How Should You Own Your Business Premises?

A very odd thing I’ve noticed in practice is that the very important question of how to structure the ownership of one’s business premises is often given little or no attention by taxpayers or their advisers; and yet this decision can have very far reaching consequences, as I’ll come on to show.

First of all, a couple of assumptions. I am assuming, in what follows, that the taxpayer is carrying on some kind of business through the medium of a limited company, and that the premises are owned by someone closely connected with that company; most frequently, the same people are both shareholders of the company and effective owners of the property. So, we’re not talking about the situation where premises are rented from an unconnected third party. I’ll briefly consider the alternative structures for carrying on a business later on in this piece, but for the time being will concentrate on the situation represented by these two assumptions, which is probably the situation most frequently met in practice.

Ignoring the more ‘far-fetched’ ideas, such as holding business properties in trust, you’ve generally got four basic types of ownership structure to choose from:

What are the respective merits and demerits of these various options from a tax point of view?

This has the big merit of simplicity. The cost of buying and holding the property, including interest paid on any loan, and capital allowances available on any inherent fixtures, are directly relievable against the profits of the business and, if they give rise to a loss, are available for relief either within the company itself or by surrender to any other member of the same group. 

If the company has made a capital gain on selling another property (say) within the preceding three years, it can ‘roll over’ that gain against the acquisition of the new property. Similarly, any sale of this property in the future can potentially be rolled over if the company acquires any kind of qualifying asset within the necessary timescale. 

The big drawback of holding the property within the trading company, to offset against these advantages of simplicity, etc., is the fact that the property is exposed to the full risk inherent in the business activity. For example, let’s imagine the worst, which is the situation where the company faces a large uninsured claim. The liquidator moves in, and of course rubs his hands with glee at the sight of the ‘real’ asset owned by the stricken company, being its bricks and mortar. The shareholders bitterly regret their having overlooked the alternative options, which involve holding the property separately from the trading company. 

It’s probably because of this spectre of financial disaster (which almost nobody in any kind of trade is free from anxiety about) that leads a lot of people to elect to acquire the property in their own personal names. So, typically, Mr and Mrs A will buy the factory at Number 1 High Street, and allow their company, A Limited, to make use of it for the purpose of its trade.

Apart from the fact that this insulates the property from the trading risk in the company (assuming neither Mr or Mrs A have been personally negligent in giving rise to any claim), holding the business premises in this way has a potential National Insurance contributions (NICs) advantage – counterintuitively enough. This is the fact that the company can pay them, if they choose, a fair rent for the use of the premises, and this rent might, in practice, be being paid to them instead of remuneration. Unlike director’s remuneration, rent, whilst still being a deduction against the company’s profits for corporation tax purposes, is free of NICs, either employer’s or employee’s, and therefore results in a much more favourable method of extracting profits from the company. 

In the event that the business is sold, there is also an advantage in holding the property in this way, which is that the purchaser can buy just the trade, without also buying the premises, if that is what suits the parties at the time. Very often, in practice, a purchaser of a business is not particularly interested in acquiring the premises as well – because he already has his own premises. Where the trading entity also owns the property this obviously gives rise to problems because of the need to disentangle the ownership of the premises from the ownership of the trade. There is no such problem, of course, where the property is owned personally outside the trading company. 

Conversely, if the purchaser does want to buy the premises as well, ‘entrepreneurs’ relief’ from capital gains tax (giving a reduced 10% rate of tax if the criteria are met) is available not just for the shares in the company but also the sale, taking place at the same time, of the premises by the individual owners (but see below).

Turning to the downsides, though, firstly you have to consider the effect of any loan to purchase the premises. If this is in individual names, then the capital repayments on this loan are not an allowable expense (because they aren’t, properly speaking, an ‘expense’ at all). Any payments made out of the company in order to fund the capital repayments of the loan will be personal income, taxable on the individuals. This could be at a higher rate of tax, indeed as high as the top 45% income tax rate.

Moreover, if the company does pay rent to the individuals in return for the occupation of the premises, this rent, despite what I’ve said above, does have the effect of reducing or even eliminating the availability of entrepreneurs’ relief on any sale of the premises. 

At first sight, you might think that the freestanding property company is the answer to all of these problems. It insulates the value of the property from any claim against the trading company itself; and the rents paid are only subject to corporation tax rates (currently a flat 19%) rather than income tax rates.

However, from many points of view, the freestanding property company (held by Mr and Mrs A personally as a separate shareholding to their shareholding in the trading company) is almost a model of how not to do it.

From the point of view of capital gains, neither the property itself (because it is owned by a company and not an individual) nor the shares in the property holding company, are eligible for entrepreneurs’ relief. As a freestanding company, the tax system treats it, most unfairly, as being an investment company in every respect, rather than a trading company. So, you lose the benefits of entrepreneurs’ relief; and you also lose the benefit of any roll over relief – because the relief simply isn’t available to an investment company. 

In the inheritance tax (IHT) sphere, what is, or should be, a relievable business asset is (by a form of ‘black magic’) converted into an investment asset which is not eligible for any business property relief (BPR), and is therefore fully taxable at the 40% rate, potentially, in the event of the relevant person’s death.

Every so often a holding company is set up above the trading company in order to mitigate the commercial risk we’ve been talking about. The property is acquired in this holding company; or, if it is currently owned within the trading company, is ‘hived up’ by way of intra-group dividend to that holding company. You can even set up the holding company for the purpose of this transaction, with HMRC’s prior blessing. 

In this way, you avoid various of the drawbacks to the freestanding property-owning company. The holding company is effectively treated the same as if it were a trading company because it is the holding company of a trading group. So, entrepreneurs’ relief on sale of its shares, together with rollover relief and BPR for IHT purposes are not necessarily denied, even though the holding company itself, looked at in isolation, may be merely there for the purpose of holding the asset. So, where trading premises are already held within the trading company, and have a value, the practice of ‘top hatting’ this trading company has become deservedly very popular. 

Under this process, a holding company is set up, as I’ve said, ‘above’ the trading company and all of the valuable assets (not necessarily just the premises) are transferred up, hopefully away from harm’s way. This can be done without triggering any tax charge – subject to HMRC clearance – and without affecting the trading status of the whole set up for tax purposes.

Do just consider, however, finally, whether the classic trading company set up is actually the best one for your circumstances. The limited liability partnership (LLP) structure is a very real alternative, and LLPs aren’t just useful for accountants and solicitors, as many people think. 

As with a group of companies, it’s possible to have a ‘holding’ LLP above a trading LLP in order to mitigate risk, and the tax outcomes are very different – often refreshingly different – because of the fact that LLPs are taxed as partnerships.

So, always take a hard look at your business structure when considering any substantial asset purchase, such as the purchase of business premises.