ownership of a property into a trust without informing your lender and seeking their consent would most likely be a breach of a mortgage’s terms and conditions.”

It is therefore reasonably clear that entering into this arrangement without the consent of the lender likely defaults the mortgage.¹²

Legal and tax analysis – capital gain

X probably has a large latent capital gain in the properties. For example, if X’s acquisition cost of the portfolio was £4m, and X sold it now for current market value of £8m, X would have a £4m capital gain, and pay £1.12m CGT.

But Property118 claim their Substantial Incorporation Structure means that CGT incorporation relief applies.

That would have two very nice outcomes for X. First, there’s no CGT at all to pay on the transfer to the Company. Second, the capital gain is “rolled over” into the shares in the Company, so that any sale of the shares is subject to CGT broadly as if X had held them all along. The latent capital gain of the properties themselves is eliminated – the properties are “rebased” to current market value. So if the Company sold the properties for £8m, there would be zero tax to pay.

However, there is considerable doubt whether incorporation relief will apply.

The legislation requires that “the whole of the assets of the business” move to the Company. And that’s not happening¹³

The problem here is that legal title in the properties is being left behind. This is not some minor legal formality; legal title over real estate has reality and value to it. You can’t borrow without legal title. You can’t refinance. You can’t sell. In many “bare trust” cases this is a distinction without a difference, because the beneficiary can call for legal title at any time. Here they cannot, because the consent of the mortgage lender would be required. The Company’s inability to acquire legal title is a real constraint on its business – and that demonstrates that it did not in fact acquire the “whole assets of the business”.¹⁴

Another way of putting the same point is that there is no transfer of a “business as a going concern”, just an economic transfer under a trust. The “business” is operated by the person with the legal title, as it’s that person who has all the dealings with the tenant, bank, service providers, etc. This “business” isn’t moving at all.

So our view is that incorporation relief likely does not apply.¹⁵

(In many cases there will also be doubt as to whether X’s activity as a landlord is enough to constitute a “business”.¹⁶)

UPDATE: Mark Smith finally published a specific response to this point on 20 October 2023. He makes the obvious point that capital gains tax normally looks to beneficial ownership, not legal ownership, when considering whether a disposal has been made. But section 162 is not looking at whether a CGT disposal has been made – it uses the terms “whole assets of the business” and “transfers… a business as a going concern”. We read these as factual tests. And, factually, significant elements of the business remain with the landlord. Only the landlord can deal with the lender, the tenants, letting agents, and other contractual parties. The business of the company is very different – it’s just a passive investor. We made this point above; Mr Smith does not attempt to respond to it.

Mr Smith again makes the claim that HMRC have accepted the position. This would only be relevant if the true nature of the structure was disclosed to HMRC, and the s162 point above specifically drawn to HMRC’s attention. We doubt that is the case, but even if it was, it would only provide comfort to the taxpayers specifically covered by that correspondence. HMRC would not be bound for other Property118 clients.

There is therefore, as ever, no substitute for properly considering the legal position.

Legal analysis – SDLT

On the face of it, SDLT¹⁷ is due on the transfer of the properties by X to the Company, on the full market value at a marginal rate of up to 15%.¹⁸ That’s potentially a huge up-front cost. There’s a relief for partnerships incorporating, but not for individuals incorporating.

In many cases, SDLT would make the Substantial Incorporation Structure uneconomic, with a large up-front tax cost. Here’s the Property118/Cotswold Barristers solution:

It’s to claim that, where a husband and wife run a property rental business together, in fact they’ve always been a partnership, and partnership relief is available. They do this, even in cases where there was no partnership agreement, no partnership tax returns, and no extraneous evidence of any kind that a partnership existed. Technically that does not make it impossible that there was a partnership – it’s a question of fact. But the recent SC Properties case shows just how difficult is to establish a partnership in such circumstances – and the burden of proof is on the taxpayer. It is usual for a married couple to manage their financial affairs together, but that does not normally mean there is a partnership in the legal sense. Relations between spouses are very different from the business relations of partners in a partnership.¹⁹

If SDLT were payable (because the properties are not partnership property), then interest and penalties for late filing would be due. Although multiple dwellings relief would usually be available to reduce the SDLT charge, this relief is unavailable if it is not claimed in a return or an amendment to a return. And an SDLT return cannot be amended more than one year after the filing date for the transfer. If any of the properties were occupied by X or his relatives (or not held for a qualifying business purpose) the SDLT rate on that property would be 15%.²⁰

In our view, it will only be in rare cases that this strategy succeeds, and SDLT relief applies – and HMRC guidance suggests that HMRC are likely to contest the point.²¹

Finally, although no annual tax on enveloped dwelling (ATED) would be payable to the extent that the properties are let out to third parties, ATED relief must be claimed. It is unclear to us if Property 118 advise their clients to file ATED returns (our sources have not seen such advice). Failure to file triggers late-filing penalties of up to £1,600 per return per year. For companies that used these arrangements over five years ago, it might come as quite a shock that they are liable to £8,000 of penalties even though no ATED is due.

Legal and tax analysis – taxation of the interest payments

Property118 and Cotswold Barristers say:

They make a slightly different claim in the video below: that the “legal owner continues to make mortgage payments (as nominee of the beneficiary) and claims the payments back from the beneficiary as out of pocket expenses, which are tax free”.

But that is not right at all. X, the legal owner, is not the “agent” or “nominee” of the Company under the loan – X remains the borrower under the loan in their own right. You cannot declare a trust over obligations. What is actually happening is that the Company is making indemnity payments to X, which pays the mortgage lender (and this is the case as a legal matter even if, as I suspect, there are never any cash payments from the Company to X). X therefore remains taxable.

When we look at the actual legal and tax analysis that follows from this, the entire structure falls apart.

Deductibility of interest payments for the Company

Mark Smith says in this video that the payment is “deductible in accordance with normal corporation tax principles”. That’s not correct.

The corporation tax treatment of debt is governed by the loan relationship rules in Part 5 of Corporation Tax Act 2009. For these rules to apply, the Company must have a “loan relationship”, for which it has to be “standing in the position of debtor under a money debt” which must “arise from a transaction for the lending of money“. But the Company doesn’t have a money debt and never borrowed any money – it’s just making indemnity payments. There is only one loan, and that was from the mortgage lender to X – and it’s still there.²²

So the Company doesn’t have a loan relationship and will not achieve a deduction under the loan relationship rules.²³

It might achieve a deduction under the general rules for a company carrying on a UK property business. That requires the indemnity payments to be recognised in the accounts and for the indemnity payments to be regarded from a tax perspective as income of the property business and not as further consideration for the capital transaction of the original acquisition of the beneficial interest. We don’t think either is a straightforward point. ²⁴

So it cannot be assumed that the Company will achieve a deduction for its indemnity payments. If it doesn’t, we are in a worst-case scenario for X which looks like this:

More than doubling X’s original £2,400 tax bill. Not a good result.

Even if the Company does achieve a deduction, the result is still worse than the original £2,400 of tax:

We put this point to Cotswold Barristers. They asserted that the payment was deductible but were unable to explain how or why.

Taxability of indemnity payments

We can immediately dismiss the explanation in the video – that X is receiving tax-free out-of-pocket expenses. That would be the case if the loan had been entered into by X as trustee for the Company. But it wasn’t – the loan was simply entered into by X and X alone, and the trust can’t change that). The payments X makes to the lender are not trust expenses – they’re X’s personal expenses. And no agreement X signs with the Company can change this – you can’t transfer an obligation, or create a trust over an obligation.

That’s a big problem. X no longer has a property business (because he is a mere trustee). So X has zero basis for claiming a deduction on the interest he pays the bank. But he is now receiving a stream of indemnity payments under a legal obligation. They will be taxable (perhaps as “annual payments“, perhaps as “miscellaneous income“). That creates a large tax charge for X – it’s the worst-case outcome we show above.

We see only one potential counter-argument: to say that the indemnity payments actually form part of the consideration for the original sale,²⁵ and so are capital and not revenue items. If so, and the original sale was exempt from CGT, then there’s no additional tax to pay; but the consequence of this argument is that the Company absolutely won’t get a tax deduction for its indemnity payments (because they must be capital payments too). That results in this, which we think is the best-case outcome of the Substantial Incorporation Structure:

Note that the best-case outcome here (which we’d expect HMRC to resist) is still worse than the original £2,400 tax bill. You’d have been better off doing nothing.

Or, if the original sale was subject to CGT then probably²⁶ each indemnity payment is subject to CGT at 28%, resulting in this bad-but-not-quite-worst-case outcome:

We put this point to Cotswold Barristers. They were unable to explain why the indemnity receipts weren’t taxable, but said that HMRC had never raised the point. We expect that is because the issue has never been properly disclosed to HMRC.

Back in 2019, Mark Smith gave a mystifying explanation in a now-deleted video:

“Finance costs accrue to the beneficiary, the company pays the expense of running the mortgage and it’s deductible on normal corporation tax principles. You don’t even have to change your direct debit or standing order payments, because you are allowed to receive the money for the mortgage repayments from the company as their agent without it being taxable in your hands, as long as at some point it flows through the company books, the company bank account, it’s only taxable by the company. You only receive the money as their agent, you make the payment as the company’s agent. And there’s a fallback position. Even if HMRC tried to tax you on it, you only pay tax at trustee rates, which basically washes out any impact of having to pay tax on it because you get the tax credit back again at 20% basic rate.”

This is gobbledygook. The individual is not the company’s agent when making mortgage payments – the individual entered into the mortgage as principal. The mortgage doesn’t form part of the trust – you can’t declare a trust over an obligation. The trust rate (and associated credit rules) apply to settlements, not bare/simple trusts – they cannot apply to this structure (and if the arrangement was a settlement there would be an array of other consequences, mostly adverse).

Legal and tax analysis – inheritance tax

Cotswold Barristers send clients materials presenting them with extraordinarily large (and unrealistic) inheritance tax calculations. We’ve seen one projecting that a client’s portfolio of under £10m would be worth £200m in ten years’ time, so with a potential inheritance tax bill of £80m. This is, at best, sharp practice and, at worst, misselling.

They say that the advantage of their Smart Company solution is that:

So you say the property portfolio is currently worth £10m, and issue shares which are worth the value of the portfolio minus £10m. Those shares are therefore worth £0 today (you claim), and you can give the shares to your children with no inheritance tax or capital gains consequences. But if the portfolio did become worth £200m in ten years’ time, the shares would be worth £190m. More magic.

The flaw in this is that the shares plainly aren’t actually worth £0 when created. It’s easy to test this: would they sell them to Tax Policy Associates for £1,000? That’s a fantastic deal for them, if the shares are really worth nothing. But obviously, nobody would take up that offer – because there’s a large expected capital appreciation embedded in the value of the shares. And that’s the tax conclusion too: the shares have a large current value equal to the discounted expected capital appreciation. We’re aware of two cases where shares of this kind have been litigated, and the contention that the shares were valueless failed (with, in one case, the Tribunal actually giving the shares a seven-figure value).

That means this structure probably has immediate inheritance tax and capital gains tax consequences (possibly also consequences under the “employment related securities” rules).

A further twist:

Cotswold Barristers and Property118 often advise putting these shares in a discretionary trust. We’ve seen them recommend “Creation of a Discretionary Trust controlled by you via a Letter of Wishes to shelter all future capital growth in the portfolio from Inheritance Tax”.

A “discretionary trust controlled by you” isn’t a trust – it’s a sham.

And another twist:

Part of the idea seems to be that shares are being created for children, so they can receive dividends and pay less tax than the parents (because of their allowances and lower tax rates). But there are specific rules that stop this.

DOTAS

Given that the main (and perhaps sole) purpose of Property118’s scheme is tax avoidance, it seems likely that their structures should be registered with HMRC under DOTAS – the rules requiring disclosure of tax avoidance schemes.

Cotswold Barristers told us that HMRC considered this point in 2021 and did not take it forward.

We would query if Cotswold Barristers made HMRC aware of the size of their fees. A “premium fee” (being a fee which is more than the time value of the work carried out) is one of the hallmarks which can trigger DOTAS.

Another DOTAS “hallmark” is where it is reasonable to expect a promoter would wish an element of the arrangements to be kept confidential from any other promoter. Property118 sent us correspondence refusing to explain elements of their structure, because it was “valuable intellectual property”. That may amount to an (accidental) admission that the confidentiality hallmark applies.

The “standardised tax product” hallmark may apply as well. Property118 boast about their “suite of documentation”.

Failure to comply with DOTAS can result in fines of up to £1m.

More strange Property118 advice

The Property118 website has other examples of tax planning that raises alarm bells, because it has no reasonable prospect of success. We’ll mention just two examples:

Capital gains value shifting

The capital gains tax avoidance below ignores the existence of a specific anti-avoidance rule:

An entirely artificial step is used to reduce the capital value of the shares, and then immediately re-inflate it. There are very longstanding rules to counter such “value-shifting” transactions (as well as a plethora of other statutory rules, plus common law anti-avoidance principles).

The structure as presented in our view has no reasonable prospect of success.

UPDATE 22 September: after this report was published we found more details of this scheme, and it turns out to be rather different from the description above, and much worse. We’ve written a short analysis of this here.

SDLT avoidance

This page suggests that SDLT can be reduced when acquiring a “house in multiple occupation” (HMO), i.e. where many people have separate bedrooms but there is one front door and usually one living room. The idea is that “multiple dwellings relief” applies.

That is, however, wrong – MDR applies only where there are separate dwellings, and a bedroom is not a dwelling. That was fairly obvious when the page was written in 2020. It is more obvious now, as an Upper Tier Tribunal has ruled on the point.²⁷

What if you’ve entered into a Property118 scheme?

We would strongly suggest you seek advice from an independent tax professional, in particular a tax lawyer or an accountant who is a member of a regulated tax body (e.g. ACCA, ATT, CIOT, ICAEW, ICAS or STEP). Given the potential for a mortgage default, we would also suggest you urgently seek advice from a solicitor experienced with trusts and mortgages/real estate finance (e.g. a member of STEP).

We would advise against approaching Property118 given the obvious potential for a conflict of interest.

Property118 and Cotswold Barristers’ response to this article

It is common practice to give the subject of a report or investigation 24 hours to respond. The response we received from Property118 was unusual in several respects. We set it out below in full.

The initial response was a request from the CEO of Cotswold Barristers to join a recorded Zoom call: “Why won’t you come on video and ask your questions? The public deserve to make their own assessment”.

Property118 then failed to respond to any of the technical questions we asked.

Cotswold Barristers responded, but leant very heavily on the claim that their approach has been accepted by HMRC and other accounting firms. We are sceptical that full disclosure was ever made to HMRC; if you approach HMRC for a clearance but don’t mention all the facts, or all the technical issues relevant to the clearance, then any clearance you get cannot be relied upon.²⁸ And HMRC clearances can never be relied upon where there is tax avoidance.

The final response was a vague legal threat: “Your continued blackmail is noted and our response to any damages caused to our businesses by your future actions will be dealt with accordingly.”

In the interests of transparency, we set out the correspondence in full below. The thumbnails should expand when you click on them. Alternatively, the correspondence can be downloaded as a PDF here.

Our original query:

The initial response from Property118, including HMRC correspondence²⁹, customer testimonials, a complaint about the timescale and a vague legal threat:

The clerk/CEO of Cotswolds Chambers responded by suggesting a recorded Zoom call, because that’s “what the public would expect in 2023”:

We then received a letter from Mark Smith. This responds to our queries about the unusual relationship between Property118 and Cotswolds Barristers by referring to a recent BSB audit (discussed further above). Mr Smith responds to our CGT incorporation relief criticism by misunderstanding the s28 deeming rule; otherwise there is little in the way of technical content. For the most part, the response is “no one else has complained“:

We asked for a specific response to the technical points we had made:

Smith asks for two weeks to respond to our email. When we say that’s not realistic, and these are points they should already know the answers to, Mark Alexander sends a somewhat intemperate response:

Then a more detailed response, with a long list of people he works with (names redacted out of fairness to the individuals):

And finally a vague legal threat and accusation of blackmail:

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Many thanks to G and S for bringing this to our attention. Thanks to J, T, F and BM for their help with the mortgage aspects, as well as UK Finance. Thanks to E for trust law expertise, T for insurance law input, H, S and O for the barrister conduct issues, A and Sean Randall for the specialist SDLT input, and C for advice on the direct tax/indemnity point. Thanks to Pete Miller, who wrote on the incorporation relief point three months ago, and independently reached the same conclusion as us. Pete and Sean also kindly reviewed a draft of this report, and provided invaluable feedback. J kindly provided some technical corrections after the initial version of this report was published. And thanks to Ray McCann (former senior HMRC inspector and past President of the Chartered Institute of Taxation).

We rely upon the goodwill and expertise of a large number of tax professionals, only some of whom we can name. As ever, Tax Policy Associates takes sole responsibility for the contents of this report.

Landlord image by rawpixel.com on Freepik. House image by new7ducks on Freepik. Bank image by Freepik – Flaticon