When it comes to setting up a “buy-to-let” residential property business, we are often asked what the best ownership structure is. The commercial activity is widespread and the taxation features involved are not straightforward, so it is hardly surprising. The principal decision is between setting up a planned “buy-to-let” business in a limited liability company or running it personally (which includes use of a partnership arrangement, treated as “personal” for taxation purposes).
Below, we outline some initial guidance as a start-point for making the high-level decision between company or personal ownership. This covers the broad principles and commercial realities and is intended as a starter only. Further professional advice should be sought before any decision is made.
The use of limited company has a number of benefits (and potential benefits) as follows:
- Using a limited company provides a potentially convenient separation of business activity from an individual’s personal affairs.
- The “limited” liability provided by a company (i.e. limited to the assets within that entity) is always worth having, even in relation to activities where commercial risks are perceived as “low”.
- The company is currently subject to a flat 19% rate of Corporation Tax on income and gains. This is a very low corporate tax rate relative to the world’s “western democracies” and compares favourably with Income Tax rates (higher rate 40%, additional rate 45%) – but see (Cons – point 2) below.
- Building on (3) above, low Corporation Tax is particularly helpful in paying down mortgage debt, paying for new acquisitions, refurbishments etc. Funding growth out of 81p (after tax) in every £1 profit is materially easier than doing the same where higher Income Tax rates are being suffered.
- Companies are not subject to the alarming restriction on deduction for financing costs borne by individuals in relation to their residential property businesses. Financing costs are only eligible for basic rate Income Tax relief, so higher rate (and additional rate) individual taxpayers can be significantly penalised by this.
- A limited company comes with an ownership structure, organised into “shares”, which is convenient for the purposes of transferring interests around different participators (e.g. family members). It is typically easier to vary interests with transfers of company shares than working with % interests in (all) the underlying properties.
- The limited company also facilitates management of Income Tax upon extraction of income. It is up to the directors when to pay out dividends and in what sums, providing a “tap” to turn on and off for income, and a means to access all available reliefs and allowances around participating family (and/or other) members.
There are, however, downsides involved in the use of a company which need to be factored in before making any decision on the ownership structure to be adopted for the buy-to-let business:
- There is administration involved in maintaining a company. Annual financial statements (in their formalised format), annual Corporation Tax returns, and annual Companies House Compliance Statements, all have to be drawn up and paid for. In practice these things do not need to be onerous – and it has to be said that there will still need to be annual accounts and tax returns prepared even if the business is run personally.
- The company adds a “second tier” of taxation (i.e. profits in the company are taxed initially and then dividends paid out of the company’s after-tax profits are subject to Dividend Income Tax (Dividend Income Tax is at lower rates than the rates for property profits noted (Pros – point 3) above. If all of the business’ net income is to be extracted for personal use each year then, depending upon the extent of the restriction on financing cost deductions which might apply to the individual owner, the combination of Corporation Tax followed by Income Tax on a “full extraction” of net profits will typically exceed a single tier of Income Tax. Where the individuals would be basic rate Income Taxpayers only, a company is unlikely to be tax advantageous. In any event, some forecasting and assessment work is necessary to clarify the position for the specific business owners in their specific circumstances.
- In our experience, buy-to-let lenders tend to require mortgage terms which are at least a little more expensive than they typically might be for individuals. This is something of a puzzle, bearing in mind that the lower taxation in a company should mean that the lender’s default risk is reduced not increased (especially if the individual owner is willing to give personal guarantees). Quotes need to be obtained and any increased financing costs factored into the overall financial comparison between the two options of company or individual business ownership.
The above list of pros and cons is only a starter and cannot be a comprehensive checklist of everything to consider (nor does it provide the essential financial assessment often involved in making a reliable decision). The above also does not attempt to address the alternative arrangements within “personal” ownership, including joint ownership, general partnership, and limited liability partnership (LLP), all of which can be discussed after a decision has been taken on the basic choice between company or personal.
If you have questions about your plans for a residential buy-to-let property business, please do not hesitate to email firstname.lastname@example.org to discuss.