Alan Pink illustrates the benefits of holding property portfolios in partnership structures and points to problems that can arise and their solutions.
Where there is more than one person involved in the ownership of a property portfolio, apart from straightforward joint ownership, investors basically have a choice between property companies and property partnerships as a way of structuring the ownership.
With recent and impending changes to tax rates, property partnerships are beginning to look even more attractive as an alternative to the property investment company than they were before.
Gone are the days where you had basically the same rate of tax on income, whether it was passed through a limited company on the way to individuals’ bank accounts, or was received by those individuals directly as owners. In 2023, we are promised a corporation tax rate of 25% for larger companies and ‘close investment holding companies’, and a higher rate of income tax comes in from April 2022 on dividends. So the effective rate of tax on income passed through a company and paid out as dividends is going to be significantly higher in f imminent future than (say) rents received by individuals who own those properties direct.
The benefits of property partnerships
But property partnerships as a way of holding property portfolios don’t only compare well against companies; they can also be significantly tax-efficient compared with straightforward ownership by a single individual.
For a start, the chances are that a number of individuals, perhaps members of a single family or household, will be paying income tax on the rents at a lower overall rate, because of the availability of the personal allowances and lower (20%) income tax bands of a number of people.
To use a very simple example, a portfolio yielding rents of £100,000 a year to a single individual investor will suffer a much higher overall tax rate than if the same amount of rents were received by two individuals who have no other significant income because, in the former case, about half of the income will be chargeable at 40%, whereas splitting the income down the middle results in an overall tax rate of less than 20% in this example.
A second and rather less obvious advantage of spreading ownership amongst a number of people is the availability of a number of capital gains tax (CGT) annual exemptions. For example, a property which has five owners, for example, can yield a gain of over £60,000 without any tax being due, provided the five individuals concerned don’t make any other capital gains in the same year because of the just over £12,000 annual exemption that they each enjoy.
What is a property partnership?
But what is a property partnership, exactly? What distinguishes it from mere joint ownership of a property portfolio? When you start examining this question in any depth, some insuperable problems arise.
We need to start off by asking the question: ‘what is a partnership?’. The famous definition is in the Partnership Act 1890, where a partnership is described as: ‘the relation which subsists between persons carrying on a business in common with a view to profit.’ You will note that the word used here is ‘business’ and not ‘trade’, and this is interesting. It opens the door, seemingly, to activities like holding property for rent, which aren’t trades in the true sense of the word, but still being activities that you can carry on in ‘partnership’.
Unfortunately, this is where things get very vague and woolly, it seems to me. To take the most extreme example: is a husband and wife owning a single small flat which is let out to a tenant long term ‘a partnership’ situation? It looks very much like simple joint ownership, and it begins to be difficult to put your finger on a difference between a partnership and mere joint ownership, when the holding of the property is concerned.
This may all seem very rarefied and theoretical as a discussion, but it could become painfully important in the real world if HMRC decided to attack a given arrangement.
Nailing my own colours to the mast, I must say that there’s severe doubt in my mind that a pure investment activity, without any trade involved, can necessarily be regarded as being carried on in a partnership merely because there are a number of people whose names are put on the accounts and who share the profits amongst themselves.
A matter of culture
In some cultures, an unspoken assumption is made that any assets owned by any family member are actually effectively owned in common by the whole family. So-called ‘property partnerships’ are sometimes found amongst members of these groupings, and typically a number of properties are held in the names of different individuals but are treated both for accounting and tax purposes as if they were held in common. Very often, the question of who actually is named on the land registry as owner of a property is determined solely by who was able to get the necessary mortgage loan at the time the property was bought.
Partnership accounts are sometimes prepared for collections of properties owned in this way, and the profits are shared between the partners or family members on a basis which completely ignores who the actual legal owners of the properties are.
This is, of course, brilliantly tax-efficient if it works, because the ‘partners’ can agree to share out the rental profits differently each year and in such a way as to reduce the overall burden of tax, by using lots of different people’s available allowances and lower rate bands. But could a set up like this be accused of cutting corners and getting unjustifiable tax advantages in doing so? Frankly, I think they could indeed be accused of this by HMRC, who might also point to the typically indeterminate nature of the income and capital profit-sharing arrangements to bolster their case that there isn’t a proper partnership in cases like this.
A solution to the problem
One possible solution to the problem of sharing out income between a number of individuals would be to put the portfolio into a limited company, in which the individuals own shares, perhaps in different classes so that dividends can be paid at different rates depending on the requirements of tax efficiency. However, I’ve already pointed out that companies are nothing like such a good idea as compared with direct ownership as, perhaps, they used to be. So, step forward the limited liability partnership (LLP).
Because LLPs are treated as partnerships for tax purposes, they neatly sidestep all the tax disadvantages which can be perceived with company holding structures; there is no ‘double charge to capital gains taxation’ on disposal of investment assets, and there’s no addition to the tax burden resulting from the 25% corporation tax rate combined with the ‘dividend tax’ rates. Instead, each member of the LLP who receives a profit share is taxed on that profit share exactly as if they had received profits from a business they were carrying on solely in their own name. LLPs, like partnerships, also enable a lot of individuals to use their CGT annual exemptions because gains can be shared out amongst all the members, and a gain made by an LLP is treated as if it were made by those members directly (and not by the LLP itself).
Practical tip
But why am I suggesting LLPs as a solution to the property partnership problem? Quite simply, because the LLP legislation brings in a presumption that any activity carried on by an LLP is actually carried on by the members of the LLP in partnership. This is a legal fiction which applies only for tax purposes, but the important point to note is that a business (whether an investment business or not) carried on by an LLP is automatically treated for tax purposes as being a partnership – so the attack I fear on the ‘shortcut’ family partnership arrangements I’ve discussed can be avoided by simply turning the ordinary partnership into an LLP.
