The UK has become a nation of landlords! Before the economic downturn began, low inflation, stock market volatility, uncertainty over pensions, dramatic house price rises and less risky housing laws had combined with the success of buy to let to allow people to invest in property on a scale never seen before in the UK. Many of these investors need to seriously consider the benefits of holding property in a limited company, or if that is not possible, putting the assets into a property management company.
There are numerous ways to reduce tax by setting up a limited company for a property portfolio. Corporation tax rates are simply much lower than personal tax rates. Rental profits can be taxed at rates as low as 0%.
Higher rate tax payers in particular benefit enormously. If you set up a limited company for your properties, the first and most immediate benefit is that the first ten thousand pounds of profit is tax free because the corporation tax band is nil up to £10,000. For example, there would be no tax to pay on, say £9,000 profit, whereas the Inland Revenue would demand £3,600 in tax from a sole trader who pays higher rate tax.
After the first £10,000 of profit corporation rates rise to 19% on the first £300,000 of profit. Above that there is a sliding scale to a maximum of 30%. Without the protection of a limited company there would be 40% tax to pay on all profit and gains.
Another attraction of limited company status is that ownership can be transferred without incurring an immediate capital gains tax liability. If the property is inside a limited company a family member, for example, can subscribe some shares and ownership can pass to that family member tax free, as the value of the transfer can be held over for capital gains purposes.
A limited company can also pay out profits in the form of dividends, which do not attract National Insurance contributions at present. Although there is extra tax to pay if you extract dividends, a company can be an extremely powerful tax shelter if you can afford to keep reinvesting profits for many years.
Of course you need to consider the difficulties of extracting funds from the company. The company is a separate legal entity. It pays its own tax on profits and gains, can be sued for its debts and is the legal owner of the money it makes. If the shareholders want to take money out, there will be a tax charge. Wages, salaries and bonuses are the most expensive way to get money out of a company, but even so there can be a very significant tax saving and accumulation effect by using a limited company and this can, over time, lead to a fair difference in the size of portfolio held.
Apart from the tax issues there is also the valuable attraction of limited liability. For example if a tenant trips over a faulty rug supplied by you and decides to sue, your personal assets are outside the company and are protected.
Landlords and property investors can also form UK Limited Liability Partnerships for UK property transactions. An LLP is a body corporate with limited liability and legal personality. It is therefore a legally a type of limited company (but without a conventional share capital) which can function like a partnership in practice and which is deemed to be transparent for UK tax purposes, with the members of the LLP being treated as if they were partners in a partnership (which strictly they are not).
The advantages outlined above need to be weighed against those of being a sole trader. Sole traders purchase property as an individual in the hope of obtaining the capital gains benefits, but face a higher rate of income tax on net rental income, which can make capital repayment of borrowings seem expensive.
Property management companies
Where it is not possible (or desirable) to hold properties within a limited company, the use of a property management company can also save vast amounts of tax. Property investors can consider a relatively new type of company, a right to manage (RTM), which is often now used in place of a Flat Management company. The RTM represents the interest of owners of dwellings that share common areas or rights, typically flats, to participate in the running of the common areas or exercising their rights of access.
Unlike a Flat Management Company there are no shareholders, but instead rights of membership are conferred on the parties concerned. The flat owners may force the managers of the building to accept the setting up of such companies. The Commonhold & Leasehold Reform Act 2002 came into effect three years ago and provides a right to leaseholders in flats to force a transfer of the landlord’s management functions to a company of their own – an RTM. Landlord consent is not required as long as relevant criteria are met. The right is exercised by serving a formal written notice upon the Landlord who may, after the appropriate periods of time have elapsed, become a member of the new company themselves once the right to manage has been acquired. Specialist advice should be sought if there is a dispute. The following criteria must be satisfied:
- The building must be self- contained ( or if part of another building , be capable of being redeveloped independently)
- It must include at least two flats
- At least two-thirds of the flats must be let to ‘qualifying tenants’ (i.e a leaseholder whose lease was originally granted for an original term of more than 21 years). There is no requirement for any past or present residence in the flats, or any limit on the number of flats which can be owned by one person.
- It can be part-commercial but the non-residential part must not exceed 25% of the total floor area
- The right to manage may only be exercised by a RTM company and the members of the RTM company must comprise a sufficient number of qualifying tenants. (The required minimum number of qualifying tenants must be equal to at least half the total number of flats in the building)
- The right relates to a building, so in an estate of separate blocks, each block would need to qualify separately and an individual RTM served.
Once formed, the company must formally invite any leaseholders that did not participate in the formation of the company to become members. The company itself must be limited by guarantee and not have a share capital and its Memorandum & Articles of Association must follow a specified form laid down by legislation. These companies are normally set up on the advice or under the guidance of a solicitor familiar with property law. Formation agents like Duport can form such companies quickly and easily.
Flat management company
Developers in particular often turn to flat management companies, especially if they own blocks of flats where an arrangement needs to be made to deal with the running, maintenance and repair of the common parts of the building. The leaseholders of the flats are the members of the company. They may appoint a management agent to carry out the day to day work, or one may be specified in the leases with the freeholder. A flat management company is normally incorporated to manage a property or group of properties where there are multiple tenants. It is normally used to protect the interests of the leaseholders.
A Flat Management company has its Memorandum and Articles of Association specially drawn up to allow the company to own, manage and administer a leasehold or freehold property, which is normally divided into several dwellings units or flats, with each leaseholder owning a share in the company. The leaseholder will be obliged to transfer the ownership of the share to the new leaseholder when disposing of the property.
Flat management formation packages are often a solution for developers. The company can be tailored to the client’s specific requirements – for example with enough copies of Memorandum and Articles of Association for each leaseholder. Developers can choose between a company limited by shares or limited by guarantee. Either of these forms of incorporation provides limited liability for its members. Each company can also collect maintenance charges and any ground rents, arrange security, decoration, insurance etc.
The company limited by guarantee intends to provide a form of incorporation with limited liability suitable for a group of members with a mutual interest of a not-for-profit nature. The main advantage of using a guarantee company rather than a company limited by shares is that no stamped transfer is needed on changes of members (on sale of the related lease). The articles can simply provide for the membership of the outgoing lessee to terminate automatically when they cease to hold the lease, without the need for signatures.
Whatever the size or complexity of a property portfolio, limited company status deserves serious consideration. For top rate tax payers, especially those who want to reinvest some profits to grow the business rather than taking them all for personal use, the use of a limited company is probably a very wise move. The 19% rate of corporation tax is a real advantage in such cases and will make a difference to the bottom line. However, there are numerous issues to consider and because each business is unique it is important to speak to a qualified accountant and get specific advice.
