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Transferring rental income: Be careful!

Mark McLaughlin highlights an income tax anti-avoidance provision that merits careful attention.  

It is not uncommon for the owner of an investment property (e.g. a parent) to wish to transfer rental income (e.g. to adult offspring) but retain ownership of the property. 

However, the tax implications need careful consideration. 

How much to give away? 

For example, the gift of a property interest is 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 might only wish to transfer a small interest (e.g. 10%) to the child, to keep the gain as low as possible (nb this immediate CGT problem can often be overcome by creating a trust for the adult offspring 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”. 

Your income…or mine? 

However, care is needed. For example, the ‘settlements’ anti-avoidance rules could counter any income tax saving if the parent can benefit from the property interest gifted (ITTOIA 2005, s 625).  

For example, if the property interest is gifted on condition that the adult child (a basic rate taxpayer) returns it 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, Settlements and Estates manual at TSEM4200). 

Transferring income only 

Instead of transferring a property interest to the child, the parent might prefer to transfer the right to a proportion of rental income instead, 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 on the parent’s disposal of the right. 

However, such an arrangement is potentially ‘caught’ by income tax anti-avoidance legislation regarding ‘transfers of income streams’. Those provisions apply broadly where a right to ‘relevant receipts’ (which could include rental income) is transferred to another person without a transfer of the underlying asset (i.e. the property). 

If these provisions apply, the transferor 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 (ITA 2007, ss 809AZA-809AZB). 

Practical tip 

The above is not an exhaustive summary of tax issues; there are potentially others (e.g. inheritance tax). The tax (and non-tax) issues must be considered ‘in the round’ to prevent unwelcome surprises.