•The rules for allocating profits between joint investors can depend on the relationship between the investors.
•The arrangements can legitimately be amended to suit the parties.
In the previous two articles, we have considered some key aspects of ownership, including:
•Beneficial v legal ownership – tax follows beneficial ownership;
•Ownership as Joint Tenants, or Tenants in Common (or having your cake and eating it);
•Strictly, most joint property investments are not ‘partnerships’ and this potentially affects how the income is taxed.
We shall now consider how profits may be divided amongst the investors, how flexible those arrangements can be and how they may be turned to best advantage.
There are special rules for married couples as joint investors and we shall cover those in some detail too.
‘Divvying up’ the profits
If there are no specific agreements (or appropriate evidence of intention) in place between the parties, then profits will be split as follows:
•Joint tenancy – where each has an equal interest in the overall asset – the presumption is for profits to be split equally amongst the owners.
•Tenants in common – where each has their own ‘separate’ and potentially unequal share in the property – the presumption is for profits to be split amongst the investors in proportion to their respective beneficial interests.
Joint owners who are married to each other (or in a civil partnership with each other) are assumed to share their profits equally between themselves, whether they own as joint tenants or tenants in common.
However, this assumption is displaced where spouses are in a partnership properly, and not ‘merely’ joint investors. In such cases the rental profits are split in accordance with the rules for partnerships – usually the profit-share agreed by the partners for the period in question.
Overriding the default profit split
Joint investors (who are not married to each other) may allocate current and future profits between themselves as they see fit. This does NOT have to follow actual legal/beneficial ownership proportions.
Similar rules apply for partners in a partnership: they can apply a general profit-sharing agreement or one specifically in relation to property income.
Spouses and civil partners generally have a harder time displacing the 50:50 split: they have to make a formal election, as explained next.
Spouses/civil partners: breaking the 50:50 split
For many couples, the 50:50 presumption is simple and potentially quite useful. But changing that default split is more involved and more problematic than for other owners. Spouses really have only one choice – 50:50, or in proportion to actual underlying beneficial ownership.
Where the beneficial interests are split unequally, and the spouses want to benefit from that unequal split, they are obliged to notify HMRC in writing, using “Form 17”. (www.hmrc.gov.uk/forms/form17.pdf) The form must detail the property/properties in question and the corresponding beneficial interest held by each spouse. The form must be signed by both spouses and submitted to HMRC within 60 days of signature, together with evidence of the beneficial ownership as stated, (such as copy deeds or similar).
Note that this is the only situation where HMRC will need to be notified, or require evidence of beneficial ownership as standard. Partnerships or general joint investors do not need to advise HMRC of the split of rental income, or provide evidence of their beneficial ownership in a property – although it could be requested, for instance in a tax enquiry.
The updated income split will then be processed and will normally continue to apply until replaced by a fresh Form 17 or similar.
The rules for capital gains tax (CGT) allow property to be transferred between two spouses who are living together as a couple, without triggering a CGT bill (the ‘no gain/no loss’ principle). This potentially means that beneficial interests can be changed to suit – more than once, if appropriate.
But do bear in mind:
•Mortgage lenders may have placed restrictions on transferring ownership.
•‘Lifetime gifts’ are free of stamp duty land tax (SDLT) but if a spouse agrees to take on (more) mortgage debt, then he or she has effectively given consideration for SDLT purposes and SDLT may be due even though money has not changed hands.
•There will probably be a cost to drawing up the legal documentation to give effect to a transfer.
You can change your mind
Joint investors who are not married to each other and partners in a partnership are able to set the income split – and to re-set it – as and when they see fit (within reason), without having to change the underlying beneficial interests. They can do so at any point in a tax or accounting year. The only caveat is that profit-share cannot be decided or amended retrospectively: joint investors cannot wait until filling in their tax returns to decide what their profit shares might have been the year before.
Tax ‘trick’ for spouses, etc.
It is perhaps ironic that, while tax law generally allows greater freedom to transfer assets in marriage, the rules for jointly owned assets are potentially quite awkward for couples.
But here is a useful trick available only to spouses or civil partners, which could work out quite nicely for William and Katherine, the protagonists in the first example in our first article of the series.
If we cast our minds back, William and Katherine were each relatively high-earning individuals, with incomes in a normal year of around £45,000 each. Katherine was going to take a year off to have a baby, so her income would fall to nil but as a couple they were considering buying a property and renting it out for net annual yield of roughly £10,000.
We had already observed that ideally, Katherine should get all of the property income while ‘on maternity’ but that on her return to work, she risked losing child benefit if her income rose from £45,000 to £55,000 – wouldn’t it be great if they could later split the income 50:50..?
Throughout this series, we have emphasised that it is beneficial ownership which is key from a tax perspective. But one of the less well-known quirks of the legislation is that a person needs only transfer a nominal legal interest in a property to his or her spouse, in order to trigger the default 50:50 income split. A transfer of legal interest can be relatively simple and inexpensive to effect.
Using that earlier example, Katherine could acquire the property initially just in her name, let the property until her return to work (fully utilising her tax-free personal allowance) and then transfer a legal interest to William so that from that point onwards, the income would be split equally, and neither would then be exposed to a clawback of child benefit through the high income child benefit charge, which kicks in at taxable incomes of £50,000 plus.
Conclusion and Practical Tip :
Over this short series of articles we have covered the basics of joint property ownership and its taxation across various ownership models, with some hints and warnings along the way.
Whilst ‘unmarried’ joint investors and partners have some flexibility in terms of profit-share, it is advisable that they keep contemporaneous evidence of their decisions to amend profit-sharing arrangements, as it is a common route of attack by HMRC.