Jennifer Adams considers the tax implications of a director charging the company rent for the use of commercial property.
Many directors own business premises either personally or via a self-invested personal pension (SIPP), charging the company rent rather than the company owning the premises itself.
For these purposes, commercial property includes business premises (shops, offices, warehouses, restaurants etc.) but also other categories specifically excluded from the residential property rules, such as care homes and student accommodation.
Director’s tax position
Whether charging rent is tax-efficient needs to be looked at by not only taking into account the director's immediate income tax position and the company's tax situation, but also the director's future capital gains tax (CGT) position when the property or the company itself is eventually sold.
For the director, charging rent can be a tax-efficient method of extracting monies from the company rather than by the salary/bonus or dividends route. Unlike salaries or bonuses, there is no National Insurance contributions (NICs) cost for either the employer or employee. However, the director will be liable for income tax on the rent received less any rental expenses (therefore, the rent paid by the company should at least equal the costs incurred). Furthermore, an individual who only rents out a single business premises is unlikely to be liable to NICs based on carrying on a business.
Tax and the company
In comparison with dividends, rental payments do not require the company to have sufficient distributable profits necessary for a dividend to be paid. The company is allowed full corporation tax relief at 19% on payments made. Another reason for the company to pay rent is that the only way to obtain tax relief for any interest that may be payable, should a mortgage have been taken out to purchase the property initially, is to set it against rental income.
However, there is no requirement for the company to be charged rent for the use of its premises. This is worth bearing in mind because whilst rent is relatively tax-efficient, it will still be subject to effective income tax rates of up to 60%. If it is decided to charge rent, care needs to be taken as to the amount charged. as this must be at no more than open market value. Otherwise, any excess amount will not be an allowable expense for the company, being treated as a ‘distribution’ to the director landlord and taxed at the same marginal tax rate as a dividend.
Capital gains tax problems?
As ever there is a 'payback' to any tax benefit, as charging rent can result in full or partial loss of CGT business asset disposal relief (BADR) for the director when the property is eventually sold or transferred at the same time as the company shares are sold or transferred.
Any gain eligible for BADR is subject to restriction, with the balance remaining a chargeable gain without the relief. One such restriction is where the premises were available for business use only on the payment of rent. By charging full market rent, all BADR is lost for any gain made as the property will count as an investment asset and relief will be restricted. If the company pays rent at lower than the market rent, or paid rent since 6 April 2008 (when the rules changed), the proportion of the gain on which BADR can be claimed is restricted in proportion to the amount of rent paid. The payment of market rent throughout ownership will not necessarily result in relief being wholly lost, as the use of the property throughout the period of ownership is also taken into account.
Practical tip
Although the director landlord is the owner of the company by being a shareholder, it would be advisable for a formal lease to be drawn up so that the company can make alterations and undertake repairs without the risk of the property owner being taxed on the ‘benefit’ of the company doing the work for him.
