Surely there must be a more tax efficient way?

by Readers Question

13:55 PM, 14th August 2019
About 2 years 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 Fact Find, expert analysis and a recorded video conference with your Property118 Consultant and your Accountant. Thereafter, our recommendations will be reviewed by Cotswold Barristers (at no extra charge). If they agree, and if you instruct them to complete the legal work to implement our suggestions, Cotswold Barristers will adopt our recommendations as their own professional advice, for which they carry professional indemnity insurance of £10,000,000 per claim. All consultations are confidential and you will be provided with a copy of the recording of the video conference. We GUARANTEE total satisfaction or a full refund.
  • Book a Tax Planning Consultation

  • 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 Fact Find, expert analysis and a recorded video conference with your Property118 Consultant and your Accountant. Thereafter, our recommendations will be reviewed by Cotswold Barristers (at no extra charge). If they agree, and if you instruct them to complete the legal work to implement our suggestions, Cotswold Barristers will adopt our recommendations as their own professional advice, for which they carry professional indemnity insurance of £10,000,000 per claim. All consultations are confidential and you will be provided with a copy of the recording of the video conference. We GUARANTEE total satisfaction or a full refund.
  • Book a Tax Planning Consultation

  • 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.

Comments

Mark Alexander

11:01 AM, 17th August 2019
About 2 years ago

Reply to the comment left by longbow at 17/08/2019 - 10:40
Hi Longbow

It's very difficult to say without a full consultation as to whether a structure of this nature would be applicable or economical for you. Each case is different and advice of this nature always needs to be bespoke rather than 'cookie cutter' templated.

Having said that, an initial consultation costs just £400 and comes with a guarantee of total satisfaction or a full refund, so you have nothing to lose if you make a booking. If we can't help you the process will cost you nothing. So long as you make the commitment we take the risk.

Just as a guide though, the solution for Wayne cost just shy of his first years tax savings, which is generally how Intellectual Property and this form of specialist tax advice and legal work is charged, subject to commerciality for the acting Barrister of course. If a person would only save let's say £20,000 a year in tax it might not viable for the Barrister. That said, it might be viable, it would very much depend on the complexity of the case, but we would establish that at the consultation stage.

Beaver

11:58 AM, 19th August 2019
About 2 years ago

Reply to the comment left by Craig M at 16/08/2019 - 10:09
They could: And creating a SSAS would enable them to diversify into holding rented commercial property (they didn't specify rented residential property) if they wished to. I suspect they would also be able to reduce profits by paying into pensions for their children either by paying into the same SSAS or into SIPPs. Both SSAS and full SIPPs can hold non-residential property subject to HMRC rules. A simple arrangement for example would be for their residential property "business" to rent an office from their SIPP or SSAS.

Beaver

12:00 PM, 19th August 2019
About 2 years ago

Reply to the comment left by Craig M at 16/08/2019 - 12:37
Who do you use to run your SSAS or did you set it up yourself?

Craig M

12:15 PM, 19th August 2019
About 2 years ago

Reply to the comment left by JJ at 19/08/2019 - 12:00
We used the services of SSAS Practitioner.com to help us set up our SSAS Pension, and continue to use their annual subscription service to ensure that everything we do, stays within the strict HMRC guidelines.

Beaver

12:18 PM, 19th August 2019
About 2 years ago

Reply to the comment left by Craig M at 19/08/2019 - 12:15
Thanks. That's helpful.

And are they trustees of your SSAS for their fee, or do you remain in control of your own SSAS?

Craig M

12:41 PM, 19th August 2019
About 2 years ago

Reply to the comment left by JJ at 19/08/2019 - 12:18
My wife and I are the only trustees and we complete the administration of our SSAS, however, we dont do anything without running past the team at SSAS Practitioner.com. Due to the fact that they have been supplying this service for many years, they have a complete range of guidelines/templates/processes that they ensure we use. When my wife and I were looking at the SSAS Pension marketplace we uncovered a lot of companies who offer a service, however, for us, we wanted more control over the administration of our own pension, but with guidance on everything we wanted to do - SSAS Practitioner.com give us exactly that.

Beaver

15:22 PM, 19th August 2019
About 2 years ago

Reply to the comment left by Craig M at 19/08/2019 - 12:41
That sounds good: I know there's an automatic tax charge (55%?) if you get things wrong. But that sounds as though you are in charge of the assets in the fund. Presumably you are in charge of the SSAS bank account or accounts as well, not the SSAS company.

Craig M

15:41 PM, 19th August 2019
About 2 years ago

Reply to the comment left by JJ at 19/08/2019 - 15:22
Correct.

icklebtl

22:26 PM, 6th September 2019
About 2 years ago

When we decided to get into property seriously, we set up a holding company for the reasons given in the article. However, we found finance almost impossible. This was the last straw in the list of things that ruled out different lenders (think of a game of "guess who" where after 4 questions there is no-one left!).

We switched tactic and made the SPV standalone. We each have our own Ltd Co's and do inter-company loans to the SPV to provide finance for purchases.

Our Ltd Co's are low risk - they are very unlikely to go bust. The OP's circumstances may differ.

With regards to SASS's for property. I thought this would be a good way to go. However, I've now back out of this for diversity reasons.

We look to maximise SIPP contributions and deliberately do non property investments (100% equity funds) with retained profit in Ltd Co. being loaned to SPV for residential property.

As an aside, if you have no earnings other than the £12,500 salary (dividends don't count for this purpose), have you looked into the "Starting Rate Band"? https://www.gov.uk/apply-tax-free-interest-on-savings

If you were able to personally lend money as a director to any of your companies for legitimate reasons and charge a commercial rate of interest for a unsecured loan then you may need to declare less dividends.

Mark Alexander

23:06 PM, 6th September 2019
About 2 years ago

Reply to the comment left by icklebtl at 06/09/2019 - 22:26
With the greatest of respect for what you have stated Graham, I think you are missing the point.

The purpose of the Holding Company is to allow dividends to flow out of the Operational Company without undue taxation and to disconnect risk.

The Holding Company can then make loans to the Property Company whether it is a stand-alone SPV or a wholly owned subsidiary.

At the “vanilla” end of the BTL Limited Company lending market then the stand alone SPV model will often be preferable to lenders. However, for larger businesses the corporate structure, whereby the SPV’s are wholly owned by the Holding Company, is often preferable.

It’s “horses for courses” and there will never be a ‘one-size-fits-all’ structure. Bespoke advice is necessary in all cases. The purpose of this article was to raise awareness of what can be achieved, not to act as a manual for every possibility.

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