By Louise Misiewicz
Updated and relevant for 2017/18 tax year
Do you have a company for your core business activities?
Are you being taxed heavily on the money that you withdraw from the company and invest in property?
The problem – tax on money you pull out of a company
The problem I see with many property investors who own limited companies is that they do not take into account the amount of tax they pay by taking wages or dividends from the company. If you are a higher rate taxpayer then you will pay an additional 32.5% tax on the money you take out of the company as dividends.
We wrote another article on the most tax efficient ways of extracting money from a limited company, which illustrated the optimum level of wages and dividends that you should take out of the company.
I have worked with a few clients who made a loss on a flip once they took tax into account. Why would you put in the hard work just to pay HMRC?
You may wish to claim entrepreneurs’ relief on your trading business activities and therefore do not wish to jeopardise this by investing in residential properties that you plan to keep long-term and rent out. As such you could have two limited companies:
- One for trade business activities
- One for investment activities
Scenario 1: Current structure
Let’s say you pay yourself £100K out of the limited company and use £50K for a property investment:
- £74,074 gross amount required from the company
- £24,074 dividend tax at 32.5% for high rate tax payers
- £50,000 left for the property investment
You then buy a property using the above money that makes £500 per month profit:
- £6,000 annual profit
- £2,400 tax at 40% on the above amount (This is a minimum because of Section 24)
- £3,600 net cash
As you can see from the above scenario you are going to pay tax of £26,474 (£24,074 tax on dividends plus the income tax on the profit of £2,400). This does not even take into account the fact that mortgage interest relief will soon be capped at 20%. This issue is explored further in our budget announcement blog. You can also download our Section 24 tax calculator to see how the mortgage interest relief cap will affect you.
Scenario 2: Suggested limited company structure
Instead of buying properties in your own name you can buy properties in a new limited company. As suggested from the above that this limited company needs to be kept separate from your rate business and will need its own SIC code you need to use mortgages.
You, as an individual, set up the company with a £1 share, or £2 if you are setting the company up with your partner. This way you can take advantage of the entrepreneurs’ relief if the company is shut down.
Company A (your trading company) loans Company B (your investment company) £50,000. No tax is payable on this loan.
Now let’s take another look at the figures.
- £6,000 annual profit in Company B
- £1,500 interest paid to Company A
- £4,500 profit
- £665 tax based on 19% corporation tax.
You can see from the above that you will pay just £665 tax in scenario 2 compared to a tax liability in scenario 1 of £13,650.
Download our tax efficient property investment guide for 2018 here
Interest from one company to another: commercial arrangement
As Company A is loaning Company B money and they are both separate legal entities then the loan interest needs to be at commercial rates. Therefore it needs to be circa 3% above the Bank of England interest rate, which right now would mean a 3.5% loan interest charge.
• 3.5% interest per annum from one limited company
• The interest income will be taxable in Company A
• The interest charged to the second company will be a tax deductible expense for Company B
As an aside, I would caution against charging a limited company an interest charge if you personally loan it money as you would then be paying tax on the interest.
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