One of the most common questions that we are asked when discussing UK property investment is whether it should be done with the use of a company or trust.
Here we will take a brief look at the possible benefits and drawbacks of using such a structure instead of simply buying a UK property in your own name. The correct route forward for each person will depend on their own specific circumstances and future plans, and we strongly suggest that you speak to us before making any decisions, but the below provides an overall summary of the likely relevant considerations.
Companies
It is possible to set up a company through which your properties can then be purchased.
That company can be structured in various ways, with different types of company shares conveying different rights (such as right to rental income, right to capital value or voting rights/control).
The correct structure will depend on your circumstances and what you are looking to achieve.
Benefits of owning UK property within a company:
1. Full deduction of mortgage interest, as opposed to basic rate credit
It was previously the case that mortgage interest was a deduction from rental income when calculating UK Income Tax due. This was abolished and replaced with a credit at basic rate for interest paid, meaning a reduction in interest relief for higher rate taxpayers.
If a company owns rental properties then it may still deduct interest from income before accounting for profit.
Clearly this is only particularly relevant if you are a higher rate taxpayer, which is most likely to happen if you move to the UK and work.
2. Lower tax rate on rental income
Corporation tax rate is only 19% for companies whose profit is GBP 50k or below.
Your personal top rate of tax could be as high as 47%, depending on your level of UK taxable income.
3. Potentially no IHT on your death in relation to the assets owned by the company
As an example, the structure of the company can be such that ownership of the capital value of the properties could be held within shares owned by your children. The shares owned by you could convey the right to a) control of the properties and b) income from the properties. Alternatively, you can have shares which contain the current value of your properties but your children can hold shares in which the value growth of the properties accrues.
Given that division of rights, on your death there would be no IHT to pay as the value of the properties had already been passed to your children when the properties were transferred to the company. If that transfer happened more than 7 years prior to death then there would be no IHT to pay. Contrast that to passing away whilst yourselves owning the properties, in which case their value could be fully subject to IHT at a 40% rate.
4. Simplified Succession
If the properties are owned by a company, there is far less admin to be done when you pass away, as the properties simply continue to be owned by the same entity (though certain shares in that entity may at that time pass according to your will). The lack of needing to involve Land Registry and any mortgage providers etc could make probate far smoother.
Downsides of owning UK property within a company:
1. Mortgages can be more problematic and expensive to source.
2. Cost of company setup and maintenance can be significant
You will almost certainly have to hire a firm to carry these task out for you, which will involve an initial outlay and then annual tax return and record-keeping costs.
3. Taking profits out results in double taxation
Should you wish to take profits out of the company, those profits would be paid out in the form of taxable dividends. Clearly the profits would already have suffered Corporate Income Tax, hence the mention of double taxation.
Of course the profits could instead be left to build within the company, possibly enabling it to invest in further property in the future. Ideally you would not want to use the profits to pay down mortgages of course, as with the interest being fully deductible it makes sense to stay as leveraged as possible.
4. Annual Tax on Enveloped Dwellings
There is a tax to pay annually by any company which owns property valued at 500k GBP or more, though an exemption exists for properties let out on a commercial basis.
Property value | Annual charge |
More than £500,000 up to £1 million | £4,400 |
More than £1 million up to £2 million | £9,000 |
More than £2 million up to £5 million | £30,550 |
More than £5 million up to £10 million | £71,500 |
More than £10 million up to £20 million | £143,550 |
More than £20 million | £287,500 |
Note that the property values above are applicable per property and not in respect of the total value of properties owned by a company. Hence, it is possible for a company to hold many lower value properties without ever being liable to this tax.
Crucially however, there is relief from this tax for those who are letting out the relevant property as a business (and not to family members). The property will still need to be reported to HMRC, but the above tax amounts should be avoidable in such circumstances.
5. Higher Stamp Duty on purchase
In England and Wales, a purchase through a company is always subject to the higher stamp duty rate (typically an extra 3%).
In Scotland, the stamp duty payable buy a company when purchasing a property can be higher than is paid by individuals.
6. No personal allowance
For property owned by individuals, it is possible for rental income to fall within their personal allowance and so pay little or no tax. For companies, every bit of profit is subject to corporation tax with no such personal allowance
Existing properties:
It should be noted also that there are further disadvantages if considering transferring properties that you already own into a company, and so it would generally be advisable to set up the company and carry out your property purchases through it.
a) Capital Gains Tax on each property transfer into your company
Typically you will be liable to pay tax on any gains, based on the purchase price of each property in comparison to the open market value of the same property when transferred to the company.
b) Stamp Duty will be payable on each property transfer to company
As the transfer of property into a company is effectively a purchase by the company, stamp duty will be payable
Trusts
A trust is an arrangement whereby the settlor (you) transfers assets to a trustee, who then must administer the assets for the benefit of the beneficiaries. A trust basically splits the ownership of an asset in two, with legal ownership passing to the trustee and beneficial ownership passing to the beneficiaries.
Trusts can be created during your lifetime or by your will on death, with the latter being very common as a way to maintain some control over how assets are handled after death.
It should be noted that in recent years the use of trusts to own properties has become less tax efficient than it once was.
Advantages of a Trust
1. Trusts, unlike companies, can remain completely private.
2. Inheritance Tax can be mitigated by lowering the value of one’s estate during life
The transfer of assets into a trust can be either a Potentially Exempt Transfer or a Chargeable Lifetime Transfer. If it amounts to the former, the asset will fall outside of your estate fully once 7 years have passed since the time of transfer. If it is the latter, Inheritance Tax can be chargeable immediately and ona periodic basis.
Transfers into what is known as a Bare Trust are generally PETs, whereas transfers into Discretionary Trusts can be Chargeable. Put very briefly, Discretionary Trusts are typically those in which the beneficiaries can be amended after the trust is established, whereas Bare Trusts are those in which the eventual beneficiaries are set in stone.
3. Trusts can be used to safeguard ownership of an asset (eg for the benefit of children) from spouses, ex-spouses or creditors.
4. Property within a trust need not go through the probate process on your death
Disadvantages of a Trust
1. Higher tax rates on rental profits
Rental income can be taxed at 45%
2. No personal allowance to mitigate tax on rental income
3. If the trust is discretionary, immediate and periodic Inheritance Tax can be due
This area is complex, and will not be covered in full in this article. Suffice to say for now that if you are dealing with a property valued at £325k or more, the use of a discretionary trust may be more costly and problematic that you would like.
4. The cost and complexity of maintaining a trust should not be underestimated
5. Smaller CGT annual exemption compared to individuals
Conclusions
For those who intend to generate rental income from a property or properties, and are looking for the best structure in which to do so, a trust will not generally be in consideration. The decision currently lies between whether to use a company or not, with a trust not likely to be suitable.
If your marginal UK Income Tax rate is high (45% or 47%), you would then be far better from an Income Tax perspective having your rental income passing into a company and taxed as profit (19% instead of 47%), after deducting full mortgage interest (instead of getting a basic rate credit). The resultant annual Income Tax Saving must be weighed against the costs of establishing and running such a structure.
If you wished to be able to easily pass ownership of your properties to your children over time, and especially whilst they are minors (which would be impossible if owning them directly of course), then moving the properties into a company could be highly useful. You could then make Potentially Exempt Transfers (7 year clock) as and when you wished, or could simply ensure that all growth on the properties falls immediately outside your estate for tax purposes. This can be done whilst maintaining a fair degree of flexibility without triggering immediate and ongoing IHT charges (as can happen when using a trust)
If you envisage properties staying in your family across generations, the ease of ownership transfer that the company would bring could be highly useful and could save considerable sums in IHT over the years
For those who wish to simply protect an asset and ensure that it is passed to future generations, and who are looking to mitigate Inheritance Tax on a property or properties, trusts may come into consideration. Additionally, it is very easy to incorporate the establishment of certain types of trusts into a will, which can enable people to avail of some IHT planning and asset protection strategies without the need for immediate and ongoing cost during their own lifetime.
As you may expect, there is no one correct answer. Speak to us so that we can help you establish which approach would suit your circumstances and goals.
Chartwell Associates
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