Should you buy a commercial property via a company?

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As a general rule its usually advised that anyone planning on purchasing a commercial property to let should do so personally rather than using a company. The simple reason for this is that on a future disposal of the property if you own it personally you could qualify for business asset taper relief to reduce the gain by up to 75%. This equates to a 10% rate of CGT for a higher rate taxpayer. If you use a company you won't qualify for any taper relief at all. In addition you'll have the additional costs of extracting the property. This means that on a disposal personal ownership has some substantial advantages over company ownership.

You'll therefore find that many accountants will automatically advise you to purchase commercial property personally. However, it's not always as straightforward as this. In this article we're going to look at some of the situations where personal ownership may be less attractive.

Some of the main situations where this can apply are:

Where maximising rental income is the top priority

This is the main one. If you are looking mainly at the net income return rather than capital growth you may see some benefits in using a company. As a higher rate taxpayer you will pay income tax at 40% on the rental profits irrespective of whether you reinvest the profits into the property or other properties.

By contrast a company will pay corporation tax at the rate of 19% on profits up to £300,000. If you kept profits within the company and did not extract you could therefore see a significant tax saving on rental income. The problem then, of course, would be that when you extract the profits there would then be a further income tax charge that would eliminate the benefit from the lower rate of coporation tax.

In order to get a real benefit from using the company you would need to find a way to extract the profits without an income tax charge. There are two main methods of doing this. Firstly you could just extract profits during any tax years of low income, and provided you extracted amounts within your available basic rate tax band there would be no income tax charge. The other option would be to become non UK resident for a tax year and extract profits free of UK income tax. As a non UK resident you would only be charged to UK income tax on dividends to the extent of any tax deducted at source. As dividends are paid with a notional tax credit, the net effect of this is that you wouldn't be charged to income tax on the dividend receipt. This could therefore be a useful option to extacting cash from the company free of income tax.

Remember though this will only be a big benefit as regards the income. If a large gain arises, although you could extract the proceeds free of tax by becoming non UK resident, the company itself would still be taxed on the gain, and as taper relief would not be due the tax payable could still be signficantly higher than personal ownership.

Example

Peter purchases a factory for £1M. He lets it to a manufgacturing company for five years, then sells for £2M.

The CGT he will pay, ignoring the annual exemption would be £100,000.

If he bought the factory via a company the gain arising to the company would be £1M. He would be entitled to indexation relief - say £75,000. The remaining gain of £925K would be subject to corporation tax as follows:

300,000* 19% 57,000 625,000* 32.5% 203,125

The total tax charge would be in the region of £260,000. This is even if the proceeds were extracted tax free as a non UK resident.

Therefore although you can get some big benefits in terms of reducing tax on income, if a signfiicant gain is expected you would still need to be very of wary of using a company in this case.

Where an offshore company is used

If you use an offshore non resident company, one of the big advantages of using a UK company, namely the tax charge on a disposal of the property, can be eliminated.

A non UK resident company is not charged to tax on any gains it realises unless the asset was used in a UK branch or agency trade. In this case the owner of the property (the company) has used the property for an investment purpose (ie to let it) and therefore no CGT would be due.

However, for a UK resident this benefit is more apparent than real. There are a number of anti avoidance provisions that would make it very difficult to use an offshore company in this way if you were non UK resident. In particular:

• the company would need to be controlled from overseas, which would be difficult to show if the directors and shareholders were UK resident.
• there is an anti avoidance provision that attributes gains of offshore companies to UK residents in various circumstances.

Therefore if you did want to use this route you would need to take some detailed advice. If you're non UK resident of course you could use an offshore company and avoid UK tax on the gain, although you could also hold it personally and achieve the same result.

Note if you are a UK resident, but a non UK domiciliary the second anti avoidance rule above does not usually apply. Similarly as the second 'attribution of gain' rule only applies where an individual is UK resident and domiciled during the tax year of the gain you could in theory establish the company as a UK resident, and then leave the UK prior to the disposal. Your main problem would then be avoiding the UK being controlled from the UK.

Where the property is not let to traders

If the property is not let to traders, or is not let at all, no business asset taper relief would be due on the disposal in any case. This makes the differences between personal and corporate ownership less stark, and much will in this case depend on the length of the period of ownership as well as the treatment of the proceeds in the company.

If the property is not used by traders taper relief will still be due but at the non business assets rate. On the basis that you are a higher rate taxpayer, the rates of taper relief will reduce the effective CGT rate according to the length of your ownership as follows:

3 years 38% 4 years 36% 5 Years 34% 6 Years 32% 7 Years 30% 8 Years 28% 9 Years 26% 10 years 24%

Note this only applies to ownership post 5 April 1998, although if you owned the property at 17 March 1998 you'll get a free 'bonus' year. For example a purchase in 1995 will qualify for the 24% CGT rate in tax year 2007/2008.

When you compare this with the company tax charge of 19% for gains of up to £300,000, and an effective 32.75% tax rate on any excess gain above this (up to £1.5M) the company option could lead to a significantly lower tax charge, particularly for gains within the 19% tax band.

Of course this is only a true saving if you can extract the proceeds from the company free of tax (as above by becoming non resident or extracting during tax years of low other income). If you have to pay UK income tax on the extraction at the higher rate personal ownership would probably be preferred.

Example

A gain on a property of £200,000 (with proceeds of £300,000) arises after five years ownership.

If this was owned personally after the annual CGT exemption and taper relief the CGT payable would be £64,480 for a higher rate taxpayer.

If a company was used, assuming indexation relief of £5,000, the corporation tax payable would be £37,050.

If the proceeds could be extracted without a further tax charge the company route would offer a saving of £27,430. However if the full remaining proceeds were extracted the total tax payable would be over £100K. Therefore if a company was to be used, packing your bags for a year (at least) would be well worth it.

Where the property is to be sold on quickly

If the property is to be sold on quickly it probably wouldn't even be classed as an investment transaction. Instead it could be classed as trading, and any profit would be taxed as income as opposed to capital gain.

This makes a big difference to the decision, as even if you own the property personally, your reliefs would be limited, and you certainly would not get the capital gains tax reliefs such as taper relief and the annual CGT exemption.

In this case, using a company has more advantages, as the tax rate payable personally will probably be 40%, as well as a 1% NIC charge on profits above the basic rate band. If you use the company, you'llbe taxed at 19%, and even if you extract some of the proceeds whilst UK resident, your effective tax rate will probably still be below the 41% tax rate. If you retain all the profits in the company there would be a substantial tax saving.

Where the shares can be sold as a non UK resident

If you are planning to be non UK resident in the future (with an absence for more than five tax years) and you could arrange for a disposal of the shares in the property holding company, as opposed to a disposal of the actual property there may then be advantages to using a company. The big plus point of owning personally (ie the reduced CGT on disposal) would not be significant, as the shares could be sold free of UK CGT in any case. In addition, you could use the company to obtain a lower tax rate on rental receipts, and then extract the cash tax free after you left the UK. You'd then have only suffered a 19% tax rate just on the rental receipts.

So there you have it, some of the exceptions to the general rule that commercial property is better off owned personally. The main benefit to personal ownership is the benefit of taper relief. If this is not available, or if CGT is not a key issue, then the company alternative does become more attractive