Setting up your own property management company to reduce income tax
In the past it used to be a pretty popular tax planning opportunity. You'd retain ownership of your rental properties in your own name and set up a property service company.
The company would assist in finding tenants, collecting rents, undertake repairs etc (in other words the activities that would usually be undertook by an independent property management company). In exchange the company would be paid an agency fee for providing the services (usually 10-15%).
The main advantage of this was that a few years ago a company could earn profits of up to £10,000 free of corporation tax. So the main idea behind the connected service company was to take advantage of the company's tax free band.
The rules have now changed, with companies being taxed on profits up to £300,000 at 20%. The main rate of corporation tax is now 23%.
Given this it's worth asking is the property service company still a good idea?
Well not surprisingly they're not as attractive now as they once were but given the right circumstances they can still be useful.
Corporation tax
The corporation tax rate for small companies is now 20%. In comparison if you own properties personally and are a higher rate taxpayer you'll be taxed at 40% on the rental profits. So in principle a service company can be attractive as you're essentially swapping profits taxable at 40% for profits taxable at 20%.
The tax saving is even greater if you have income above £150K and pay tax at the additional rate (45%).
This though is only the case provided you don't take profits out of the company, or at least you don't take them out while you're a higher rate/additional rate taxpayer. If you took profits out as dividends (the most common option) you'd suffer an additional 25%/30.55% tax charge on you personally eliminating the benefit of using the company.
Therefore using the service company could be attractive where:
•You are retaining profits within the company long term - perhaps to start a future trading activity
•You plan to extract profits from the company in the future when you are a basic rate taxpayer. If for example you are a higher rate taxpayer now, but would plan to retire in five years time at which point you would be a basic rate taxpayer, using the service company could be attractive. Any dividends extracted within the basic rate tax band would be free of any additional income tax liability for you. Therefore the net effect of this would be that you'd have only suffered the 20% corporation tax charge, as opposed to an earlier 40% income tax charge.
•You are currently UK resident but plan to move overseas in the future and remain non resident for more than 5 tax years. If this is the case providing you make sure you establish yourself as non UK resident you would be able to extract the cash from the company free of any further UK income tax charge.
Here's an example illustrating a couple of these points:
Example
Frank owns 5 investment properties generating rental profits of £50,000 per tax year. Assuming he is a higher rate taxpayer, he'd pay income tax of £20,000 on this.
Over the next five years the income remains the same and then he emigrates to New Zealand. His total income tax bill would be £100K over the five years.
If he used a service company, he could use the company to process all payments and deal with the tenants. The company would pay Frank 85% of the profits and retain the other 15%. Frank would therefore receive £42,500, and the company would retain the other £7,500. Frank would pay income tax of £17,000. Assuming the company bears all the expenses it would pay corporation tax of £1,500).
After the five tax years the company would have retained cash of around £30,000 which could then be extracted from the company free of UK income tax as he's a non resident. This may also be free of of New Zealand income tax under there new tax rules for immigrants.
The tax bill if the company was used would be around £93,000. There would therefore be a tax saving of around £7K in this case. Not massive but it would more than cover the costs of using the company. In addition if the rents were higher the benefit of using the company would be higher.
Why not just have company ownership?
You could of course just have the company own the properties outright. Then all of the rental profits would be subject to the lower rates of corporation tax. Providing one of the cases above applied (ie and there was no tax charge on extraction of the profits) then there could be a significant tax saving.
For example in the case above rental profits of £50,000 would result in a corporation tax charge of £10,000 per year. Over the five years this would total £50,000, and if the cash in the company (£200,000) was extracted free of further tax there would be a tax saving of around £50,000 when compared to personal ownership. The tax saving when compared to owning and using a service company would be around £43K.
This is a massive tax saving and well worth considering, the only downside to this is the position when you sell the property.
Capital gains treatment
If you own it personally you'll be entitled to offset the annual CGT exemption on disposal (£10,900, but this could be doubled if you transfer an interest in the property to your spouse), as well as PPR relief if you occupy it and the 18/28% rate of CGT. In addition if you leave the UK and sell up you could avoid paying any CGT. The fact that you use the company to handle the tenants would not impact on the CGT position and no gain would arise to the company instead it would all be taxed on you.
Contrast this with the position if you opt for full company ownership. The company will get no annual exemption, no PPR relief and no non residency exemption as well as being subject to the corporation tax rates and not the 18/28% rate of CGT (which could in itself be attractive particularly where the corporation tax is payable at 20% or 23% in the future and your personal CGT rate would be 28%). The only relief in this case would be indexation relief to take account for the effects of inflation but this is unlikely to be significant.
Of course you could always structure this as a share disposal (ie sell the shares in the company rather than the underlying properties) to take account of the 18/28% CGT rate, the annual exemptions and any non UK residency. The downside to this is that any purchaser would be likely to want a discount on the purchase price to reflect the inherent tax liability in the company.
So which is best then?
Which matters most to you (ie income v capital) is for you to decide. However looking at the company, many gains will be significant. As such the proceeds may well be large and extracting annually to utilise any remaining basic rate tax band may not be feasible. Therefore the best option in this case would be to become non resident and extract proceeds free of income tax.
Of course if you'd owned personally and had become non resident you'd get a complete CGT exemption, rather than paying corporation tax at 20% on the gain. As such you'd need to weigh up the difference between the CGT saving and the saving in income tax on rental income.
The only difference is that for income tax you wouldn't have to remain non resident for five years.
Looking at the example above if Frank sold the properties for £750,000 realising a gain of £500,000 after five years if he'd owned personally he could avoid CGT in full if he was non UK resident. Even if he sold whilst he was UK resident (or if for example failed to meet the five year requirement) he'd be taxed at the 28% rate of CGT. Assuming annual CGT exemptions of £11,000 each for him and his wife (if she was a higher rate taxpayer) they would have a CGT charge of £133,840.
If he'd owned the properties via a company the company would pay tax on the profits of:
300,000 @ 20% = 60,000
200,000 @ 23% = 46,000
Total = 106,000
So in this case the company would pay more tax than an individual and the cash would still need to be extracted. If you were staying UK resident the extra 25% tax charge on any amounts received over your basic rate tax band would be likely to make the company less desirable (and if you were to try and take the proceeds out in small amounts per tax year in this case it would take you around 13 years to take out the full proceeds assuming you had no other income at all).
Therefore using the company would only really be attractive in this case if you were non UK resident. Of course if you were to extract it tax free as a non resident you'd then need to consider the trade off such as:
If you could own property and obtain the CGT exemption on disposal (as well as avoiding overseas CGT when you sell) you probably wouldn't want to use the company route, as you'd save tax on rental income but you'd pay extra tax on the disposal of £106,000.
Clearly if the properties qualified for additional reliefs such as principal private residence relief this would also swing it in favour of owning personally as opposed to using a company.
What you need to do to use the property service company option?
The most important aspect is that all dealings between you, the company and the tenants are on an arms length basis. This means that the agency fee the company charges you should be set at a similar level to the fee that other independent agents would charge. You should therefore ensure you research the rates that local agents would charge for the same services the company will be providing you, and stick to this. Retain any evidence supporting this in case you need to back up the arms length nature of the agreement.
Keep all books and records for the company separate. If you undertake any services for the company you can certainly bill the company for your time although you will then need to account for income tax and NI on the receipts.
Ensure that the company is structured as a trading operation. If the Revenue was successful in arguing it was an investment activity this would be disastrous as they'd probably class the company as a close investment company. In this case the tax rate would be 23% as opposed to 20%, and this would not make the company anywhere as attractive. The above actions would help to indicate it was a genuine trade but if you could also obtain any third party agency contracts this would then seal it, and ensure there was no possible risk of an investment company argument.
About the Author
The Author of this article/answer is our site Editor, Lee Hadnum. Lee is a rarity among tax advisers having both legal and chartered accountant qualifications. After qualifying a prize winner in the Institute of Chartered Accountants exams, he also went on to become a chartered tax adviser (CTA).
He worked in Ernst & Youngs Entrepreneurial Services department for a number of years before setting up his own tax planning practice. He is now a full time tax author.