Be very careful when transferring property loans in a section 162 incorporation

Property business incorporations have been quite topical recently. The tax blogger Dan Neidle has attacked various mass marketed planning strategies in this area. For example, he has heavily criticised the practice of using a deed of trust to transfer property from a sole trader or partnership to a company.

The issue

This method is sometimes employed with the intention of allowing the recipient company to continue to enjoy the borrowing terms which were granted to the sole trader or partnership. Because the legal title of the property remains with the transferor and the mortgage payments continue to be paid (often by the transferor acting as agent of the transferee), the stakeholders hope that ‘the boat will not be rocked’ and therefore the terms of the mortgage will continue.

This article does not aim to debate the issues surrounding deeds of trusts. There has been plenty of commentary around this. Rather, it aims to highlight a potential trap which might apply in ‘above board’ property incorporations where lenders are kept fully in the loop during the incorporation process.

Recap on s162 incorporation and ESC D32

The key points relating to property loans and s162 relief are as follows:

• Section 162 allows any capital gains on the transfer of a property to a company to be deferred against the value of consideration shares if certain conditions are met. This is done by calculating the tax cost of the shares received as their market value less the capital gain that would have otherwise been realised.
• One condition for full relief is that the company provides shares as the only consideration for the property business.
• The ability to defer gains is reduced to the extent that non-share consideration is provided.
• Also, all business assets except cash need to be transferred (strictly if even a £100 - If liabilities are transferred then this would be non-share consideration and would restrict the relief.
• ESC D32 explains how the strict point above on non-share consideration should not be used to restrict the relief when proper business liabilities are transferred.

Therefore, from the above, if a lender were to agree to novate the transferor’s borrowing to the company on incorporation then there should be no problem with s162.

The problem is that, in practice, lenders are not very helpful in these kinds of transactions and tend to dictate the terms. Often, they will want to make a new loan (possibly with new terms) to the recipient company and this loan will be used to pay the transferor so that it can repay its loan.

The issue with this is that the repayment of the old loan constitutes non-share consideration and this scenario is clearly not protected by ESC D32. The fear is thus that s162 would not apply to a certain percentage of the gain (the percentage of non-share consideration) and so that proportion of the gain would become immediately chargeable.

Chartered Institute of Tax (CIOT) seeks clarification

On 28 February 2024, the CIOT sent a letter to HMRC on this very subject and other issues relating to D32.

It will be interesting to see how HMRC responds...

Hamilton Rose's view

Given all the negative press around deeds of trust, it would be ironic if taxpayers are unwittingly caught by the above trap just for doing ‘the right thing’ and being completely transparent with their lenders. Until this issue is resolved – perhaps by HMRC issuing a statement that they are prepared to extend ESC D32 to the above scenario – we would recommend making extensive use of HMRC’s non-statutory clearance procedure to obtain comfort on a case-by-case basis.

If such comfort is not given, then transactions may be frustrated. However, this is probably preferable to a hefty tax bill caused by the receipt of cash consideration.