The Perils of the Property Company
It’s surprising how a seemingly innocuous structure for holding property can have us shivering with horror as tax advisers. One such is the parallel property holding company.
The structure look likes this: a trading company occupies business premises, be they offices, a factory, or land. Another company, which is not part of the same group as the trading company, but is owned by the same shareholder or shareholders, owns those business premises, and rents them to the trading company. This may have been set up for excellent commercial reasons: for example, the wish to keep the valuable property at arms length from the trading company, and therefore “safe” from liabilities. But if the arrangements have been set up like this, no matter how good the commercial motivation, what you have ended up with here is a tax nightmare.
For a start, you have deprived the property of business property relief from inheritance tax. This means that, if the shareholder of the two companies dies, the full value of the property, as represented by his shareholding in the property company, is chargeable to inheritance tax at 40%.
If, instead of holding the asset in the parallel property company, it had been held as an asset of the trading company, or other holding company which owned the trading company, the relief would have been at 100%, in other words there would have been no tax on this value at all.
Even owning the property individually, outside the limited company “wrapper” would be eligible for business property relief, although this is even if only at 50%.
Capital gains tax
The drawbacks of these arrangements from the CGT point of view represent a “double whammy”. Firstly, the property itself is treated as if it were nothing to do with the trade, because it has been separated out in a different company which is not part of the group. So there would be no chance of getting entrepreneurs’ relief on selling the asset (companies don’t get entrepreneurs’ relief anyway) and, also, you have forfeited any chance of getting “rollover relief”. Rollover relief applies where you sell an asset that you have used for the purposes of a trade and you buy another one within a set timescale. The tax on the sale of the old asset doesn’t arise, but is rolled over into the cost of the new. But to get this relief it needs to be treated as a trading assets, and the fact that in our example the property is being used by a closely associated company for its trade cuts no ice at all. So rollover relief is out if you do things this way.
The shares in the company itself, also, don’t qualify for entrepreneurs’ relief. So, if you sell the property company (which a purchaser might want to buy because it saves him stamp duty land tax) or, alternatively, if the company sells the property and you then wind up the company, you are fully taxable on the proceeds without the benefit of entrepreneurs’ relief – even though the property was an integral part of a trade you carrying on through the trading company.
The holding company alternative
If what you were thinking of was protecting the value of the property from the trade, why not have it in a holding company, rather than a parallel property company? The tax disadvantages we’ve mentioned miraculously disappear if you do it like this. Because the property is now within the same group structure as the trade, it gets all the benefits of trading treatment which there are in the tax code, including inheritance tax business property relief at 100%, entrepreneurs’ relief on any disposal of the shares in the company, and rollover relief if the premises are sold and replaced by others.
The one part of this idea to make us scratch our heads as tax advisers, though, is the possibility that, by holding the property in a company at all, you are potentially increasing the tax burden on any ultimate sale of that property. This is because, whilst companies get indexation allowance against capital gains on sale of assets, and the resultant reduced gain is only taxed at 20%, there is a second layer of personal tax on getting the money out of the company.
Parallel property LLP
So how about considering a similar arrangement to the one we have execrated above, but making the property holding entity a limited liability partnership (LLP) instead of a limited company?
The only potential downside, you might think, is inheritance tax, because the property should still be eligible for versions of entrepreneurs’ relief and rollover relief from CGT. Holding the property outside the trading company, though, which is what we are advocating here, still reduces your available rate of business property relief to 50%. (There is even a Revenue argument, which tax advisers cannot quite believe they are serious about, that the rate of relief is actually nil.)
There are two particular points to watch with the parallel LLP route which do relate to CGT, though:
- You should avoid, if possible, paying any rent from the trading company to the property LLP for the use of the property, or if for any reason rent is unavoidable, try to minimise this as much as possible. This is because, in the event that you sold the company and the property together, your entrepreneurs’ relief on the property part of the deal will be restricted to the extent that you have paid rent – goodness knows why.
- If the company is also a member of the LLP, which could be a useful structure in order to enable the company to fund the LLP, there could be a knock on effect on the status of the company’s shares. Since March 2015, companies which are members of LLP’s are treated as conducting an investment business, which could endanger the company’s whole status as a trading company for entrepreneurs’ relief.
A trading LLP
These issues would not arise, or could be avoided, if it was the LLP itself that was carrying on the trade. You could have a “holding LLP” above the trading LLP, to own the property. The danger here is that the profits of the LLP would be subject to a higher rate of tax, though, because the individual members would pay income tax rates on their profit shares. There may well be ways to get round this, but these need to be carefully thought through.