Lee Sharpe continues his series of articles on transferring property down to the next generation.
In the first two articles, we looked at some of the key tax aspects of transferring property owned directly. In this third and final article, I’ll look at how things change under corporate ownership.
Practically speaking, using a company as the ‘wrapper’ for their property portfolio should make it much easier for the landlord to manage the transfer of wealth to their children, usually by way of gifts in small stages over a number of years. This should, in turn, mean that the landlord (and potentially their spouse or civil partner) can make the best and repeated use of their annual capital gains tax (CGT) exemptions, inheritance tax (IHT) nil-rate bands, etc.
What do YOU own?
A company has its own separate legal identity; so even if I own 100% of a company’s issued share capital, I do not actually own the company’s assets. The shares nevertheless represent an interest in the value of the company; the more net wealth is in the company, the more valuable the shares.
Given that the assets being transferred are shares rather than a direct interest in bricks and mortar, etc., then:
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If I transfer the shares and make a capital gain, it will be taxable at the ‘normal’ 10% and 20% rates of CGT, rather than the 18% and 28% CGT rates on residential property disposals.
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If the company itself makes a capital gain (for example, by selling a property it owns), it will be taxable at the standard corporation tax rate applicable for that level of taxable profits and gains in aggregate:
Taxable up to £50,000 19.0% (new small profits rate)
Taxable from £50,001 - £250,000 26.5% (new marginal rate)
Taxable £250,001 and above 25.0% (higher main rate)
Those rates apply irrespective of whether the company is disposing of residential property (which could be exposed to CGT at 28%, if held personally).
Most companies issue a single class or type of share (typically £1 ordinary shares), with each share having the same rights and powers as the next. But there is a very simple trap here, to do with control.
Controlling interests: When is 2% worth a LOT more than 2%?
If I own 49% of a company worth £1m overall, and my co-founder Donald holds the other 51%, then on simple maths, his 51% holding should be worth only slightly more than my holding of 49%. But Donald’s voting rights are sufficient to secure control of ‘our’ company and I will, in most circumstances, have to follow the majority decision (i.e., whatever Donald decides).
We say that Donald’s 51% controlling interest carries a premium because it is actually worth much more than 51% of the underlying value of the company. It could be worth (say) £600,000.
But my 49% interest should therefore be discounted because it is actually worth quite a bit less than 49% of the company. Generally, the smaller the interest, the heavier the discount. My 49% holding might be worth just £400,000.
In an OMB company scenario like Donald’s and mine, involving large blocks of shares, the 2% voting power separating us is generally worth a lot more than a simple 2% of the overall company value.
IHT and the ‘loss to donor’ trap
The idea that the transfer of only a small number of shares can result in a large change in the value of the resulting shareholding is particularly important for shares and IHT. For example, Donald might hope to significantly reduce the value of his estate and potential IHT exposure by transferring just a 2% holding in our £1m company to his adult son, Dewey. This would reduce his holding from a 51% controlling stake to a 49% interest, similar to mine.
There is nothing wrong with this from a tax perspective; an outright gift from one individual to another will be a potentially exempt transfer, with no IHT due so long as the donor survives the gift by at least seven years. But if Donald were to die (say) just two years later, his lifetime gift would be included in the IHT calculation on death and would reflect the fall in value of his estate on making the gift.
Simply re-using the figures above, the value of that lifetime gift for IHT purposes:
- is NOT just 2% x £1million = £20,000; and
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is more like £600,000 - £400,000 = £200,000.
As per my first article in the series, Donald would potentially have been exposed to CGT when giving the shares to Dewey, and IHT might later turn out to be due on that same transfer if Donald were to die within seven years. This issue applies to company shares as well as to a transfer of property or other assets generally, but it is particularly acute when giving away a controlling interest in the company, even when only a small percentage of shares is being transferred.
Stamp duty
Readers will be familiar with the imposition of stamp duty land tax (SDLT), and its devolved equivalents in Scotland and in Wales. Shares are not subject to SDLT but to stamp duty at a rate of just 0.5%.
In broad terms, stamp tax exposure is typically less of a concern when dealing with shares rather than property itself (see the previous article in the series for more on SDLT and gifts).
Where is the capital gain on incorporation hiding?
If the director shareholders had a pre-existing property portfolio that they transferred to the property company, there will usually have been a capital gain on the incorporation of that business. There are several routes, each of which has potential benefits and penalties:
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The landlords may have claimed incorporation relief from CGT – the company acquires all the assets of the property business at their current market value while the gain is postponed (‘held over’) in the value of the shares. This, in turn, means:
- when the company disposes of an ‘old’ property asset owned by the landlords, the company will have only a small capital gain on the uplift in value between incorporation and the date of its own disposal; but
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any disposal of the shares will likely trigger a corresponding proportion of the capital gain from when the landlords incorporated the property portfolio.
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In some scenarios, it may have been possible for the landlords to claim gift relief on qualifying business assets. In this case, the landlord will have postponed the capital gain on some or all of the properties on a per-asset basis (at their discretion) so that, this time, the held-over gain arises on the company’s onward disposal of that property asset.
- This means that the company will likely pay more corporation tax when selling or otherwise disposing of those properties.
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However, there is no held-over gain on the shares under this gift relief route, so the landlords can transfer their shares to the next generation and any capital gain is on only the uplift in value since the landlord acquired the shares. However, this gift relief for business assets is generally reserved for assets in a trade, or for property that qualifies as furnished holiday accommodation.
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Finally, it is possible that the landlords will have simply paid any CGT on transferring their portfolio into the company, in which case the CGT ‘slate’ will have been wiped clean:
- Any gain by the company on disposing of a property will be based only on the uplift in value since the company acquired it.
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Likewise, there will be no held-over gain embedded in the shares either.
Conclusion
While companies can offer a simple medium for transferring property wealth between the generations during one’s lifetime, there are added complications, such as company law and arranging those transfers particularly so as then to minimise exposure to lifetime CGT. Careful long-term planning is essential – having the property in a company is likely only a stepping stone, rather than the goal itself.
