Property development through a company: ‘Pros’ and ‘cons’

Lee Sharpe looks at the advantages and disadvantages of incorporating a property development business.

There are many good reasons for running a trading property development business through a limited company. However, a limited company is not always appropriate.

(a) Low tax on profits – the UK corporation tax rate is currently 19%, and is set to fall to just 17% from April 2020 (although much water has flowed under the bridge since Mr Osborne (remember him?) made that commitment). This rate applies to any level of profits, so when a sole trader or partnership is potentially exposed to rates of income tax and National Insurance contributions (NICs) of (45 + 2)% = 47%, a corporation tax rate of 17% comes to almost one-third of the marginal rate for unincorporated businesses, for large profits. 

Keep in mind that additional tax usually has to be paid to get the money out of the company and into the hands of its shareholder/directors (we shall look at that below), but where the developer can afford not to withdraw all profits to fund personal expenses, he or she can retain much more of the business profits for re-investment into the next project through a limited company.

(b) Consistent tax on profits – profits can be very ‘lumpy’, and it is not uncommon for developers to take on a project every 18 months to two years. 

Unfortunately for individuals, recognising profits only every other tax year means potentially wasting tax-free allowances, lower tax rates, etc. in the ‘fallow’ year:

Example: Regular vs ‘lumpy’ profits 

Shappi has a property business that she runs through her company. It normally takes her company about 18 months to complete a project, averaging a profit of £200,000 over that time. 

ShappCo pays corporation tax of £200,000 @ 19% (for now) = £38,000 on the profits from every project.

Anders runs his property development business personally. He also makes around £200,000 every 18 months or so, but pays income tax and NICs rather than corporation tax. He started his most recent project on 1 January 2018 and finished on 30 June 2019. His previous project would, therefore, have finished on 31 December 2017 (i.e. 2017/18), and he will have made no taxable profits in 2018/19, but will make £200,000 profit in 2019/20.

Assuming no other income, his personal liability for 2019/20 will be just under £82,000. Profits are so high that Anders has forfeited his tax-free personal allowance for the year, and he is paying 45% income tax (plus NICs) on the last £50,000 of his income. So far, taxing the profits through a company would have cost Anders less than half the tax from working personally.

If Anders had instead made profits of £100,000 in each of 2018/19 and 2019/20, his tax bills would have been:

2018/19 - Profits £100,000; Tax and NICs = £33,000

2019/20 - Profits £100,000; Tax and NICs = £32,500, leaving Anders with around £67,500 (compare to table at ‘Disadvantages’ below).

His total liability spread over both years would have been a little under £65,500 – so taking profits only every other year is costing at least £16,000 more in tax and NICs. 

Furthermore, if Anders wants a decent state pension, he will have to top up his Class 2 NICs every other year to maintain his contribution record for those ‘nil’ years when profits will not otherwise trigger a Class 2 NICs liability (although these rules may soon change). The corporate route allows a director/employee to sustain an NICs record eligible for state pension purposes with a salary as low as £6,137 in 2019/20.

 

Extraction route	Typical rates	Typical 2019/20 yield on £100,000 (after CT/NICs)	Comments
Salary/Bonus	0% personal allowance up to 47% income tax & NICs at the highest ‘additional’ rate Typically 42% at higher rate	£60,110*	The most expensive way to extract profits and generally less favourable than simply operating unincorporated in the first place
Dividend	0% Personal allowance/‘Dividend allowance’ up to 38.1% (no NICs) at additional rate Typically 32.5% at Higher Rate	£69,340**	Company must have sufficient post-tax profits not yet paid out to support a dividend; generally paid in proportion to shareholdings
Capital extraction, typically on winding up	0% annual exemption/up to 20% at higher rate and above but typically 10% when claiming entrepreneurs’ relief (ER)	£76,376***	Anti-avoidance legislation can ‘turn’ capital extraction to income distribution; various criteria required for capital treatment (such as having to appoint a liquidator) and particularly for ER

*Profits are taxed after salaries, so no corporation tax on salaries or bonus – but employers’ NICs due (13.8%). Additional costs of running a company, etc., assumed negligible for the purposes of comparing tax efficiency. 

**Assumes salary of £8,400 and balance paid out in dividends.

***Net yield can be higher if dividends distributed before winding up.

(b) Administration/privacy – there is more administration in running a company – filing accounts at Companies House and maintaining minutes of meetings, shareholder register, etc. 

The government is consulting on reforming the corporate register, and setting up a company may become more involved, and the information that the government asks about shareholders and directors may increase, with the risk that this may then become public. 

(c) Tax administration – as a separate entity, the company has its own tax return, etc. A PAYE scheme is also needed if the director/shareholder wants to draw a salary. Likewise, a separate VAT registration may be required if the company is involved in making taxable supplies (‘doing up’ an ordinary dwelling is generally VAT-exempt, but you may want to register if building dwellings from scratch, and it may be obligatory for commercial developments). 

A company is also potentially caught by the annual tax on enveloped dwellings (ATED) and/or the special 15% stamp duty land tax rate for high-value dwellings costing more than £500,000 (note that the Scottish and now Welsh equivalent regimes differ in application). In both cases, it is possible to be exempted from the charge where the company is using the dwelling for property development purposes, but such exceptions must be claimed.