Possible tax pitfalls of owning property outside of a company
Despite continuing uncertainty in the UK market, property remains an attractive investment for many. But there is no one-size fits all approach to investing in property. Instead, the right method should be carefully considered in order to avoid unexpected and unwelcome costs down the line, and there are pros and cons to owning property personally and through a company.
What are the ownership options?
As with any commercial venture, tax treatment should not override the basic commerciality of the transaction. The importance of the limited liability afforded by a company is therefore high on the list of priorities even before we get to tax matters. The exposure of unlimited liability on any form of claim against the owners is undesirable, but can, to a certain extent, be mitigated by insurance. Still, it is a vital consideration when deciding on structure.
If a property is owned by multiple individuals, formalising that shared ownership by establishing a company provides for a more flexible ownership structure. Where a company structure is not used, each joint owner must reflect their share of ownership in their income and gains arising from the property. In a company, however, shareholdings can be used to alter underlying ownership more easily, make use of dividends on different classes of share to vary income payments, and separate the control of the property business from the ownership through the use of non-voting shares.
The Tax Treatment
Turning to tax considerations, the rate of tax on rental profit (that is rental income less expenses) is the owner’s individual marginal rate of tax. So, a higher rate or additional rate taxpayer would pay tax at 40% and 45% respectively. In contrast, a company would currently pay corporation tax on rental profit at 19%, potentially rising to 25% dependent on profit levels from 1st April 2023.
Similarly, capital gains on residential property would be taxed at 28% for a higher-rate taxpayer, against the same corporation tax rate as above. It should be noted, however, that gains on commercial property (20%) or gains within the basic rate band for an individual (18%) would be at a lower rate.
Of course, there are also potentially further tax charges on extracting profit or gains from the company that should be considered when deciding on ownership structure.
What else needs to be considered?
Another potential pitfall of owning property outside a company structure is that relief for loan interest payments on loans taken out to acquire residential property are restricted for individual owners to a basic rate of 20% only, whereas previously relief had been available at the marginal tax rates above. Within a company, relief is given at the full corporation tax rate.
For highly geared residential property portfolios, or where property is held for a considerable length of time, perhaps through generations of family ownership, this can make a significant difference in overall returns. Note that for very large property groups with significant borrowing (an interest expense of more than £2 million), a corporate interest restriction may also apply.
There may also be VAT issues to consider. Income from, and sales of, residential property are exempt from VAT. Commercial property is also usually exempt, unless a notice to waive exemption, otherwise known as an option to tax, is made, which brings the income and sales of such properties within the VAT regime. If you individually register for VAT in order to opt to tax, it brings any other supplies you make as an individual, such as from self-employment, within the scope of VAT, even where you may have previously been under the registration threshold.
On a less widely applicable but still worthwhile point, individuals who are non-domiciled in the UK have historically been able to shelter from inheritance tax by owning UK property through an offshore company. Whilst this no longer provides any exemption from tax for residential property, it does still afford some protection in relation to commercial property, which would not be available if the property was owned directly by the non-domiciled individual. The structure would have to be set up before any intention to reside in the UK due to certain anti-avoidance rules.
Clearly then, there are a number of potential pitfalls arising from owning property outside of a company, though it should not be overlooked that there are also issues around company ownership, such as annual tax on enveloped dwellings (ATED) and double tax on extraction. Each case needs to be looked at on its own facts and the intentions and tax profile of the owners, so that tax planning advice is taken accordingly.