Reduce Property Gains Tax, Property Investors

Using holding company tax structures as a property investor or developer

simon

Simon Misiewicz

21st September 2020

Is it time that you got a holding company in place in a group tax structure?

We are not going to discuss the benefits of a limited company being part of a tax group structure. We have previously discussed the tax benefits of extracting money out of a limited company.

There are good reasons to have a group tax structure that owns multiple UK limited companies

– Minimising risk rather than using just one limited company

– Transfer of money between UK limited companies and indeed foreign companies

– The movement of fixed assets free from Stamp Duty Land Tax (SDLT) and Capital Gains Tax (CGT)

Conversely, it may be difficult to perform tax planning if someone has multiple companies. Which companies should you take out for wages and dividends paid? This is a frequently asked question. This can cause problems when you work with Joint Venture (JV) partners and you all want to extract money out of the limited com[any as director wages or shareholder dividends.

For example, you have three companies with JV partners and they all wish to take dividends, forcing you to do the same. That can cause you a tax nightmare. Having a holding company means all dividends paid are passed from each company to the holding company tax-free. That means you only have to worry about how much money (wages & dividends paid) you extract personally from the holding company.

You may have multiple companies because of flips or trades. A holding company may be a solution to minimizing administration and confusion. This means that the holding company owns all other companies. Property developers will open one limited company down when a building project has been sold. This helps the property developer to minimise risk.

Companies are associated if it is owned by another or two or more companies are owned by the same company. One company will be deemed to have control over another if it:

– owns more than 50% of the shares or
– has 50% of the voting rights or
– has a right to receive 50% of the distributable profits

A dividend distribution from one company (subsidiary) to the holding company will be free from corporation tax. This is irrespective of the amount distributed. However, please remember that an individual can only take the £2,000 tax-free dividends.

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Holding companies and group loss relief

Provided that a holding company owns 75% or more of a subsidiary then any losses generated by the subsidiary may be passed up to the holding company. This will reduce the taxable profits of the holding company. These losses must be apportioned so that the losses are applied against the same accounting dates. The loss may not be carried forwards or backwards in the holding company.

Losses must be only claimed in the same accounting year. A holding company would first utilise the brought forward losses before utilizing the losses from its subsidiary. It is also possible for other subsidiaries in the same group structure to claim the losses from the subsidiary in question. It is not just the holding company that may benefit from the loss relief.

Losses may only be utilised where the company belonged to the group in the accounting year. This means that losses may need to be time apportioned of when the company joined the group to either surrender its losses to a fellow group company or to claim the loss. The same rules apply whereby a company has an agreement to leave the group.

Any losses in the same current accounting period from selling assets may also be utilised in the same way as above but must be made within two years of disposal. Any losses incurred pre-grouping must be only used within the company that incurred the loss. Our property accountants have managed to save their clients tax by understanding the basics of loss relief.

This is a great way to reduce overall profits and corporation tax liabilities. Tax reclaims or credits would not be allowed if one limited company, which was not connected to another, made a loss. The same person that owns a second limited company would have a tax liability if the second company made a profit. This is because the unconnected companies can not offset losses against the profit of another.

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SDLT & VAT for transfer of assets between group companies

There are no SDLT charges for assets transferred from one company to another within a group. If a company that receives an asset leaves the group within three years will have to pay the SDLT.

Unconnected companies that wish to transfer properties between them would have to pay residential rates of SDLT or commercial rates of SDLT even if they are ultimately owned by the same person(s). The creation of a holding company allows property transfer to be made without this SDLT liability.

There are no VAT implications of transferring assets from one company to another. However, consideration needs to be given where the asset has opted to tax.

Selling shares of a holding company & Entrepreneurs Relief IER) (Now Business Asset Disposal Relief - BADR)

If you sell your shares to the holding company then you may be subject to Capital Gains Tax (CGT). You cannot claim holdover relief for investment company shares. You will have CGT liabilities based on the deemed profit of the shares less  CGT annual allowances.

Entrepreneur’s relief may be claimed if the holding company is a trading company as well as its subsidiaries. Entrepreneur’s relief may not be claimed if the holding company or its subsidiaries were set up for investment purposes.

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 partially 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 dividends or winding uprights.

The benefit of the entrepreneur’s relief is that the tax rate of closing down a UK limited company would mean that a Capital Gains Tax (CGT) tax rate of just 10% would be applied, after the annual CGT annual allowances.

Upon the closure of each SPV, the money would be returned to the holding company. When the property developer finds another exciting building project they would create a new SPV/subsidiary limited company underneath the holding company.

This effectively is a group tax structure.

Entrepreneurs relief (ER), Business Asset Disposal Relief (BADR) and Targeted Anti Avoidance Rules (TAAR)

Property developers used to open up one limited company and then close it after a project was complete. Upon closing the company the property developer would take the money out of the limited company and pay 10% CGT as explained above. However, HMRC introduced Targeted Anti Avoidance Rules (TAAR) that prevented property developers that owned UK limited companies to open and closing similar companies within a two-year window.

The reason that HMRC introduced TAAR was that they felt property developers were getting an unfair tax benefit compared to the everyday person that pays income tax on the money they owned and CGT rates are 10% for basic rate taxpayers and 20% for high rate taxpayers. Property developers that had the option of opening and closing down similar UK limited companies were getting a reduced CGT rate of 10% even if they were high rate taxpayers.

You may have come across the term “Special Purpose Vehicle” or “SPV”. This SPV legal entity is nothing more than a limited company. A subsidiary is a limited company that is owned by another limited company, normally referred to as a holding company.

The most simple approach to solve the issues surrounding TAAR is to create a UK holding company within a number of subsidiary limited companies or SPV underneath

Once all the projects are completed the property developer can then close down all SPVs/subsidiary companies and the holding company and eventually claim what was called Entroeenuer’s Relief (ER) bit not termed Business Asset Disposal Relief (BADR) at 10% without the fear of HMRC making claims of tax evasion.

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?

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
£50,000 profit
£9,500 corporation tax liability assuming 19%
£40,500 cash left in the business to be taken out (ignoring shareholder funds)

As high rate taxpayers 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

Capital allowances within a group structure

Typically businesses receive an entitlement of £250,000 Annual Investment Allowance (AIA) per the government website but only one claim may be made for the entire group irrespective of how many companies it may contain. No annual investment allowance or first-year allowance is available if acquired from a ‘connected person. I am sure that one of our property accountants will be able to help you with these strategies.

Too many limited companies causes mayhem

There are many property investors who are using limited companies in the wrong way. They are mixing up trade activities with investment holding companies. There are also some property investors who have more than three limited companies because they have set up a limited company for each property deal/joint venture.

The issues with having lots of limited companies in the wrong structure can be seen below:

– An administrative nightmare to look after each limited company with receipts and paperwork
– Several bookkeeping spreadsheets/online systems
– A wallet/purse full of company cards and always having to make sure you use the correct one
– Multiple bank accounts and bank statements
– Additional accountancy costs for the annual accounts
– Filing of several annual returns
– Difficulty with tax planning as you are personally receiving wages/dividends paid from different sources

Can you relate to the above?

Can you see how things can get really messy?

If you have answered yes to these questions then keep reading for some solutions.

A real life client example — setting up too many companies

For the purpose of this article, we are going to name my client John to protect his identity.

John has more than 20 properties, some of which are in his name and some of which belong to his 15 limited companies. John is buying properties but not thinking with the end in mind, so he buys them all in separate limited companies. He is working with different joint venture partners and decides to set up one limited company for each one.

Within his own limited company, he is mixing buy to hold properties with buy to sell in the same company.

All in all the 15 limited companies are simply tying him up in knots with paperwork, administration, constant phone calls to his accountant to discuss the year-end and filing annual returns. This leaves him with little time for himself and his family or to develop his business. He has now become an administrator and is consequently annoyed and frustrated.

The issue with mixing up buy to hold and buy to sell properties within a limited company can be quite harmful because:

– When you flip there is a degree of risk. Your other properties are at risk if everything goes wrong with that property flip and it creates a significant liability that is greater than the value of the property.
– If you mix up buy to hold and buy to sell then you lose the right to claim entrepreneurs’ relief.

Practical steps you should now take to set up a tax efficient group structure

It is one thing to understand the theory but it is another to put it into practice. This is why I have written a step-by-step guide to implementing this strategy:

1. Set up a holding company structure using alphabet shares to ensure the owners can extract money out of the limited company in the most tax-efficient way.
2. Set up individual Special Purpose Vehicles (SPV) subsidiary companies that are 100% owned by the holding company.
3. Close down the SPV upon the building project being completed and move the money back up to the holding company.
4. Repeat steps 2-3 for each project
5. Close down all SPVs and the holding company
6. Extract the cash out of the holding company and claim Entrepreneur’s Relief (ER), now termed Business Asset Disposal Relief (BADR) at the 10% rate for Capital Gains Tax (CGT).

See how easy the above is? You can hopefully now see that there is no need to set up limited companies for each property or each joint venture.

If you are thinking about setting up a limited company to do flips then you may need to consider whether you need to be Construction Industry Scheme (CIS) registered.

Mortgage editor’s comments

To ensure you get access to the best SPV limited company mortgage rates, a trading business (i.e. a development company; taking the example above) should not be mixed with an investment vehicle (i.e. an SPV which holds and manages the buy-to-let property).

Not only will you limit your access to lenders and the best SPV mortgage deals, but the lenders you’re left with will be more inclined to look into the trading business in much more detail.

To keep things clean and tidy, we recommend you keep your trading activities separate to your property investment activities. This not only protects your access to the best deals but also makes obtaining those deals as quick and easy as it can be.

Our limited company mortgage specialists can help you with all SPV finance matters – both for standalone SPV buy-to-let limited companies and trading businesses. Contact us now to discuss your SPV mortgage requirements:  https://www.limitedcompanyspvmortgages.co.uk/contact-us/

Why do people work with joint venture partners?

Are you working with or thinking of working with joint venture partners?

There are many advantages of working with other people in your property business. Some of the more obvious advantages are:

– Time: One person may have more time than the other to get things done
– Money: One person may have the time but not the money to buy properties
– Expertise: You may be looking to create a power team. One person may be a creator of ideas and the other is an implementor that ensures things are complete. You may have another person that is happy to meet and greet other people to join the team or invest money.
– Financing: You may decide to be your own bank and therefore pool the finances together with other joint venture partners. This will then stop the need to work with banks.
– Isolation: working on your own in business can be lonely. By working with other people it makes it more sociable. The additional bonus of being able to bounce ideas off one another.

There will be other reasons why you want to work with joint venture partners.

Working with joint venture partners

Here’s an example to better explain how holding companies can be beneficial:

There is a property investor called Stuart. He works full time as a medical consultant. He works 50-60 hours per week and is often on call. His time is taken up in his medical profession.

He attends a networking event for doctors and the subject of property investing comes up. There is a lady called Lafina that is also a doctor but has more time to spend looking at property and managing tenants. She wishes to rapidly grow her profile and needs additional money. This is a great opportunity for them to be working with joint venture partners.

Given they are both in the medical profession they agree to set up a limited company, otherwise known as a Special Purpose Vehicle (SPV).

After a couple of years, Stuart and Lafina buy a few properties inside the limited company and they are making money. They are doing so well that they earn £20,000 profit after tax.

At the same time as working with Lafina, Stuart also worked with David. That joint venture partnership was doing even better as they were buying Houses of Multiple Occupation (HMOs). This company was generating a profit after tax of £30,000.

What are the tax issues of working with joint venture partners?

Stuart had no intention of taking money out of the company as he earns enough from his consultancy business. However, both Lafina and David want to take dividends out of the respective companies. Lafina takes £10,000 dividends and David wants to take his share of the profits of £15,000.

As Stuart owns the shares in the two limited companies he has to take the £25,000 profits as dividends from the limited company. As he is an additional rate taxpayer the tax on dividends is

– 0% for the first £2,000
– 38.1% for the remaining £23,000

This means that Stuart now has an income tax liability of £8,763 even though he did not want the dividends in the first place.

Stuart could have set up a holding company. This holding company could then own the shares in the companies co-owned by Lafina and David. As such the dividends could be passed up to the holding company and there would be no tax liability.

David could then look at extracting dividends from holding companies to the tune of £2,000 per year. By extracting these dividends from holding companies in this way they become tax-free. He could take out more dividends as and when he wants. However, the key difference is that Stuart has an option whether or not to pay himself these dividends.

There are many advantages of using limited companies. We have written another article on how to extract money out of a limited company.

How UK holding companies affects our American Readers

Since 2018 the Inland Revenue Service (IRS) established a new tax called  Global intangible low-taxed income, which may also be referred to as GILTI. This prevents American owners from establishing UK limited companies that shield them from higher tax rates in the United States.

Usually, Americans will pay income tax on dividends that they receive from Controlled Foreign Corporations (CFCs). However, since 2018 the IRS now tax Americans based on the profits made in the UK limited companies irrespective if the money that has been distributed in the form of dividends not.

Learn more about our International services to help Americans move or invest in the United Kingdom

How does this affect Hong Kongers that are looking to move or invest in the United Kingdom from Hong Kong?

Unlike the Inland Revenue Service (IRS) in the United States, the Inland Revenue Department (IRD) in Hong Kong does not tax Honger Kongers on the money they earn in foreign counties. The fact that money from a UK limited company has or has not been paid to a Hong Konger does not matter. This is because there are no additional tax liabilities from the IRD.

Learn more about our International services to help Hong Kongers move or invest in the United Kingdom

How does this affect our British readers that are looking to move or invest in either the United States or Hong Kong?

People that have a UK limited company need to understand the foreign taxes of the counts they are moving to. For example, someone that is moving from the United Kingdom to the United States will need to pay tax on their worldwide income. This means that UK dividends and UK limited company profits would be subject to tax in the US.

Hong Kong is a little easier as there are no tax liabilities for the UK or any other foreign companies in Hong Kong.

Learn more about our international tax services to help British people that wish to invest or move to the United States or Hong Kong

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