Article relevant to the tax year 2019/20.
Are you thinking of selling a property development company?
How do you claim Entrepreneur tax relief when selling a property?
You may be interested in our main article “buy to let tax for UK landlords”. This article discusses all the different types of tax that you need to be aware of as a UK landlord. You may also be interested in reasons why people should and should not use a limited company to buy a property
Throughout this article, we talk about Entrepreneurs Relief (ER), but we need to be mindful that HMRC has now changed the narrative to Business Asset Disposal Relief (BADR). The same 10% rate applies but the name has changed. Sceptics will say this has been done so that HMRC can remove BADR so that people will not notice because they do not understand the relationship between BADR and ER.
You may be a property developer thinking of selling a property development company. It is important for you to understand how to claim entrepreneur tax relief when selling up.
It may be time to hand over the reins to someone new or maybe you are looking for a career change. Whatever the reason for selling your property development company, you will need to consider the amount of Capital Gains Tax (CGT) that will result in the sale.
The usual CGT bands for selling a business is 10% for basic rate taxpayers. This rate increases for high rate taxpayers to 20%. These bands are only applicable for people that own a limited company or have a trade activity in their personal name.
Please remember that selling a residential property investment in your own name, that the CGT rates are different. Selling a residential property will be charged 18% for basic rate taxpayers and 28% for high rate taxpayers.
Entrepreneur tax relief allows you to reduce the amount of capital gains tax that you normally pay. Selling a residential property the CGT rate is 18% for basic rate taxpayers and 28% for high rate taxpayers. The entrepreneur tax relief CGT rate is 10%. Entrepreneur tax relief can only be claimed by individuals, not trusts or companies.
Entrepreneur tax relief is capped to £10m per individual throughout their lifetime.
Selling a property development company example
We will look at David and Davina who are husband and wife and are property developers. They set up a limited company and wanted to de-risk their business and set up individual Special Purpose Vehicle (SPV) for each property development.
If anything should happen from a legal or financial perspective then the liability will be limited to the company, hence the name. This is of course providing that they have not provided a personal guarantee.
They tend to set up two limited companies per year as they look to buy and sell properties within 9 months. They have asked the question, how do I minimise tax when selling a property development company?
On one of the property development companies had a profit of:
£200,000 sales price of the building less sales fees
£100,000 of buying the property that was sold
£50,000 refurbishment costs
£9,500 corporation tax liability assuming 19%
£40,500 cash left in the business to be taken out (ignoring shareholder funds)
As high rate tax payers that pay 20% CGT on selling their property development company, this would amount to £8,100.
Hopefully, you will see that the total tax on this property development company is £17,600
What is Entrepreneur tax Relief and how is it used when selling a limited company
Entrepreneurs’ Relief when selling a business is a preferential Capital Gains Tax rate of 10%. To qualify for entrepreneur tax relief you must satisfy the below criteria:
• The person claiming ER has at least 5% of voting shares in the business which is being part or fully closed down.
• The person claiming ER has owned the shares in the business for at least 12 months. From April 2019 this will increase to 24 months
• The business on which ER is being claimed is a Trading business (ie not property rental business, bank interest or stocks and shares trading income) or it is the holding company of a trading group within the last 12 months. Again from April 2019, this period will increase from 12 months to 24.
• The person claiming ER works in the business (ie is not a “sleeping partner”).
Since the autumn 2018 budget announcement two additional tests have been introduced, with immediate effect: In addition to giving the holder at least 5% of the votes, the ordinary shareholding must also give at least:
– 5% of the company’s distributable profits available to ordinary shareholders; and
– 5% of assets in a winding up.
Please remember that the shareholder must also have worked in the business as a director or an employee.
This applies especially to structures involving growth shares or preferred ordinary shares. This also applies where a share class has preferential dividend or winding uprights.
Capital Gains Tax Calculator – £9.95
This CGT calculator will tell you how much is to pay and how to reduce it further.
Selling a property development company and entrepreneur tax relief
As we saw from the above example that David and Davina start and close a business within 12 months. They do meet entrepreneur tax’ relief conditions as seen below
– They both work on the business
– It is a trade activity (flipping properties)
– They won 5% of the shares
With the old regime for entrepreneurs’’ relief, this would have been fine. However, now that the rules have changed and the owner needs to be 24 months, they would fail this condition and would not get entrepreneurs’’ relief at all.
What is TAAR and how does that affect entrepreneur tax relief
You must also be aware of another article we wrote about TAAR, which stands for Targeted Anti Avoidance Rules. This prevents people from creating and closing companies within quick succession where the type of trade are similar in nature.
This is relevant for property developers that wanted to buy a property in a limited company and close it once sold. Property developers were able to shield any risks within the company. They were also able to benefit from entrepreneurs’’ relief at 10% rather than paying income tax.
David and Davina start at least one new property development company each year. It is therefore likely that they would come under the scrutiny of TAAR. In the above example, we saw how they made £50,000 profit. Given that TAAR would suggest that this profit should be classed as income tax it is likely that they will pay 40% income tax as high rate taxpayers. This tax charge would be £20,000.
National insurance charge
The above £20,000 tax charge does not seem like a lot given they had paid £17,600 in tax (£9,500 corporation tax plus £8,100 CGT at 20%). As the tax profit will now be based on income tax because of TAAR they will also be subject to National insurance.
National insurance is charged at 9% for profits between £8,424 and £46,350. There is also a charge in excess of profits being £46,350 of 2%. Therefore if they are to share the £50,000 profit then £25,000 each will come to a national insurance charge of 9% X (£25,000 – £8,424) being £1,491.84 each. In total, they would have a national insurance charge of £2,983.68.
The total tax charge given TAAR would now increase to £22,983.68 (£20,000 total income tax charge plus £2,983.68 national insurance).
Therefore because of TAAR, their tax liability will now increase to £5,293.68 (£22,983.68 less the previous tax charge of £17,600). This additional tax is more than 10% of the profit made.
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Holding companies & entrepreneur tax relief
Given the new changes to entrepreneur tax relief for property developers, it would be better to set up a holding company in the first instance. Whenever a property is to be flipped then a new SPV may be created, (which is owned by the holding company).
This still ensures that the risk is limited to the SPV.
Any profits may then be distributed to the holding company. Once the property developer has had its fill with property developments then the holding company may be closed down. The money left in the company may then be distributed to the shareholder/director. This will have the benefit of Entrepreneurs’ relief when selling their business.
Clearly, there is a delay of the eventual money getting to the property developer but it will at least ensure that the money is transferred in the most tax efficient way. This method also ensures that the shares are owned for more than two years and avoids the issues that TAAR brings about.
If David and Davina had spoken with Optimise Accountants, as their tax specialists, we would have set up a holding company that would own all the SPVs in question. As such, when David and Davina had their fill with property developments they would simply close down the holding company. They would meet all the conditions set by entrepreneurs’ relief and only pay 10% tax.
The tax charge on the above example, (if that is all the profit they made throughout all SPVs and the holding company) would be charged £9,500 corporation tax as stated previously. However, their income tax charge would be decreased from the previously stated £8,100 to £4,050. This is because they would not be charged 20% CGT but 10% entrepreneur tax relief.
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