In good company when it comes to saving buy-to-let money

This article looks at the different tax rates that apply to individuals and companies, and also identifies some of the main points that should be considered in deciding whether to use a company “vehicle”. Where an individual owns a rental property, he or she is taxed to income tax on the net rental income, which means that a tax rate of up to 50 per cent can apply, depending on their other taxable income.

Generally, a company that invests in property would pay “small profits rate”, which means a tax rate of 21 per cent on annual profits of up to £300,000. This means a potential saving of up to 29 per cent, which could equate to a significant figure in the case of a sizeable property portfolio. However, as taxable rental income is after deducting the interest on any borrowings, the potential annual savings are reduced where the equity in the properties is relatively small.

When a company sells a property, the capital profit is generally taxable at 21 per cent rate, whereas an individual, who is a higher rate payer, pays capital gains tax (CGT) at 28 per cent, so again there is a potential saving to be had.

So far so good, but now comes the problem; with an existing property portfolio there are two potentially significant costs in transferring the properties into a company. Firstly, a stamp duty land tax (SDLT) charge at probably four per cent of the value of the properties, and secondly, there is a CGT disposal, with a likely tax charge at 28 per cent of the capital profit. Therefore, with properties that have been owned for many years the CGT is likely to be considerably more than for someone who has only recently been building up their portfolio.

For long-standing rental businesses the potential SDLT and CGT charges may be too costly to bear, but with a more recent start-up the costs may not be that great. Certainly, with someone now buying their first buy-to-let properties you do not have these stumbling blocks.

The tax savings on the annual rental income and capital gains are “retained” for as long as the company rolls up its profits.

However, if there is a requirement to “extract” profits from the company, then there is an exposure to income tax.

In order to minimise this charge you would generally look to pay a small part of this as a salary or bonus, with the balance as dividends.

There may also be some merit, if practical, to defer the taking of dividends until a later year, in the expectation of a lower marginal rate of tax, perhaps where an individual’s income has dropped following retirement.

Generally, the use of a company is most suited to the situation where the properties are intended to be owned long-term, with the profits to be rolled up and invested in further properties.

The rolled-up profits within the company become potentially taxable to capital gains tax on a winding-up of the company, but where it is intended to keep the company longer-term, perhaps with an intention that it will be passed on to children on death, then this potential tax charge can be largely discounted. Setting aside the tax issues, there are costs associated with the setting up, running and winding-up of a company, and these all need to be considered.

There are clearly many issues to be considered, both tax and commercial, before choosing to run a property investment business through a company, and an individual’s personal financial circumstances must be carefully factored into the calculations. As always, you are strongly advised to seek a professional opinion before making a decision.

David King is a tax consultant at Garbutt & Elliott, Leeds 0113 2739600 and York 01904 464100.