When UK resident investors are considering how to hold new investment property acquisitions the main options available are to hold the property personally, via a partnership or in a company. There are various advantages and disadvantages to each approach.
Owning a property personally will generally be the simplest option. With regard to the ongoing tax treatment:
• Rental income – The rental profits will be taxable at the owner’s marginal income tax rate, potentially at up to 45%. To the extent any borrowing has been used to acquire the property then the new restriction on finance costs will apply from 6 April 2017. See my previous article for further details regarding these rules http://renovateme.co.uk/blog/property-tax-new-rules-finance-costs-deductions-buy-let-landlords/
• Tax on disposal – After deduction of any available CGT annual exempt amount (currently £11,100) any gain arising on the property will subject to capital gains tax (“CGT”) at either 18% or 28% depending on the individual’s marginal income tax rate.
Ownership through a Partnership
Where property is owned jointly with one or more persons, joint letting in itself does not make the activity a partnership. In particular to qualify as a partnership, HMRC consider there must normally be a significant amount of additional services provided and a similar degree of organisation to an ordinary commercial business. Should the operation be considered a partnership, the ongoing tax treatment is as follows:
• Rental income – Each partner will be subject to income tax on their share of rental income allocated to them under the partnership agreement. As above, to the extent any borrowing has been used to acquire the property then the new restriction on finance costs will apply from 6 April 2017. It is important to note that any income profits or losses that arise under the partnership cannot be aggregated with any personally held investment properties.
• Tax on disposal –On a disposal of a property each partner will be taxed on the share of the gain allocated to them in accordance with the partnership agreement. Each partner will be taxed on the gain at a rate of 18% or 28% rate depending on their marginal income tax rate.
Ownership through a UK company
Another option will be to own the property via a company.
• Rental income – The company will be subject to corporation tax on the rental income, currently at a rate of 20% (due to drop to 18% from 1 April 2020). NB to the extent any borrowing has been used to acquire the property then the new restriction on finance cost will not apply to companies.
• Tax on disposal – Any gains that arise on a disposal of the property will also be subject to corporation tax. The company will be entitled to deduct indexation allowance against the disposal proceeds to allow for inflation.
• Extraction of funds – Further tax maybe due on the extraction of rental profits from the company.
Other matters to consider
A partnership or corporate structure will have annual obligations, such as accounts and annual returns, which will have an annual cost associated with them and also initial set up costs.
Consider the following example – Joe is a higher rate tax payer who wishes to acquire an investment property which will receive rental income of £30,000 per year. He will not be funding the acquisition using borrowing.
Personally owned Partnership Corporate Structure (post 6 April 2016) with dividends being extracted Corporate Structure (post 6 April 2016) with no profits being extracted
Tax on rental profits of £30,000 Income tax at 40% = £12,000 Income tax @ 40% = £12,000
Corporation tax @ 20% = £6,000 Corporation tax @ 20% = £6,000
Total profit after tax £18,000 £18,000 £24,000 £24,000
Tax on dividends N/a N/a £24,000 dividend less £5,000 annual allowance = £19,000 taxable
£19,000 @ 32.5% tax = £6,175 N/A
Total tax on extraction £12,000
£12,000 £12,175 £6,000
|Corporate Structure (post 6 April 2016) with dividends being extracted
|Corporate Structure (post 6 April 2016) with no profits being extracted
|Tax on rental profits of £30,000
|Income tax at 40% = £12,000
Income tax @ 40% = £12,000
|Corporation tax @ 20% = £6,000
|Corporation tax @ 20% = £6,000
|Total profit after tax
|Tax on dividends
|£24,000 dividend less £5,000 annual allowance = £19,000 taxable£19,000 @ 32.5% tax = £6,175
|Total tax on extraction
When setting up a new property investment business a company may well have advantages if the long term business plan is for profits to be reinvested in the business to promote future growth enabling the business to pay corporation tax rates on profits and to benefit from the finance cost deduction from rental profits if the intention is to using borrowing to fund the acquisition. However, with such a structure, the extraction of rental profits will also need to be considered in comparison to owning the property directly – particularly in light of the increased dividend tax rates coming into effect from 6 April 2016.
It is not yet clear to what extent companies will be impacted by the new SDLT rules on buying second properties announced in the Autumn Statement. To the extent companies are affected by these rules, then the new SDLT rules will be another factor to be considered.
Whilst every effort has been made to provide information current at the date of publication, tax laws around the world change constantly. Please note that this article has been produced based on information contained in the Autumn Statement announcement documents and prior to any draft legislation being produced. Accordingly, the material should be viewed only as a general guide and should not be relied on without consulting your local KPMG tax adviser for the specific application of a country’s tax rules to your own situation.
If you need assistance with any related matters, please do e-mail Simon at firstname.lastname@example.org.