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UK Property Tax Portal
Tax Articles
Over the years, property investment has generally turned out to be a good bet. More than a good bet. Certainly it’s an area where the Government do not see any need to hand out tax incentives (other than in specialist area such as in the Or so you might think. But, whether by accident or design (we suspect the former), some valuable tax breaks are indeed on offer. Well, not so much on offer - you have to dig around quit a bit to find them! Here, we shall come up with a plan which has nothing at all to do with furnished holiday lettings, but which nonetheless can produce major tax benefits for the property investor. The benefits are twofold:
Sounds too good to be true? These days, thanks to recent changes in the tax rules, it isn’t! There are two key elements to our plan. First, the property itself must be chosen wisely and then - second - the letting of it must be structured in the correct way. Grant Letts has a chunk of money to invest in property. Grant is a higher rate taxpayer, so he could very easily find himself paying income tax at 40% on the rental profits he makes. And, when he comes to sell up, he could very easily find himself paying capital gains tax (‘CGT’) on most of the profit at 40%, with little or no taper relief. He doesn’t want to do that. What might we suggest? Choosing the property wiselyActually, it’s not just a question of choosing the investment property wisely. The tenant(s) must be chosen wisely too! Some readers may be ahead of us here. Our plan is built around a new taper relief rule that came into effect in 2004 - on 6 April to be precise. As a result of this recent tax change, Grant is able to purchase investment properties which
And this of course means that, if he sells the investment property two or more years after he has bought it, he qualifies for 75% taper relied on any profit he makes. Put another way, the top rate of CGT payable by him on the profit becomes (40% tax less 75% taper relief) 10%. We identified, in the November 2003 edition of TAX INSIGHT, the kinds of investment properties that qualify for this surprising tax break. Having read this, Grant knows that the first thing he must do - if he wants to take advantage of this taper relief incentive - is to forget residential properties. That’s because residential properties count as non-business assets (unless they are
(And the property must of course be used by the tenant(s) in their trades.) Finding the right sort of tenant might sound a bit of a pain. But, as the saying goes, no pain no gain. And, if Grant follows our advice here, he does indeed put himself in line for a substantial gain - in the form of reduced tax bills. Let’s try quantifying this. Case Study (continued). It’s ten years later. And Grant sells up, realising a profit of £100,000. Here’s how the two alternatives - favoured tenant or ‘ordinary’ tenant - work out. (We assume here that his annual CGT exemption stands at the current figure of £8,200.) Business Non-business investment investment £ £ Profit before taper relief 100,000 100,000 Less: Taper relief (75%/40%) 75,000 40,000 25,000 60,000 Less: Annual CGT exemption 8,200 8,200 Pay CGT on £16,800 £51,800 If Grant is ‘careless’ about the kind of tenant(s) he finds, his tax bill will be more than three times higher than it need have been. Worse still, if the profitable sale is made quickly - say, after only three or four years - there’ll be little or no non-business asset taper relief. And his tax bill will be some five times higher! Grant resolves to be fussy about his tenants. Getting the structure rightHaving sorted out the long-term problem - how to minimise the CGT liability on the eventual (hoped-for profitable sale - we now look at something rather more immediate. How can the tax on the annual rental profits be kept to a minimum? Grant is already a higher rate taxpayer, so he doesn’t want to receive the income personally. Wouldn’t it be better if his property investment business were run through a company, set up for the purpose? That way, the rental profits would be taxed at corporation tax rates, which are much lower than 40%. This sound like a good idea. But there’s one major snag. If the property is owned by a company, then the taper relief advantages that Grant is so keen to attract are forfeited. Companies do not qualify for taper relief at all - not even at non-business asset rates. Instead, all they get is the indexation allowance. So it’s as you were: the property needs to be owned individually, and not through a company. So where might we go from here? This is what Grant might do. Case study (continued). Grant decides to set up a company for the purpose: Letts Lettings Limited. Grant will own the property personally, but will lease it to the company for a modest rent. The company will then sublet it at a higher ( The result of this is that most of the profit-rental will end up in the hands of Letts Lettings, with very little bein received by Grant personally. And the tax outcome is a very happy one for Grant. Broadly:
Of course, this 0% starting-rate only applies these days if the company doesn’t pay dividends. But dividends are the last thing Grant wants - remember, he’s a higher rate taxpayer. No, he just wants the profits (or most of them to be rolled-up inside Letts Lettings. He will extract them in due course when the company comes to an end, and will then pay only CGT - with a deduction for taper relief. Sounds good. But let’s pause here for a moment to take stock. A couple of questions might come to the mind of the reader. We shall try to pre-empt them. 1. Are we certain that the lower rates of corporation tax for small companies apply here (0% to 19%), and not the full rate of 30%? 2. And doesn’t this year’s Finance Act introduce some new rules - called ‘transfer pricing’ rules - to prevent undercharges for goods and services, such as the lease from Grant to his company at a low rent? Legitimate questions both. But, in fact, we don’t believe either of them should derail our plan. 1. The lower rates of corporation tax apply not only to trading companies but also to property investment companies. Grant’s company should qualify as property investment company, as it will hold an ‘interest in land’ (a phrase which includes buildings) which it will let out. There is a caveat here: this beneficial tax status is not bestowed if the lettings are between ‘connected persons’. Grant and his company clearly are ‘connected’, so doesn’t this blow a hole in our suggestion? We think not. The caveat applies only if the company lets the property to connected persons. Here, the company will lease the property on favourable terms from a connected party (Grant), which is not the same thing at all. So this shouldn’t be a problem: the company’s lettings will be to independent third parties. 2. The new ‘transfer pricing’ rules, by and large, do not apply to small businesses. So we believe that there’s nothing to stop a company owner providing his time, or his property, to his company with little or no charge. In short, in our view, it is indeed possible to channel most of the rental income from a personally-owned property into a tax-friendly company environment. We’re nearly there. But maybe there’s one final concern.
Fortunately, this isn’t as perturbing as it sounds. That’s because the taper relief rules look at the end-user of the property. Provided that the ultimate tenant - the one who actually occupies the property - falls into the ‘favoured’ category, then business-asset taper relief is available. So no worries here after all. ConclusionIn our view, it is possible for a property investor to get the best of both worlds for tax. He can enjoy the beneficial CGT treatment that applies to capital profits made by individuals (but not by companies), together with the low rates of tax on income that companies enjoy but which (high-rate) individuals don’t. The property investor’s TAX-EFFICIENT GAMEPLAN1. Form a company. (Or maybe you have one already.) 2. Find a suitable property - commercial not residential. 3. Find suitable tenant(s) - pretty well any trading business that is not a quoted company. 4. The property will be owned by you, but the tenants will pay rent to your company. To achieve this you need to enter into a lease agreement with your company, whereby the company pays you a modest rental. 5. Sit back. Only modest amounts of tax should become payable each year on the rental profits, thanks to the low-tax regime for small companies. And when the property eventually comes to be sold (hopefully profitably), again any tax bill should be modest, thanks to business-asset taper relief for individuals. One final comment. As we said previously, the annual profits will be accumulated within the company, and not distributed until the company is wound up. The point to be made here is that the profit on the shares, when the company is wound up, will attract taper relief only at non-business asset rates. (We explained the reason for this in the January 2004 issue of TAX INSIGHT. Broadly, the beneficial treatment for ‘favoured’ investment properties applies to individuals, and not to companies. Shares in a company count as business assets only if the company is a ‘qualifying’ company - largely, an unlisted trading company or group. This definition excludes investment companies no matter how desirable - or ‘favoured’ - that investment might be!) However, after ten years, even the non-business asset taper relief will amount to 40%. Put another way, a higher-rate taxpayer will pay tax at a maximum rate of ‘only’ 24% - and will be entitled to the annual exemption too. So he’s still in pocket. And of course, this more miserly rate of taper relief applies only to the shares, and not to the property itself. Vitally, the property has been kept outside the company and, for this reason, it attracts taper relief under the generous ‘business asset’ rules. Maximum rate of tax: 10%.
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Tax incentives for Ss503 and 504 TA 1988 and S241 TCGA 1992. Choosing the property wisely Business-asset status for taper relief purposes, when the tenant is an unlisted trading company, has in fact applied since FA 2000). Sole traders and partnerships were not granted this status until as amended by S160 FA 2003. Trades carried on by trustees or by personal representatives qualify too (Paras 5(3) and (4) Sch A1). Relief for business assets is given at the rate of 75% after two years - contrasting with relief at only 40% for non-business assets, and even then only after ten years - by virtue of the table in S2A(5) TCGA 1992. The annual CGT exemption is given by S3(2) TCGA 1992 as amended. Getting the structure right Taper relief does not apply to companies (and unincorporated associations) because S2A(1)(a) TCGA 1992 links the relief to S2(2) - and companies are not chargeable under S2 but under S8. Companies qualify for the indexation allowance by virtue of S53(1A) TCGA 1992. Small companies rate of corporation tax: S13 TA 1988 read with S26 FA 2004. Starting rate of corporation tax: S13AA TA 1988 read with S27 (a) FA 2004. The new ‘dividend tax’: S28 and Sch 3 FA 2004, which inserts S13AB and Sch A2 into TA 1988. The lower rates of corporation tax are denied to ‘close investment holding companies’ (S13A TA 1988). This denial applies when land is let to a connected person by virtue of S13A(2)(b). We suggest that the property is provided to the company at a low rent (rather than at no rent) otherwise, maybe, the company isn’t really ‘making an investment’ in land at all. The new transfer pricing rules are to be found in Ss30 to 32 FA 2004. The general exemption for small to medium-sized businesses is contained in S31. Note however that, in exceptional circumstances, the Inland Revenue are able to impose the transfer pricing regime on such businesses ( 5C Sch 28AA TA 1988 as inserted by S31(4) FA 2004), but it not thought that our suggestion will fall foul of this exception. Looking at the end-user for taper relief: Para 5(1), (1A) and (2) Sch A1 TCGA 1992. Conclusion The beneficial taper relief treatment for ‘favoured’ investment properties applies to individuals (and to trustees and personal representatives too, but not to companies) by virtue of (1) TCGA 1992. For shares in companies, the definition of a ‘qualifying company’ is to be found at Para 6 Sch A1 TCGA 1992. Additional comment Strictly, the grant of a lease at undervalue to the owner’s company (a connected person) counts as a part-disposal under the CGT rules (S42 TCGA 1992). However, any notional profit here may well be covered by his annual CGT exemption and taper relief. The shorter the lease to the company, the less likely this is to become a problem. (Of course, if the lease is short, this may become unsatisfactory from the end-user’s viewpoint. In that event, might the lease to the company include a clause permitting the owner to elect for a to be paid? The notional profit on the part-disposal should then be kept to minimal proportions.)
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