Business Premises: Tax Pros and Cons

Should You Buy Business Premises Personally?

A lot of company directors/shareholders choose to personally buy premises for their businesses because personal ownership has advantages over company ownership.

• Legal protection. If your business goes bust, the property may be safer from creditors in your own name – you and your company are separate legal entities.
• Income tax. Many directors/shareholders who personally own business premises get their companies to pay them rent. This is viewed as a tax-efficient way to get money out of the company. Unlike a dividend, rent is a tax deductible expense for the company and, unlike a salary, there is no national insurance on rental income, although income tax is payable.

Recently, a client contacted us, asking whether this conventional wisdom should perhaps be turned on its head:

I bought an office for my business a few years ago for around £300,000. Fortunately for me, I was able to buy it without a mortgage. Unfortunately for me, the property hasn’t risen in value. If I sold it today, I would probably make a loss once various selling costs were deducted.

The company pays me £12,000 a year rent. I pay tax on this income because I don’t have any mortgage interest to offset. I also take a small salary and dividend out of the company. The company has some cash which I’d like to get my hands on, but naturally I’d prefer to not pay any income tax if at all possible (eg by taking a bigger dividend).

Could I sell the property to the company as a way of getting my hands on the company’s cash? What are the short term and long term tax consequences?

I have not opted to tax the property for VAT purposes, and am not personally registered for VAT.

This strategy could allow a company director to extract a sizeable amount of tax-free cash from a company. However, there are lots of other tax and non-tax issues that have to be considered.

The short term tax consequences of selling your trading premises to your company include:

Capital gains tax. If a company owner sells a property to their company, the transaction is subject to capital gains tax. In this example, the owner has made a capital loss and so there will be no tax payable. The loss can be stored away and used in a future tax year: but only against any gains the owner makes on further sales of assets to the company!

Selling the property to the company might be less attractive if the property had risen in value significantly. The director/shareholder and the company are ‘connected persons’, so the basic rule is that the property’s market value would have to be used in the calculation.

However, in most cases, the director/shareholder could effectively avoid any immediate CGT charge by selling the property for a lower price and claiming hold-over relief for the difference. This relief effectively allows a lower sale price to be used and to still be effective for CGT purposes, but the relief is only available if the company is a trading company, the property is used in that trade, and the company is the property owner’s ‘personal company’.

Broadly speaking, a company is your ‘personal company’ if you own enough shares to give you at least 5% of the voting rights in the company.

Stamp duty land tax (SDLT). This is one of the biggest short-term drawbacks of selling your property to your company. SDLT at 3% will have to be paid if the property is worth more than £250,000. In this example, the property is worth around £300,000, so the total tax could be around £10,000.

Unlike CGT, the SDLT on a sale of property to your own company must be based on the property’s market value – there is no ‘hold-over relief’ for this tax!

The SDLT could be avoided or reduced by selling just part of the property to the company. If a share in commercial property worth no more than £150,000 is sold to the company, no SDLT will be payable.

However, selling the property to the company in stages over several years may not help you avoid SDLT, because you may fall foul of the ‘linked transaction’ rules: ie all the transactions would be combined for SDLT purposes.

Income Tax. If your company buys your property it will then owe you money. This can be paid out without any income tax or national insurance consequences. In this example, the director may be able to withdraw approximately £300,000 from their company completely tax free.

If the company doesn’t have enough cash to pay you the full amount in one go, the money can be taken out as and when it becomes available, even if this takes several years.

Mortgages. The reader in this case does not have any borrowings. If the property did have a mortgage attached, a significant proportion of the tax-free money paid out by the company may have to be used to pay off the original mortgage and the whole exercise could become a bit pointless. There may also be early redemption fees to pay.

While we are on the subject of company borrowings, it is important to point out that company owners can borrow money personally and lend it to their companies. The interest can usually be offset against the company owner’s other income: e.g. salary, dividends and interest.

For example, a company owner can borrow against their home, lend the money to their company, get their company to buy business premises, and all of the interest can be claimed against the company owner’s taxable income from all sources.

Longer-term implications

Rental income. The company now owns the property, so the director/shareholder can no longer be paid rental income, thereby losing a potentially tax-efficient income stream.

Rental losses. If this was your only rental property, the sale would effectively result in the termination of your property rental business. One probable consequence of selling your only rental property is that any rental losses carried forward from previous tax years are lost permanently.

Accumulated rental losses are very valuable – every £1 of losses is worth up to 60p in saved tax.

Selling the property. What happens if the property is sold in the future? Will the company pay less tax on any capital gain?

A few years ago, companies potentially paid a lot more tax on property capital gains than individuals. This is not necessarily the case any longer.

Individuals who are higher-rate taxpayers pay up to 28% capital gains tax. Companies pay corporation tax at 20% on up to £300,000 of profits. The tax rate then goes up to 27.5% (for 2011/12), but this rate will fall to just 23.75% from April 2014.

For individuals, the first £10,600 of capital gains are tax free thanks to the annual exemption. Companies, on the other hand, enjoy indexation relief. This is potentially much more valuable than the CGT exemption. In this example, indexation relief could easily shelter around £100,000 of the property’s capital gains from tax if it is sold in ten years’ time.

However, it is important to realise that any hold-over relief claim on the original sale of the property to the company will reduce the company’s deductible cost on the ultimate sale: and will also effectively reduce the indexation relief available as a consequence.

Although company ownership may produce a smaller taxable gain than personal ownership, it is important to point out that both companies and individuals can claim rollover relief when they sell trading premises and buy new trading premises to replace them. This may allow them to postpone paying tax for very long periods of time.

Selling the business. If you sell your company one day, you may be able to claim Entrepreneurs’ Relief if you also sell the trading premises that you own personally. This lets you pay capital gains tax at just 10%.

However, if the company has been paying you a full market rent, you may not be able to claim any Entrepreneurs’ Relief on the property (although some relief will usually still be available where you were renting the property to the company before 6th April 2008).

What happens if the company owns the property? If the buyer of the business wants the property included in the sale, you could sell your shares in the company and all of the proceeds may qualify for Entrepreneurs’ Relief.

However, an expensive property asset may put off prospective buyers who don’t need it (eg if the business being sold is not reliant on a specific property – think internet company rather than restaurant). In such a case, the property may have to be sold first with corporation tax payable on the capital gain and income tax paid when the money is extracted from the company prior to the sale.

More likely, the purchaser may not want to buy shares in such a company at all, and may insist on an asset purchase instead. Of course, this outcome remains a possibility whoever owns the property!

Other things you can do when your business property is owned personally include:

Borrow against it. Interest costs will generally be tax deductible against the rental income you receive from your company. If you borrow no more than the business premises original value when you first rented it out, you can even use the borrowed money for personal reasons. For example, the funds could be used to pay off personal debts for which interest is not tax deductible, e.g. a home mortgage.

Transfer it to a SIPP. Many property owners put their trading premises into a pension scheme. Future rental income and capital gains are then tax free.