Our briefing property investments – what’s the best ownership structure? sets out the factors to be considered in deciding whether to hold a property investment directly or via a company. Perhaps you’ve concluded that the company route sounds like the better option for you. But if you already hold a property investment or a portfolio of properties, there will be tax consequences to transferring ownership to a company. In this briefing we highlight the main tax areas to be addressed.
You will need to draw up legal documentation to transfer the property to the company: if necessary we can introduce you to property lawyers we have worked with to carry the legal process through.
Simple sale
One option is to sell the property to the company for its market value. This is a disposal for the purposes of Capital Gains Tax (CGT). The tax payable will depend on your income for the tax year and what other gains you have made in the year; but in most cases you can assume that the CGT charged will be 28% of the difference between the value of the property when you transfer it to the company and its “base cost” to you (that is, the original cost to you or, if you owned the property on 31 March 1982, its value on that date). The company is then treated for the purposes of any subsequent disposal it may make as having acquired the property at its market value as at the date it acquired it from you.
If the property is subject to mortgage debt the transfer will require the consent of the lender. It may be possible for liability for the debt to be taken over by the company; more likely it will be necessary for the company to enter in fresh arrangements to re-finance the property with either the existing lender or another lender. But it is important to understand that for CGT purposes the disposal is regarded as taking place at market value, regardless of the amount of the cash released (or not released) to you as a result of the transfer.
Normally, the result of the transfer will be that you will be left as a creditor of the company with a balance on your “loan account” equal to your equity in the property (that is, the market value of the property minus the amount of any debt taken over by the company). You will be able to draw down that debt from the company in the future without paying any further amount of tax until such time as the debt due to you from the company has been extinguished. This will usually be a more tax-efficient way of taking future profits out of the company than payment of salary, bonus or dividend.
Stamp Duty Land Tax (“SDLT”) will need to be considered. Although in principle SDLT will be due on the market value of the property transferred, the usual reliefs and exemptions will apply and it may be possible in the right circumstances to procure that that transfer can be made without any charge to SDLT at all.
Sale for shares
Significant CGT advantages are usually available if your property portfolio is regarded by HMRC as a “business” and it is transferred to a company in exchange for shares (“incorporation relief”). In that case:
- No capital gain is recognized on the disposal
- You are treated as acquiring the shares for a cost equal to the “base cost” of the properties
- The company is nonetheless treated for CGT purposes as having acquired the properties for their market value as at the date of transfer – there is effectively a tax free “step-up” in the “base cost” for tax purposes
- But, unlike a simple sale, a sale in exchange for shares does not create a “loan account” on which you can draw down future company profits without additional tax charge
Importantly, this treatment is available only if your property investment activity meets the criteria to be described as a “business”. Essentially this requires that you undertake a reasonable amount of time and effort in managing the portfolio, but there are no hard-and-fast rules. At one extreme a single property let on a tenant’s repairing lease is unlikely to constitute a “business”; at the other, an actively managed portfolio of a dozen properties, perhaps with in-house maintenance and/or office staff employed to collect rents and manage the lettings would be very likely to qualify. Fortunately it is usually possible to seek HMRC’s advance agreement to the availability of this valuable relief.
The SDLT position is unaffected by whether CGT incorporation relief is available: as with a sale, the usual reliefs and exemptions will apply and it may be possible in the right circumstances to procure that that transfer can be made without any charge to SDLT at all.
Disincorporation
Different problems arise if you have a portfolio of properties in a company and you want to dismantle the corporate structure and hold the properties direct.
Usually, the most appropriate way to close down a company and extract the properties will be to liquidate the company. In the past it was often possible to achieve the required result by using an HMRC extra-statutory concession – a so-called “informal liquidation”. But that option hasn’t been widely available for some time; so in most cases closing down a company which has significant value in it will involve the hassle and expense of appointing a liquidator. Although we at BKL are not ourselves liquidators we can certainly if need be introduce you to liquidators we have worked with and trust.
In tax terms, there will be two levels of disposal when a company is liquidated and passes its assets to shareholders. At the company level, the company will be treated as disposing of all of its assets at market value, and any resulting capital gain will be charged to Corporation Tax (at 20%, dropping to 18% from April 2020) – or, where a non-resident company owning certain kinds of residential property is involved, to CGT at 28%.
At the shareholder level, shareholders will be treated as disposing of their shares, this time for a consideration equal to what they actually receive in the course of the liquidation (including the value of any properties passed out in kind, net of any mortgage liabilities taken over). Shareholders are likely to pay CGT at 28% on any significant capital gains, though any non-UK resident shareholders may not always be liable to UK CGT.
One crumb of comfort is that Stamp Duty Land Tax will not normally be due on the value of property passed out to shareholders in the course of a liquidation except to the extent of any mortgage debt assumed.
There is very limited scope for mitigating capital gains at the company level. For completeness, we should say that in 2013 the government introduced a very limited statutory “Disincorporation Relief”: unfortunately it will virtually never apply to the disincorporation of a property business. Opportunities at the shareholder level are a little greater: phasing disposals over a number of years might for example result in a lower rate of tax; so may gifting shares between husband and wife (or between civil partners); and if you are winding up a company at the time at which you are permanently leaving the UK to retire overseas there may be scope to avoid UK CGT altogether (though you may need to be careful about taxes in the country to which you are retiring). It is however fair to say that “disincorporation” can be a tricky and expensive exercise: it’s worth bearing in mind when you are contemplating operating through a company that transferring a business to a company can in practice turn out to be pretty much a one-way street.
For more advice on the consequences of transferring an existing portfolio to or from a company please contact your usual contact partner.