A company that rents its premises will be subject to rent reviews (often five-yearly) and landlord demands. Many companies would prefer to have greater control and long-term security over their business premises. From an investment perspective this is also attractive since the owners have ready-made and known tenants. Commercial property can be purchased by individuals (for example, the directors or shareholders), a pension scheme or the company itself.
Personal ownership
A commercial property could be bought and owned by directors or shareholders and subsequently leased to the business at a market rent. The individual owners are then liable to pay income tax on the rental income, which is a national insurance contribution-efficient method of extracting profits from a company. From the businesses perspective, rent is an allowable expense and so reduces the company’s corporation tax liability.
A commercial property could be bought and owned by directors or shareholders and subsequently leased to the business at a market rent. The individual owners are then liable to pay income tax on the rental income, which is a national insurance contribution-efficient method of extracting profits from a company. From the businesses perspective, rent is an allowable expense and so reduces the company’s corporation tax liability.
The individuals can later sell or wind up the business independently of the property.
For example, they could continue to rent out the premises to provide income in their retirement. Entrepreneurs’ relief, as outlined in Box 1, may be available on eventual sale, otherwise capital gains tax (CGT) would apply at a maximum of 28 per cent.
Personal ownership by an individual director or shareholder puts the assets at risk of creditors, divorce, death and – potentially – the timing of retirement. Where multiple owners are required, contingency plans and agreements should be put in to place.
This may include double option agreements backed by life and critical illness insurance to fund the buyout of a share in a property by the other directors. This should be part of wider director/shareholder protection plans and agreements.
Ownership on an individual level would normally require personal borrowing to fund the purchase and this gearing leads to increased personal risk. Only 50 per cent of business property relief is available to majority shareholders.
Corporate ownership
The clear advantage of the company buying the property is that it avoids the complications of personal ownership on a director’s death, divorce or retirement. The company avoids paying rent and is likely to be able to borrow more money than an individual could either through personal borrowing or a pension scheme to purchase property.
The interest payable on any debt is tax-relievable. A full 100 per cent business property relief should be available on the value of the property (depending upon the nature of the trade) and CGT payable at 10 per cent on sale due to entrepreneur’s relief.
However, there are potentially two layers of taxation on gains – corporation tax within the company when it sells the property and then CGT on the directors when they sell their shareholdings. Of course, a sale of the company’s shares to include the value of the property avoids one layer of tax.
The company may either have to commit free capital to what would be an illiquid asset or borrow to fund the property purchase – the gearing increasing risk – or both. Furthermore the property is not protected from the company’s creditors.
Pension scheme ownership
Small self-administered schemes (Ssas) or a full self-invested personal pension (Sipp) can often be used to purchase commercial property. This can be attractive for the individual members of the pension scheme due to the potential tax reliefs, and the pension scheme can provide funding not readily available for other means to fund the purchase. If the pension scheme is purchasing the property from the company or scheme members, the transaction must be done at arm’s length terms to avoid unauthorised payment charges.
Contributions to the pension scheme are tax relieved, potentially reducing the net outlay required to fund the property purchase. The full use of each pension scheme member’s annual allowance (100 per cent of earnings or £50,000 for 2013/14) plus the ability to carry forward up to a further £150,000 provides additional scope for funding.
Frozen and forgotten pensions can be consolidated to improve the buying power of the scheme subject to a check on transfer costs, loss of guarantees etc. Borrowing to fund the purchase is restricted to 50 per cent of net scheme assets.
Once purchased, the pension scheme owns the property as an asset. Market rent is paid to the pension scheme as an expense of the company and so reduces their corporation tax liability. The pension scheme will need to charge – and be paid – an open market rent, otherwise there may be unauthorised payments/scheme sanction charges. The rental income received within the pension fund is tax-free and is typically used to meet mortgage repayments. Lower borrowing limits and current interest rates make it more likely that the monthly rental income will meet both interest and capital repayments.
There is no inheritance tax liability on the value of the property within the pension fund, although there may be lifetime allowance or income tax charges after benefits are taken or at age 75 if not before. There are also no CGT liabilities on property sale and the property will generally be protected from the company’s creditors, although not from an individual member’s divorce.
Interest payable on the loan by the scheme trustees will not qualify for tax relief as the scheme does not pay tax and there is no tax relief available on borrowing costs.
The property is an illiquid asset that can cause issues upon death or retirement. All too often a commercial property over-dominates a pension portfolio, providing a lack of diversification of a pension fund. With poor planning this might impact on the level of tax-free cash that can be taken. Surplus rental income should be used to pay down any debts and also build capital outside the property.
Commercial property holdings incur additional costs within a pension from the scheme administrator, for example when the property needs to be valued, such as when benefit statements are given, benefits are drawn or loans are proposed. The property scheme will have to register for VAT if the property is not VAT exempt.
