Transferring Rental Income – Anti-Avoidance Problems?
By Mark Mclaughlin
Some individuals who own investment (e.g. buy-to-let) properties may wish to transfer rental income to someone else, whilst retaining ownership of the property.
For example, a parent may wish to pass on rental income to adult children, perhaps to provide their offspring with funds for further education, or help them to save towards buying a property of their own.
Share and share alike
The parent (in the above example) may be content to transfer an interest in the property to the child, and to share the rental income between them. The gift of a property interest will generally be treated as a disposal at market value for capital gains tax (CGT) purposes. If the property is standing at a large capital gain, the parent may only wish to transfer a small interest to the child (e.g. 10%), to keep the gain as low as possible (nb this immediate CGT problem can often be overcome by creating a trust for the child and claiming holdover relief; however, trusts are outside the scope of this article).
If the parent gifts a 10% property interest to their adult child, can this allow a larger share of property income (e.g. 50%) to be allocated to the child? HMRC seem to accept that it can. In its Property Income manual, HMRC states (at PIM1030): “Where there is no partnership, the share of any profit or loss arising from jointly owned property will normally be the same as the share owned in the property being let. But joint owners can agree a different division of profits and losses and so occasionally the share of the profits or losses will be different from the share in the property. The share for tax purposes must be the same as the share actually agreed”.
Thus it would appear that if there is a written agreement between the parent and child (before the rental income arises) setting out their respective income entitlements, income can potentially be allocated in different proportions to their ownership of the property.
However, care is needed. For example, the ‘settlements’ anti-avoidance rules can apply to counter any income tax saving for the parent if (s)he can benefit from the property interest gifted (ITTOIA 2005, s 625), or if the child is a minor (see s 629).
For example, if the property interest is gifted on condition that the adult child (a basic rate taxpayer) returns the property interest to the parent (a higher rate taxpayer) after a fixed time period, HMRC is likely to consider that this arrangement is a settlement, and tax the parent on the child’s share of the property income (see HMRC’s Trusts manual at TSEM4200).
Transferring income only
In the above example, instead of transferring a 10% property interest to the child, the parent may wish to transfer the right to a proportion of rental income instead, based on the assumption that the income will be treated as the child’s for tax purposes, at the cost of perhaps a small capital gain for the parent on disposal of the right.
However, such an arrangement is potentially ‘caught’ by income tax anti-avoidance legislation regarding ‘transfers of income streams’ (ITA 2007, Pt 13, Ch 5A). This legislation applies broadly where a right to ‘relevant receipts’ (which could include rental income) is transferred to another person without a transfer of the asset (i.e. the property) from which the income arises (ITA 2007, s 809AZA).
If these provisions apply, the person making the transfer is generally chargeable to income tax on a ‘relevant amount’ in the same way, and to the same extent, as the relevant receipts would have been chargeable but for the transfer of the rights to the income stream (s 809AZB).
An effective transfer of property income for tax purposes is likely to involve the transfer of an interest in the underlying asset. However, such a transfer (e.g. a buy-to-let property interest) gives rise to other tax implications (e.g. CGT and inheritance tax), which must be considered ‘in the round’, to prevent unwelcome surprises.