UPDATED: When purchasing an investment property one of the first considerations is whether it should be held personally or within a company wrapper.
A company is a separate legal identity to its owners; therefore, the asset belongs to the company rather than the shareholders or directors. Rental receipts and proceeds from subsequent disposals belong to the company and are subject to corporation tax at the current rate is 19 per cent. Profits can be extracted via salary or dividends both of which are subject to income tax and national insurance at varying rates depending on the level of income received by an individual within a tax year.
The key question to ask is “What is your intention for the profits?”
If the intention is to reinvest proceeds or to build up cash reserves, a corporate wrapper may be preferential because if the profits are not required to be extracted then they are not subject to income tax. If the property is held in personal names those profits are taxed on receipt.
Individuals used to be able to claim interest paid on buy-to-let mortgages as a business expense to directly reduce their taxable profits. This relief has been phased out over the past three years, and from April 6 2020 individuals will only receive relief in the form of a tax credit up to their basic rate band.
However, if significant rental profits are received by an individual, they should consider a corporate structure. Significant profits are those above £100,000 per annum as an individual’s personal allowance is restricted at this level and profits are charge to income tax at 40 per cent or 50 per cent above £150,000.
If significant rental profits of over £100,000 are received by an individual they should consider a corporate structure. Above this profit level, the income tax rate is 40 per cent or 45 per cent above £150,000, and individual’s personal allowance is restricted.
Can a director occupy company property?
As mentioned above, if profits are reinvested rather than extracted, they are not subject to income tax and national insurance. If a company purchases a property for a director or shareholder to occupy, they are receiving a benefit.
To disincentivise shareholders and directors from using company reserves to buy personal property and thereby avoid paying income tax to HMRC, the law seeks to penalise a company in various ways.
If a director, or a member of an employee’s or director’s family or household, is provided with living accommodation, a benefit in kind can arise both in respect of the accommodation itself and the associated benefits including utilities, furniture, and other services met by the company.
If the property’s value exceeds £500,000 it falls within a special regime for Stamp Duty Land Tax (“SDLT”) and Annual Tax on Enveloped Dwellings (“ATED”).
Stamp Duty Land Tax
If the property is to be occupied within the first three years following completion by a non-qualifying individual it will be subject to a 15 per cent flat rate charge of SDLT at purchase.
A non-qualifying individual is anyone who is connected to the company. This includes directors, shareholders and those connected to them. For example, their family, spouses or civil partners, their spouses or civil partners family and others. The charge is applied even if a market value rent is to be paid.
Annual Tax on Enveloped Dwellings
Closely related to the above is ATED which is an annual charge based on the value of the property. ATED does not expire after three years like SDLT, it is chargeable until a property is sold and it can be extremely costly.
For example, if the property is valued at £1m the ATED charge for 2021/22 is £7,500. To complicate things further ATED is chargeable a year in advance unlike the other taxes and the regime imposes significant penalties for non-compliance.
Does it matter if property is rented or developed for sale?
A property rental business is an investment activity whereas redeveloping a property for sale is a trade. This distinction is key whether a property is held personally or by a company as the activities are subject to different tax regimes.
Residential property rental profits received by individuals are subject to Income Tax, with CGT payable at 18 per cent or 28 per cent when the property is sold.
Investment activities by individuals are subject to income tax and NIC and CGT at 18 per cent or 28 per cent on disposal.
Trading activities can benefit from a full deduction of mortgage interest when calculating trading profits and proceeds are subject to income tax and NIC.
If a company’s intention is investment, the property will be included at market value as investment property within the financial statements. Profits are chargeable to corporation tax and on sale a chargeable gain is calculated. Unlike above, the gain is also chargeable to corporation tax, but certain costs will be allocated against annual profits and certain capital costs will be allocated to the cost of the property until sale. This means that some expenditure will not receive tax relief until sale.
If a property is developed for sale it will be shown at cost as stock within the financial statements. Profits and sale proceeds are subject to corporation tax. A property developer may need to consider other regimes as a result of its activities.
If sub-contractors are engaged to develop the property, the works will be within the scope of Construction Industry Scheme (“CIS”). CIS requires monthly returns and additional compliance, please ensure you talk to your accountant or tax adviser before undertaking any works.
With tax intention is key, if it is subsequently decided that a property will be kept as an investment rather than sold a company could be subject to a “dry” tax charge when moving it from cost in stock to market value in investment property. It is known as a dry tax charge as tax is due although no proceeds are received.