Who Should Own Business Premises - You or the Company?
Pros and cons of buying business premises
For company owners, one very important question is whether to buy business property personally or through the company. Similar issues also face business partners.
In this article, I am assuming that the business premises are used in a trade or profession. Different considerations apply to property held as an investment or used in an investment business.
The main reason most company owners hold their business premises personally is because, if the company should become insolvent, a property held by the director personally will usually be safe from the clutches of the receiver (unless fraud or negligence is involved).
Most company owners also see the business premises as their ‘pension’ – available to rent to their old company, or another business, after they retire.
Business partners can only protect their personal property from the receiver if they operate their business through a Limited Liability Partnership. Personal ownership often still makes sense though, as they can rent the property to the partnership.
Rent is a very tax efficient form of income. Charging rent is usually a better way to extract funds from your company than salary or dividends. No National Insurance is due on rent (unlike salary) and, provided that no more than a market rent is charged, the company will obtain Corporation Tax relief (unlike a dividend).
For a business partner, charging their own partnership rent will effectively reduce the business profits and substitute them with rental income which avoids National Insurance.
Charging rent is also advisable if you had to borrow to finance part of the cost of the property: the only way to obtain tax relief for the interest is to set it against rental income. Like any other rental property, you can remortgage the property up to its value when you first rented it and still get full tax relief for the interest, even if you use the new funds for personal expenses.
Rent is not mandatory: there is no requirement for a company owner or business partner to charge it. This is worth bearing in mind because, whilst rent is relatively tax efficient, it will still be subject to effective Income Tax rates of up to 60% after 6th April 2010.
Up to £50,000 of immediate tax relief is available on the purchase of commercial property. You still get this relief if you purchase the property personally, provided that you charge a market rent. (If you charge less than a market rent, you may only be able to set the allowances against the rent received, thus delaying your relief.)
Expenditure in excess of £50,000 on qualifying fixtures and fittings in any year will attract writing down allowances at 10% or 20%.
There are two important planning points here. Firstly, you as the landlord and the company as the tenant can each spend up to £50,000 a year on fixtures and fittings and both get immediate tax relief. For example, you could buy the property and the company could fit it out. (You may need to sign a joint election to ensure full relief is obtained.)
A partner and partnership can also obtain up to £50,000 of immediate relief each where that partner does not control the partnership.
The second point is that, for some qualifying expenditure in excess of £50,000 incurred during 2009/10, the company or partnership would get first year allowances at 40% in place of the lower rate of writing down allowances available to a personal owner as the landlord.
If you own property personally, your Capital Gains Tax (‘CGT’) rate on a sale will generally be 18%. This can effectively be reduced to 10% when entrepreneurs’ relief is available.
Entrepreneurs’ relief is generally only available on a sale of business premises when you are also selling off your interest in the business. The relief is also restricted to a lifetime limit of £1 million per person. It is therefore only useful on a property sale if you are also selling your company shares or your partnership share and your capital gain on that sale is less than £1m.
This is worth bearing in mind when you’re considering how much rent to charge because any rent charged after 6th April 2008 restricts the entrepreneurs’ relief available on the property. Charging no rent preserves all of the available relief; charging at less than the market rate preserves some of it.
Sanjeev owns his company’s trading premises. He charges rent at the market rate of £25,000 a year and sets interest of £10,000 against this income. Apart from a modest salary, Sanjeev has no other income, so he pays Income Tax of just £3,000 (£15,000 x 20%) on his rental profits.
The rent charge saves the company £5,250 at the current small companies’ Corporation Tax rate of 21%. This increases to £5,500 (at 22%) from 1st April 2010.
Compared with a dividend, the rent therefore saves a net sum of £2,250 this year and £2,500 a year from 2010.
Several years later, Sanjeev sells the company and makes a capital gain of £900,000. He claims entrepreneurs’ relief on this gain but, because he charged rent, he cannot claim entrepreneurs’ relief on the property. However, the relief could only have saved him a maximum of £8,000 anyway (he has only £100,000 of relief left and it reduces the effective CGT rate by 8%: from 18% to 10%). He therefore only needs to have rented the property to the company for just over three years to have saved tax overall.
A company pays Corporation Tax on capital gains. From 1st April 2010, for a small company with profits under £300,000, this will be at 22%. If the gain on a property sale pushes the company’s total profits over £300,000, the effective Corporation Tax rate on the excess increases to 29.5%.
At first glance, these rates compare badly with the CGT rate of 10% or 18% for property owned personally. There is another factor to consider, however: companies are entitled to indexation relief. This exempts the purely inflationary element of capital gains (based on movements in the Retail Prices Index).
Tweedledum Brown buys a property for £100,000 and rents it to his company for four years before selling it for £150,100. After deducting his annual exemption of £10,100, his CGT on the sale is £7,200 (£40,000 x 18%).
Tweedledee Darling Limited also buys and sells a property for the same prices. Inflation over the intervening period has amounted to 20.1%, giving the company indexation relief of £20,100 and a taxable capital gain of £30,000. The Corporation Tax on this gain at the small companies rate of 22% is £6,600 - £600 less than the CGT paid by Tweedledum.
As we can see, indexation relief may sometimes more than compensate for the higher tax rate suffered by the company. This is especially likely if we experience a period of high inflation, or if the property is held for a long period.
Conversely, however, indexation relief is far less likely to compensate for a larger rate difference, such as when the individual is eligible for entrepreneurs’ relief, or the company suffers Corporation Tax at the 29.5% marginal rate on some or all of its gain.
Where a capital gain is realised by a partnership, each partner pays CGT on their own individual share of the gain.
Financing the Purchase
If a company owner needs to withdraw funds from the company to finance the purchase of business premises, they will need to factor in the cost of that withdrawal. Remember that dividends received by a higher rate taxpayer are subject to an effective tax rate of 25%. (Even higher rates will apply to those with income over £150,000, or between £100,000 and £112,950, from April 2010, so maybe you should get your money out now!)
Owning your company or partnership’s business premises personally is a good way to protect your investment and has some very useful tax saving advantages.
There are some potential disadvantages when you sell the property, but these are generally less significant than many people fear. Long term, however, company ownership of property may lead to significant savings on capital gains in some cases.
The Inheritance Tax disadvantages to personal ownership can often be mitigated through careful planning at a later stage. The risk in the meantime can be met with term assurance if desired.
The main point is to try to get it right the first time, as property transfers often come at a significant tax cost. If in doubt, though, personal ownership is usually the better way to start.
What If You Change Your Mind?
A company owner can usually transfer trading premises into their company free from CGT but the company will incur Stamp Duty Land Tax based on the property’s market value. Transfers of property from a company to its director/shareholder may give rise to substantial amounts of both Corporation Tax and Income Tax.
If in doubt, therefore, it is usually better for company owners to start with personal ownership, as the maximum tax cost of a later transfer is generally no more than 4%.
Transfers of property between individual partners and a partnership generally give rise to both CGT and Stamp Duty Land Tax based on a proportion of the property’s market value equal to the other partners’ shares in the partnership. In short, try to get it right first time!
When the proceeds of sale of business premises are reinvested, within three years, in new business premises, the capital gain arising on the sale can be ‘rolled over’ into the new premises, so that no tax is due.
This ‘rollover relief’ generally remains available to company owners and partners who own business premises personally. One word of warning though: the relief only applies to company owners where the new property is also purchased personally and is used by the same company.
The Final Analysis
Shares in private trading companies or the value of a partnership interest in a trade or profession are generally exempt from Inheritance Tax.
A property held personally, but used by such a company or partnership, only attracts 50% relief, leaving Inheritance Tax payable at an effective rate of 20% on the property’s value. Any mortgage against the property reduces the tax, however, as you only pay Inheritance Tax on your net wealth.
Generally, you can transfer the property to the company or partnership before you die and then get the full relief, but there’s always the risk that you won’t get the chance to do this and most transfers come at some sort of tax cost.
A better strategy might be to re-mortgage the property and invest the borrowed funds in the company or partnership. If carried out the right way, this strategy can effectively restore most of your Inheritance Tax exemption immediately.