Transferring a property to a special purpose vehicle ('SPV') prior to sale to reduce tax
Anyone holding land or property that is to be sold may look at opportunities to reduce tax payable on disposal by transferring the property to a special purpose vehicle ('SPV').
An SPV is simply a company or other entity that is established solely to hold the property. It could therefore be a company, trust or even a Limited Liability Partnership ('LLP'). More often than not though it's just a company. These are very straightforward to form and suit most peoples requirements well.
What is the purpose of the SPV?
If the property is retained in personal ownership any gain on the development will arise on the individual owners. They will therefore be subject to either capital gains tax or income tax dependent on whether the owners were property investors or property traders.
The distinction is crucial as it will dramatically impact on the tax treatment.
Property investors
Property investors holding property will be subject to CGT at 18% or 28% (if they are higher rate taxpayers).
This is a very attractive rate of tax -- particularly when compared with the higher rate of income tax, which is 45%.
Property investors can also claim the annual CGT exemption which if there are a few owners can easily mount up (eg 5 owners who club together to purchase a property could exempt gains of around £60,000 due to the combined annual exemptions).
Property traders
Property traders are subject to income tax on any profit that is realised on the disposal. This, therefore, puts them at an immediate disadvantage compared with property investors as they'll pay income tax at either 20%, 40% or 45%. In most cases, they'll be subject at least in part to tax at the 40% income tax rate.
Using an SPV
A transfer of the property to an SPV would result in a gain for tax purposes. Therefore this would need to be computed with the disposal proceeds deemed to be the market value at the date of the transfer.
However, if the owners are property investors in many cases using an SPV would not bring any tax advantages.
Aside from there being a tax charge on transfer to the company, a future disposal by the company would be taxed at 19% (increasing to up to 25% from April 2023). This, therefore, puts the company in a slightly better position than an individual investor taxed at the higher rate as they would be subject to CGT at 28%.
However, this does not take account of the fact that cash needs to be extracted from the company. If cash is extracted from the company as dividends, tax would be payable at 33.75% or 39.35% depending on income levels. This can easily outweigh the advantages of the lower tax rate.
Of course if no or only limited cash is to be extracted from the company, then using the company would in many cases be the preferred option.
Other cases where transferring to a company could be advantageous are:
- Where the company has trading losses that could be utilised
- Where the capital gains tax treatment needs to be fixed
This second issue can be important. If an individual owns land and has held it for a while, they may look to obtain planning permission at some stage and then perhaps develop it. If they developed the land and simply sold it there's a risk that they could be classed as property traders and the entire profit taxed as income.
Instead they may want to obtain planning permission and then transfer to a controlled company. The transfer to the company would crystallise the capital gain based on the market value of the land (which with planning permission could be substantial). The company would clearly be classed as a property developer given it is acquiring, developing and reselling but this is not a key issue as the gain up to planning permission is taxed on the individuals and as capital gain. This would therefore subject a large element of the gain to the 18%/28% rate of CGT -- rather than income tax at up to 45%.
Fixing capital gains in this way can be useful.
Aside from this it is often traders that may benefit from transferring a property to an SPV.
The main advantage in using a company is that if the proceeds of sale aren't extracted but instead are retained within the business for future reinvestment (eg to purchase more properties). In this case the company may be taxed at rates of 19% compared with 40% or 45% if the trade was carried out personally.
Therefore a transfer of a property to a company before significant value has been added since the original acquisition cost would be worthwhile if more properties were planned to be developed in the future. By ensuring that no significant value has been added since the purchase date it also ensures that the profit on the transfer to a company is not too significant.
Another advantage for property traders would be to transfer a property to a company, and incur the development work within the company is a disposal of the shares was planned. This would then ensure that the profit on disposal was assessed as a capital gain (sale of shares) as opposed to income (sale of property). The benefit of this is of course that the 18%/28% rate of CGT could then apply.
Many large property developers use companies to own individual developments in this way. It is also beneficial if the property is to be let as the company could then benefit from the lower tax rate on the rental income as well as the shareholders accessing the 18%/28% rate of CGT on a disposal of the shares.
Therefore transferring a property to a company can be effective in reducing the overall tax charge. The drawback is that this will crystallise a gain or profit which may be subject to tax without any actual proceeds being received to satisfy the liability.
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