Sarah Bradford looks at some of the ‘pros’ and ‘cons’ of operating a property business through a limited company.
Property companies have increased in popularity in recent years in response to a raft of tax changes reducing the attractiveness of an unincorporated property business.
While property companies do have advantages, there are disadvantages too.
Tax rates
Where a property business is operated through a limited company, the profits are chargeable to corporation tax. This will generally be advantageous, as the rates of corporation tax are lower than the rates of income tax.
Since 1 April 2023, the rate at which a company pays corporation tax depends on the level of its profits. Where profits are below the lower profits limit (set at £50,000 for a company with no associates), corporation tax is payable at the small profits rate of 19%. Where profits exceed the upper profits limit (set at £250,000 for a company with no associates), corporation tax is payable at the main rate of 25%. Where profits fall between the two limits, profits are chargeable at the main rate of 25% as reduced by marginal relief – giving an effective rate of between 19% and 25%. For companies with associates, the limits are divided by the number of associates plus one. The limits are also proportionately reduced where the accounting period is less than 12 months.
By contrast, for 2023/24 income tax is charged at the basic rate of 20% on the first £37,700 of taxable income, at the higher rate of 40% on the next slice of taxable income, from £37,701 to £125,140, and at the additional rate of 45% on taxable income more than £125,140.
No personal allowance
Unlike an individual, a company does not have a personal allowance. This means that where a property business is operated through a company, corporation tax will be payable from the first pound of taxable profit.
By contrast, an individual has a personal allowance (£12,570 for 2023/24), allowing them to enjoy the first £12,570 of their income tax-free. However, the personal allowance is gradually lost once the individual’s adjusted net income reaches £100,000 as the personal allowance is reduced by £1 for every £2 by which the individual’s income exceeds £100,000. Individuals with adjusted net income of £125,140 or more do not benefit from a personal allowance.
Accruals basis is a must
A company must use the accruals basis to calculate its taxable profit. This means that income and expenditure must be taken into account in the accounting period to which it relates, rather than that in which it was received or paid. The company must also take account of debtors and creditors and accruals and prepayments.
By contrast, the default basis of preparation for an unincorporated landlord with rental income not exceeding £150,000 a year is the simpler cash basis. Under the cash basis, income is only taken into account when it is received, and expenditure is taken into account when paid – there is no need to match the income and expenditure to the period to which it relates or to calculate debtors and creditors or accruals and prepayments.
Under the cash basis, relief for bad debts is given automatically. Also, relief for capital expenditure is given as a deduction in calculating profits unless the expenditure is of a type for which such a deduction is expressly forbidden. Under the accruals basis, relief for capital expenditure is only available through the capital allowances system.
Relief for interest and finance costs
The change in the way in which unincorporated property businesses receive relief for interest and finance costs in relation to residential properties other than furnished holiday lets has been responsible for a rise in the popularity of property companies.
A company can deduct interest and finance costs in full in calculating its taxable profits, meaning relief is given for the costs at the rate at which it pays corporation tax relief. However, while an unincorporated landlord can deduct interest and finance costs in full where they relate to commercial properties or to furnished holiday lettings, interest and finance costs in relation to residential lets cannot be deducted in calculating the landlord’s taxable profits. Instead, relief is given as a tax reduction equal to 20% of the finance and interest costs.
Thus, where the landlord is a higher or additional-rate taxpayer, they are unable to obtain relief for residential interest and finance costs at their marginal rate of tax. In a climate of rising interest rates, this is perceived as a significant disadvantage.
Capital gains
If a gain arises on the sale of a rental property by a company, the gain is charged to corporation tax rather than capital gains tax (CGT). Depending on the level of the company’s profits, the rate of corporation tax payable on the gain will be between 19% and 25%. Unlike an individual, a company does not have an annual exempt amount, so any capital gains (after deducting any allowable losses) are taxed in full.
Where a capital gain is realised by an individual, that gain is charged to CGT. An individual benefits from an annual exempt amount for CGT purposes, which for 2023/24 is set at £6,000. It is to fall to £3,000 for 2024/25. Where the property sold is a residential property, the gain is taxed at 18% if income and gains fall within the basic rate band, and at 28% once income and gains exceed the basic-rate band. For non-residential properties, gains are taxed at, respectively, 10% and 20%. Further, where an individual makes a chargeable gain on a residential property, the gain must be reported to HMRC within 60 days of the completion date, and the tax on the gain must be paid within the same time frame.
By contrast, companies do not need to report residential property gains separately – the corporation tax on the gain is payable on the normal corporation tax due date, nine months and one day after the end of the accounting period.
Extracting profits
Although the tax paid by a company on the profits of the property business may well be lower than that paid by an unincorporated landlord, if the landlord wishes to use the company’s profits personally, they will need to be extracted. This may involve additional tax and National Insurance liabilities.
Where the landlord’s personal allowance is available, a popular and tax-efficient profit extraction strategy is to pay a salary equal to the personal allowance and to take further profits as dividends (assuming the company has sufficient retained profits from which to pay them). While no employee’s National Insurance is payable on a salary equal to the personal allowance of £12,570, if the employment allowance is not available, a small amount of employer’s National Insurance will be payable by the company. The salary and any employer’s National Insurance contributions paid are deductible in computing the company’s taxable profits.
Incorporating an existing property business
Landlords with existing property portfolios may wonder whether it might be beneficial to incorporate their business to escape the interest rate restriction and benefit from the lower rates of corporation tax. However, this will have a number of tax consequences.
One of the main disadvantages is that stamp duty land tax (SDLT) must be paid again when transferring the property to the company. As the company is a connected company, SDLT is based on the market value of the property when it is transferred to the company. If the landlord has owned the property for some time, this may be considerably more than the original purchase price.
Transferring the property to the company may also trigger a CGT liability, again based on the market value. However, incorporation relief defers the gain by reducing the base cost of the shares given in exchange. The relief is given automatically, so if it is not beneficial the landlord must elect for it not to apply.
Practical tip
It is not a given that it will be more beneficial to operate a property business through a company – it will depend on the circumstances. It is important to do the sums, not forgetting the tax cost of extracting profits and incorporating the business.
