A rising trend has been witnessed among investors where they are either buying investment property via a limited company or holding property investments through the same. Is this method of holding or buying property investments tax-efficient? Or is it due to the protection given by the limited liability status of the company? Let’s find out answers to these and many other questions related to property taxes and investments.
Property Investments are Tax Driven
The primary reason nudging UK investors to hold property investments via limited companies is that doing so is tax-efficient, and the existing CT regime favours doing so. In 2010, the chancellor – George Osborne – announced several reductions in Corporation Tax rates. In subsequent budgets, the already reduced CT rates witnessed significant reductions again. However, the incumbent prime minister, Mr. Boris Johnson, has not only maintained Corporation Tax rates of 19% but is planning to hike it to 25% by 2023.
Note* Due to the very same reason, our experts will take existing CT rates of 19% into account while making calculations in this tax guide.
It goes without a doubt that CT rates have reduced significantly in the last 8 or 9 years. But successive governments have put in place several measures that resulted in increased personal taxes for individuals. This pushed individuals to run businesses through limited companies as doing so is tax-efficient.
It is pertinent here to mention that an individual who falls in the “higher rate income tax bracket” has to pay tax at a whopping rate of 40%. Contrary to that, existing CT rates stand at just 19% – even less than half of what is being paid by higher rate tax bracket individuals. So, which one is beneficial? Obviously, doing property business through limited companies.
Besides enjoying a favourable income tax regime, property investors also benefit from a much more beneficial interest relief regime. Therefore, with increased awareness about the above mentioned tax, more and more people are forming limited companies to do property businesses.
But the whole picture is not that simple. Therefore, our tax advisors will walk you through all tax issues related to forming a limited company and will let you know why forming it fora single factor [favourable CT rates] is so short-sighted.
Why is that so? Because extracting profits from limited liability companies is seriously hard and doing so sometimes completely eliminates the financial or tax advantages acquired via a favourable CT tax regime. Extracting profits from limited liability companies triggers several problems that we will discuss later.
Also, while property investors enjoy a favourable CT regime, individual investors benefit from various CGT reliefs. Therefore, it is very likely that a limited company’s long–term position–while considering investment properties and capital growth – may take a detrimental hit on overall profits and assets.
But the situation isn’t that bleak. Long-term investors can benefit from limited companies in the long run if they intend to use their property portfolio as their “pension plan”. Forming and holding a limited company is especially beneficial for the people involved in property management, dealing, or development vis-à-vis NI [national income] and Income Tax purposes.
Property Taxation & Using Limited Company for Non-Tax Reasons
There are certain non-tax issues also that should be taken into consideration when forming a limited company as a property investor.
Limited Liability Protection
This might not be the primary consideration behind forming a limited company as a property investor. Nevertheless, it is an important factor. When you form a limited liability company, it gets limited liability protection, which means the company is a separate identity. So, a limited company is responsible for its liabilities and debts. However, legislation in recent years has limited the usefulness of this aspect of limited liability companies. Now banks seek guarantees from both shareholders and directors while lending money to limited liability companies. Also, contemporary insolvency laws hold directors responsible for a large part of ’ company’s financial liabilities and responsibilities. So, modern insolvency laws may make directors liable in cases where a limited liability company has been formed to avoid paying liabilities.
Still, forming a limited liability company comes in handy if the economy takes a U-turn or if businesses face legal liabilities or unexpected losses.
Flexibility of Ownership
Forming a limited liability company gives property investors the flexibility to add new owners to their businesses – something that isn’t available to individuals and in joint partnerships. We agree that joint ownership with your partner or spouse is easy to achieve, but what will happen if you want to involve key employees or children? Things will get complicated vis-a-vis ownership. The solution is to form a limited liability company as the medium of company shares. It’s an easy way to spread ownership by adding adult children and key employees.
Separation of Ownership & Management/Succession Planning
Another great benefit of forming a limited liability company (LLC) is that it gives you the flexibility to separate management and ownership. If all this goes according to plan, your business will expand, and you may eventually wish to explore new ventures or retire. This is where an LLC company comes in handy; you can take retirement while retaining ownership of your business (as a shareholder) and pass on management responsibility to the directors. Also, when you dive deep into details, you will be amazed to know that a company’s structure gives you more control in such succession processes.
Note from Tax Experts
LLCs offeran easy way to pass on your wealth to beneficiaries while letting businesses and property investments aren’t. Why? Because letting businesses and property investments are exposed to Inheritance Tax [thus, tax consumes a significant portion of your wealth].
Using LLC, you can pass ownership to your children or other beneficiaries on small parcels over several years. As statedabove, you can use a sophisticated share to transfer underlying value to beneficiaries while keeping control of your company by yourself.
Note* An LLC may become disadvantageous on the owner’s sudden demise.
Property Taxation & Finance
The downside of forming an LLC is that property investors find it difficult to obtain the finance required to expand their business. However, the advantage is that lenders find it easy to lend money when business operations grow into a corporate portfolio.
At times, the Deed of Trust is used to deal with legal difficulties.
As stated in the above paragraphs, an LLC is a separate entity responsible for its debts and liabilities. Likewise, if you manage your property business through an LLC, you will own shares in the property, not the property itself. Speaking in legal jargon, the completely different kinds of assets will give birth to completely different legal rights. What types of rights will trigger depends on individual circumstances andplaces [the UK or other countries] where your properties are located.
If your LLC is registered in the UK, then you have to comply with UK company law. In some scenarios, existing laws may limit your capability to use company funds for your private use.
Audit and Other Statutory Requirements
HMRC compels large companies to carry out annual statutory audits of their accounts. Likewise, small companies are also not exempted as they have to file certain other documents, including annual accounts with Companies House.
When you have to manage accounts and submit statutory annual reports, it will inadvertently lead to an increase in overall costs as you have to hire seasoned professionals. However, the good thing is that you can adjust these costs against taxes and other corporation benefits.
PROS & CONS of LLC vis-a-vis Property Taxation
Now, let’s focus on the main part: tax implications of managing property business through a limited liability company. An LLC may provide better results on income, but personal ownership renders better results when it comes to capital growth.
- An LLC pays just a fixed rate of CT at 19%, irrespective of the threshold of its profits. As stated above, individuals falling in the highest tax brackets have to pay tax at a whopping rate of 45%.
- Unlike individuals, LLCs protect against dreadful relief restrictions for finance and interest.
- You can choose any year-end accounting date for your company.
- LLC can claim relief for financial costs and interest incurred on rental properties against capital gains or any other income arising during the same period or even against future capital gains or income.
- LLC can also claim relief against losses incurring from a UK property letting business against capital gains or income produced in the same period. However, it does not apply to losses incurred on furnished holiday lets.
- Property investors can claim relief against interest costs generated by borrowed funds.
- There’s no personal allowance available to the LLCs.
- There’s no exemption available to LLCs for capital gains tax purposes.
- There’s no business asset disposal relief available to the LLCs.
- If any investor or their close relative is using property owned by LLC, it can give rise to severe tax complications.
- Extracting profit from LLCs is extremely hard, and doing so gives rise to personal tax liabilities.
- Using your house or part of its portion as an office may make it difficult to claim relief for certain administrative expenses.
- LLCs can’t own a private residence and, therefore, cannot file claims for rent-a-room relief or principal private residence relief.
In a nutshell, forming an LLC for managing and running your property business has both advantages and disadvantages. Therefore, careful planning is needed, and if things are not managed well, it can give birth to serious tax complications.
If you are mulling over forming a limited liability company to manage your property business and are looking for expert advice, look no further, as IBISS & CO has got your back. We have leading tax advisors and chartered accountants on board who offer effective business tax advice and strategies. So, reach out to us and start saving your hard-earned money NOW!