Lee Sharpe looks at the tax issues to consider when a property investment company has come to the end of its life.
This article considers the main tax issues that shareholder/directors should consider if they no longer want to run their property business – or at least, not in a company.
Income or capital?
By default, any distribution (ignoring the company’s return of its share capital to its members) is an income distribution (there are other exceptions, but they are available only to trading companies).
Given the current disparity in rates between income tax and capital gains tax (CGT), most people would prefer to have their funds returned to them as a capital transaction. To avoid being treated as dividend income, either:
-
A liquidator has to be appointed, from which time distributions will be considered capital, or
-
The sums available for distribution must be very modest – broadly no more than £25,000 (unlikely for a company holding property).
What kind of assets does the company hold?
A successful property investment company will have net assets – represented, broadly, by the profits over its life that is has not yet paid out. Those may take the form of the property therein, or they could be the net cash derived from selling off property and paying off any mortgages due, etc.
Practically speaking, it might be easier for the company to liquidate its realty and simply pay out cash; but what if there is property in the company that the shareholders want to keep? It may surprise some readers to find that CGT, at least, doesn’t really ‘care’ (although there may be implications for other taxes, as we shall see).
CGT and the double tax charge
The problem with winding up a company is that there are effectively two tax points:
- The company disposes of its properties and (presumably) makes a capital gain; and
-
The shareholders ‘sell’ their shares back to the company in exchange for a proportionate share in the company’s accumulated reserves.
This is similar to when the company pays corporation tax on its profits, but the shareholder/director still has to pay income tax on any salary or dividends he or she takes from the company.
Distribute the property, or the cash proceeds from sale?
Assuming the properties have increased in value, the company will clearly make a capital gain if it sells them on the open market. But the company is also allowed to transfer out some or all the property it owns as a ‘distribution/dividend in specie’.
This can be useful if there are cherished assets in the company that the shareholders want to keep personally. But note that the company still makes a disposal for CGT purposes if it distributes property in specie; the calculation is basically the same.
However, the market value rule for disposals between connected parties (the company and its shareholders) means that CGT is payable as if sold for market value; and HMRC can disagree over what the property was actually worth. Note this cannot be circumvented simply by selling the cherished property directly to the shareholder(s); the market value rule applies regardless of whether, or how much, money actually changes hands (and SDLT may be charged on consideration; see below).
Will the property business carry on?
If the company sells all its properties with a view to winding up it will have ceased, so far as the company is concerned. Generally for corporation tax purposes, this means that any unused property business losses will be forfeit (but see below).
VAT may be an issue if commercial properties or holiday home lettings are involved:
- The company will have to de-register for VAT once it stops making VATable supplies.
- It will have to account for output VAT on any taxable assets, including any commercial properties it has ‘opted to VAT’, whether it sells them on or distributes them in specie to its shareholders. This can be avoided if the acquirers will carry on the property business as well, such that it can be treated as a ‘transfer of a going concern’ for VAT purposes. There are numerous conditions and pre-conditions that the new owners may have to satisfy immediately prior to the transfer.
-
There may be capital goods scheme adjustments (where the company has reclaimed all of the input VAT on acquisition of a commercial property ‘up front’ it may have to adjust over the next ten years of use, including onward sale).
With regard to capital allowances, there will normally be a balancing adjustment in relation to the company’s qualifying expenditure, but note:
- The regime for fixtures in commercial properties means that a buyer may really want a joint election to set the value that both sides use in their qualifying pools of expenditure (this can apply whether the buyer wants to carry on a property business or do something else with the property) (a ‘section 198 election’).
- For general plant and machinery transferred between connected parties (such as the company and its shareholders) where the property business continues, an election may be made to fix the value to be used, broadly so that neither party has a balancing adjustment to make (a ‘section 266 election’).
- However, care is needed if contemplating both elections concurrently: the section 266 election is much wider in scope. An section 198 election may not be in point depending on whether there is a connected party sale prior to winding up, or a distribution in specie.
-
The buyer cannot claim annual investment allowance where the asset is acquired from a connected party
Stamp duty land tax (and regional variations)
Transferring property by way of a distribution in specie generally avoids SDLT so long as the distribution is not expressed as satisfying a monetary debt. The same cannot be said of a simple sale to a shareholder. But care is needed if the acquirer also takes on responsibility for mortgage debt by either route, as this can count as monetary consideration for SDLT purposes.
Although similar, the precise treatment would need to be checked for transactions subject to land and buildings transaction tax (Scotland) or land transaction tax (Wales).
Dwellings with a value exceeding £500,000 are subject to the annual tax on enveloped dwellings (ATED) in the UK. Exemption (relief) applies when used in a property investment business, but undue delay in disposing of an expensive residential property after it is no longer part of the business (e.g. while deliberating over whether to sell or distribute it) could trigger an ATED charge.
Other issues
Indexation allowance is available on corporate property disposals, albeit frozen at December 2017.
Generally, however, it could be significantly more tax-efficient simply to sell the shares in the company rather than to wind it up, since there would be only one instance of CGT charge, not two.
There is anti-avoidance legislation ostensibly to attack ‘phoenixing’ companies, that converts an otherwise capital distribution to income (a dividend) where the recipient carries on a similar activity (not necessarily a trade) in the following two years. It can apply even if the activity is carried on personally. However, it cannot be invoked unless the avoidance of income tax is (one of) the main purpose(s) of the winding-up.
There can be employment tax implications for the transfer of assets to employees – typically a ‘benefit-in-kind’ tax charge.
A property investment company is not trading, so its shareholders will be ineligible for business asset disposal relief (previously known as entrepreneurs’ relief).
However the share disposal arises, individuals should check the allowable cost of their shareholdings for CGT purposes, in case previous capital gains were ‘held over’ into them – such as under incorporation relief.
Final thoughts
Winding up a company has several ‘moving parts’ and needs careful consideration. Alternatively, consider selling the properties but keeping the company open as a ‘moneybox company’ paying out dividends over the next several years. Where shareholders are comfortably basic rate taxpayers, dividends are still taxed quite cheaply (for now). Unused property losses that would otherwise be forfeit in the company could still be utilised against investment income accruing to the company in this state.
