Surely there must be a more tax efficient way?

by Readers Question

13:55 PM, 14th August 2019
About 4 months ago

Surely there must be a more tax efficient way?

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Surely there must be a more tax efficient way?

In a nutshell; my wife and I own a trading company which produces profits of circa £200,000 a year. The company pays corporation tax on these profits. We each draw a salary of £12,500 (which is tax free) based on advice from our accountants.  We then declare £37,500 each of dividends, on which we pay dividend tax of a further 7.5%.

Profits have been constant at this level for many years, which has resulted in us accumulating in excess of £500,000 of cash within the company.

We have now decided we would like to invest this cash into building a portfolio of rental properties, to plan for our retirement and to eventually leave a legacy for our children.

FIRST PROBLEM

We cannot find a buy-to-let lender willing to lend to a trading company. Even if we could, I’m not certain we would want to amalgamate the very different risk exposure of both businesses, which I suspect is also the angle the buy-to-let mortgage lenders are coming from.

SECOND PROBLEM

If we take the money out of our trading company to invest into property we will have to pay dividend tax of 32.5% each on the next £50,000 a year. If we take more than £50,000 we also start to lose our nil rate band tax allowances. If we take more than £150,000 then we will pay dividend tax of 38.1%.

THIRD PROBLEM

Our rental property business will be taxed on a fictitious level of rental profits, because we cannot treat finance costs as expenses in the same way as every other UK business can.

FOURTH PROBLEM

The fictitious level of rental profits we will be taxed on will result in our taxable incomes exceeding £100,000 a year, even if the property rental business makes losses in real terms in the first few years. The effects of this also takes us into the territory whereby we start losing our nil rate band tax allowances.

FIFTH PROBLEM

When we die and leave everything to our children, the net value of our estate, including any capital appreciation in the properties we have invested into, will be taxed yet again at 40% in the form of Inheritance Tax!

Is there a better way? Surely there must be? !!!

Thanks

Wayne

RESPONSE FROM THE PROPERTY118 TAX TEAM

Dear Wayne

Do not despair, there are solutions to every one of the challenges you have correctly identified. Please book a tax planning consultation with us so that we can tailor a bespoke plan for your needs.

Show Form To Book A Tax Planning Consultation
Consultations include new client compliance checks, fact find via email with complimentary software, expert analysis, a detailed written report and recommendations and a 30 minute Q&A session via Skype or telephone. We GUARANTEE total satisfaction or a full refund.
  • Please provide an overview of your circumstances and what you are looking to achieve.

The following is a very simplistic overview of some potential solutions:-

  1. Tax relief exists for you to be able to transfer your trading company shares into a Holding Company
  2. The Holding Company can then form an SPV property company “PropCo” as a subsidiary, which will meet the lending criteria of far more buy-to-let mortgage providers. Some mortgage brokers will tell you this can still cause problems with lenders. This is true in part, but established commercial finance brokers will have relationships which go beyond “computer says no!” – we are happy to make introductions as required.
  3. PropCo will not be affected by the restrictions on finance cost relief you so eloquently described above
  4. Your Holding Company will receive dividends from your Trading Company without deduction of any tax
  5. You may continue to declare dividends for your personal use and to utilise your basic rate tax bands as you are now
  6. The balance of funds held in your trading business can be transferred into your Holding Company
  7. Funds in the Holding Company can be loaned to its PropCo subsidiary without tax consequences. Accordingly, 100 pence in every £1 of funds currently retained in your trading business PLUS all future dividends declared by your trading business could, if required, be re-deployed into your PropCo
  8. The risks associated with PropCo failure are substantially mitigated in terms of impact on your trading company, in that PropCo losses would be restricted to the dividends you would have invested into property in any event. Your shares in your trading company would be ring fenced.

Associated IHT and legacy planning

The shares in the Holding Company could be split into two share classes.

You would hold the dividend and voting rights in the A shares. It would be these shares which would be exchanged for shares in the trading company.

A second class of B shares would have no immediate capital value other than their face value of say £100. Neither would these B shares have any automatic dividend or voting rights.

The B shares could then be transferred into a Discretionary Trust for the benefit of your children.

After doing this, the A share value of the holding company could be frozen using a Freezer Shares structure.

The company rules could be amended to attribute all future growth in share values to the B shares (Growth Shares).

When you die, it would only be the A shares which would form part of your estate for IHT purposes. This is because the B shares would sit outside of your estate, within the Discretionary Trust. Accordingly, the capital appreciation within your property portfolio would not be factored into the value of your estate for IT purposes. Likewise for any capital appreciation in the value of your trading company shares.

Protecting your legacy for your bloodline only

A formal ‘letter of wishes’,  provides rules for trustees of a Discretionary Trust to follow. This can be drafted in such a way so as to ensure that only your nominated beneficiaries and their bloodline can benefit from the trust. Also, and very importantly, the value of the trust is only ever distributed in the form of loans to beneficiaries, repayable on their death. These loans, whilst they are outstanding, also accrue interest at 2% per annum so that the value of assets keeps pace with the Bank of England annual inflation targets.

A practical example

One of your beneficiaries gets married and wants to buy a house. The trustees agree to make a loan of say £500,000 to help with this. Your beneficiary and spouse then have children. However, after a few years the couple decide to get divorced. The spouse wants half of the value of the house, which the Courts may well agree should be the case, but the debt to the trust, plus accrued interest, needs to be factored into the settlement figure. Accordingly, the entitlement of the divorcing spouse is significantly reduced.

Years later the beneficiary dies and his/her assets are valued for probate purposes. Yet again, the debt to the trust needs to be factored into the net value of the estate, not forgetting the accrued interest of course. This serves as financial salvation to your bloodline!

The above is not to be constituted as professional advice.

In all cases such as this, we defer to our Legal Counsel, Mark Smith at Cotswold Barristers to amend as necessary and adopt our suggestions as his own professional advice, which is then covered by his £2,500,000 professional indemnity insurance with Bar Mutual.

The fees for all fully insured personal advice and legal work to implement a structure of this nature are typically less than the first years savings on Dividend Tax (assuming £100,000 of dividends being used for reinvestment into PropCo in year one).

Show Form To Book A Tax Planning Consultation
Consultations include new client compliance checks, fact find via email with complimentary software, expert analysis, a detailed written report and recommendations and a 30 minute Q&A session via Skype or telephone. We GUARANTEE total satisfaction or a full refund.
  • Please provide an overview of your circumstances and what you are looking to achieve.

Landlord Tax Planning Consultancy is the core business activity of Property118 Limited (in association with Cotswold Barristers).

Professional advice from a qualified Barrister-At-Law, insured up to £2,500,000 per claim.

There will never be an optimal ‘one-size-fits-all’ business structure for tax purposes. The presentation below provides a useful overview of some of the options you might like to discuss with us.

Show Form To Book A Tax Planning Consultation
Consultations include new client compliance checks, fact find via email with complimentary software, expert analysis, a detailed written report and recommendations and a 30 minute Q&A session via Skype or telephone. We GUARANTEE total satisfaction or a full refund.
  • Please provide an overview of your circumstances and what you are looking to achieve.


Comments

Anon

14:45 PM, 14th August 2019
About 4 months ago

Would PropCo be affected if Trading Co went bust?

Mark Alexander

14:48 PM, 14th August 2019
About 4 months ago

Reply to the comment left by Anon at 14/08/2019 - 14:45
If Trading Co went bust then PropCo wouldn't receive any more dividend income from it, but that is the limit of the effects.

PropCo would continue unaffected, because Trading Co does not own its shares. Likewise, if PropCo went bust, Trading Co would be unaffected.

This is why PropCo's and Trading Co's shouldn't be subsidiaries of each other, hence the suggestion of the Holding Company between the two.

Mark Alexander

16:02 PM, 14th August 2019
About 4 months ago

The following question has just been posted on Facebook ...

"Why not lend money from the trading company directly to the property company?"

The answer to this is along much the same lines as my answers to Anon's question, i.e. if the trading company went bust its creditors would have a claim against the property company in regards the loans made to it. This is avoidable by using the recommended structure in the main body of the article above.

Craig M

10:09 AM, 16th August 2019
About 4 months ago

Hi Mark
As part of "planing for our retirement" could they also consider the creation of a SSAS Pension aligned to the PropCo SPV ?

Mark Alexander

10:14 AM, 16th August 2019
About 4 months ago

Reply to the comment left by Craig M at 16/08/2019 - 10:09
They could indeed, but their preferred asset class is residential property, so it’s not a good fit in this instance

Mark Alexander

10:16 AM, 16th August 2019
About 4 months ago

Reply to the comment left by Craig M at 16/08/2019 - 10:09
However, if they decide to invest into commercial property the SIPP/SSAS route could be extremely tax efficient for them

Craig M

12:37 PM, 16th August 2019
About 4 months ago

Reply to the comment left by Mark Alexander at 16/08/2019 - 10:16
My thought process for the SSAS was twofold really :
1 - They could make maximum pension contributions from the PropCo into their SSAS Pension - growing the pension fund
2 - The SSAS pension could offer "loanbacks" to PropCo at agreed/approved interest rates - when, paid back, the interest paid is deductible from a corporation tax perspective and is non taxable when paid back into the pension. PropCo can then purchase investments, to which a residential purchase would be allowable. "Rinse and Repeat" annually.
This what what my wife have done with our SSAS - making sure to stay within the HMRC guidelines.

Mark Alexander

12:45 PM, 16th August 2019
About 4 months ago

Reply to the comment left by Craig M at 16/08/2019 - 12:37
I like it!

Mark Alexander

8:18 AM, 17th August 2019
About 4 months ago

Reply to the comment left by Craig M at 16/08/2019 - 12:37
I have sent you an email Craig

longbow

10:40 AM, 17th August 2019
About 4 months ago

Absolutely fantastic reply to the exact situation I find myself in!

I'm not on the same level as Wayne, my trading company probably has £100,000 to invest into property each year. Would this tax/company arrangement work for someone like me? Or would the cost of setup be more then it would save?

(Roughly, what would you expect to pay for such advice, and arrangements)

Thanks so much!

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