Critique this property/ investment proposal please
Discussion
Is this a go-er, or am I missing something in the basics of a process like this? Please ignore risk, examples of numbers (£ and quantity) are used purely for ease of illustration and (sadly) do not reflect reality. Suffice to say the theory would be:
- Let’s imagine someone owns an unencumbered property worth a million quid which has only ever been a main residence, so the sale price would be free of capital gains tax.
- Let’s imagine that person sold it, and started a limited company, making a director’s loan to it of… a million quid.
- And the company purchased an HMO (or two, don’t worry about single point of risk etc, it’s the theory I’m after) with that money, including all costs (legals/ stamp/ co set setup/furniture etc), and immediately started to return say, 10% gross.
- Then every year, assuming the annual net return post costs (including corporation tax of course) is positive, the director could take their loan money back to simply repay it, until they had that million quid back. The company would not be paying interest on the loan, and would only pay it back when it had it, the director would not necessarily "need" the money as income would be available elsewhere.
Is it really that simple?
Obviously once the director’s loan is repaid, any further money taken from the company would be subject to the director’s appropriate income tax rate.
Yes, the seller would need somewhere else to live, but that could be taken care of. In particular with a deposit/ costs and income (without return of loan above) to cover another property (not worth the same, but still something tolerable).
What do we think?
I am guessing the question you are asking is what are the advantages/disadvantages of setting up a company to do this rather than doing it personally?
What exactly are you trying to achieve? That would be helpful!
In the scenario above you would cross the VAT threshold so you can automatically deduct 20% (£20k) a year from your 10% rental income.
It is unlikely you (sorry, the company) would actually achieve such a return however, so this may not be relevant now (though could be in the future).
You would certainly be able to charge a going rate of interest on such a company loan (though this would be taxable as income), so you should seriously not ignore doing so.
Repayments of the loan (and interest) are both deductible overheads from a corporation tax calculation, so that is very much in your favour.
The company can also make tax free pension contributions on your behalf - again deductible against corporation tax.
So if the company's annual earnings remain below the VAT threshold it could work like this (using an 8% annual return to avoid a CGT liability:
I hope this helps, but Eric is probably going to be far more helpful than me on this one.
What exactly are you trying to achieve? That would be helpful!
In the scenario above you would cross the VAT threshold so you can automatically deduct 20% (£20k) a year from your 10% rental income.
It is unlikely you (sorry, the company) would actually achieve such a return however, so this may not be relevant now (though could be in the future).
You would certainly be able to charge a going rate of interest on such a company loan (though this would be taxable as income), so you should seriously not ignore doing so.
Repayments of the loan (and interest) are both deductible overheads from a corporation tax calculation, so that is very much in your favour.
The company can also make tax free pension contributions on your behalf - again deductible against corporation tax.
So if the company's annual earnings remain below the VAT threshold it could work like this (using an 8% annual return to avoid a CGT liability:
- £1m loan to a company with full security on the assets invested in
- Interest charged at 5% (another round number)
- Company earns 8% a year of rental (total) turnover = £80k a year
- Company repays £50k a year of the principle and £30k of interest in year 1 (interest will obviously fall by 5% a year as capital is repaid).
- You receive £50k a year of tax free income (loan repayment) and c. £35k a year of interest earning after tax (totalling £85k a year)
- Alternatively you defer the interest until the principle is repaid. This would give you £80k a year of tax free repayments for the next 12.5 years and enable compound growth on the interest over this period, allowing you to draw down much more money
I hope this helps, but Eric is probably going to be far more helpful than me on this one.
EddieSteadyGo said:
JulianPH said:
In the scenario above you would cross the VAT threshold so you can automatically deduct 20% (£20k) a year from your 10% rental income.
Residential lettings are excluded from VAT (in the most common scenarios).Companies have to pay VAT if their turnover exceeds the VAT threshold (unless the activities they are involved with are non-VATable or VAT exempt).
Please let me know if I am wrong, I may make some changes to my own portfolio!
coyft said:
You’re wrong. Letting residential property is exempt.
Even when owned by a limited liability company..?I am quite happy to be wrong (hence asking Eric to elaborate) but (as I have never done so) I did not know that regardless of turnover a company holding residential property would be completely VAT free.
Surely there would be management elements that are not VAT free/exempt?
I do think my other points stand though. Good point, every day is a school day!
Except that repayments of the loan Capital are not tax deductible for the company - it would pay them from post-tax profits. Only the interest element (if charged) is tax deductible.
Letting of residential property is not vatable - it is irrelevant whether it is by a company, sole trader or partnership
Letting of residential property is not vatable - it is irrelevant whether it is by a company, sole trader or partnership
TNJ said:
Except that repayments of the loan Capital are not tax deductible for the company - it would pay them from post-tax profits. Only the interest element (if charged) is tax deductible.
Letting of residential property is not vatable - it is irrelevant whether it is by a company, sole trader or partnership
As I have already said, I am happy to be proved wrong, however I think you are mixing up the tax situation with an individual taking out a loan (mortgage) to purchase a property (to rent out) and an individual loaning a company money (to do the same).Letting of residential property is not vatable - it is irrelevant whether it is by a company, sole trader or partnership
Repayment of a loan (including interest) by a company is a corporate overhead. It is therefore an outgoing payable from turnover before any corporation tax is calculated.
Interest on such a loan would be a form of taxable income in the hands of the lender in almost every circumstance I can think of.
I have never lent a company money to buy a property, but I have lent companies I own money to do other things. Repayment (including interest) has always been a legitimate pre-tax expense for the companies and I have only ever had to pay tax on the interest (not the return of the principle capital).
I can't see how this would be different if the company used this money to buy property as opposed to using it for any other reason.
coyft said:
JulianPH said:
Repayment of a loan (including interest) by a company is a corporate overhead. It is therefore an outgoing payable from turnover before any corporation tax is calculated.
Only the interest is an expense and is deducted through the p&l. The capital repayment is dealt through the balance sheet and is not included in the corporation tax calculation.EddieSteadyGo said:
coyft said:
JulianPH said:
Repayment of a loan (including interest) by a company is a corporate overhead. It is therefore an outgoing payable from turnover before any corporation tax is calculated.
Only the interest is an expense and is deducted through the p&l. The capital repayment is dealt through the balance sheet and is not included in the corporation tax calculation.I ask genuinely, as I have loaned my companies money before and had the money back tax free with no corp tax liability incurred.
Admittedly, my accountant does handle the finer points of this for me, but I am quite stunned at this...!
JulianPH said:
How on earth is a loan repayment not a legitimate p&l expense!?
I ask genuinely, as I have loaned my companies money before and had the money back tax free with no corp tax liability incurred.
Admittedly, my accountant does handle the finer points of this for me, but I am quite stunned at this...!
You're only looking at half of the transaction - there was no CT liability incurred as when the loans went into the company they weren't treated as income subject to corporation tax. On the way out they aren't tax deductible either.I ask genuinely, as I have loaned my companies money before and had the money back tax free with no corp tax liability incurred.
Admittedly, my accountant does handle the finer points of this for me, but I am quite stunned at this...!
Or look at it another way - The stuff the company spends the loan money on is a tax deductible business expense. If you then treated the repayment as an expense you would be getting double relief.
Interest is taxable on the recipient and a deduction for the payer. Capital payments / repayments are not subject to tax on the recipient or an allowable deduction for the payer.
JulianPH said:
How on earth is a loan repayment not a legitimate p&l expense!?
I ask genuinely, as I have loaned my companies money before and had the money back tax free with no corp tax liability incurred.
Admittedly, my accountant does handle the finer points of this for me, but I am quite stunned at this...!
Couple of clarifications.I ask genuinely, as I have loaned my companies money before and had the money back tax free with no corp tax liability incurred.
Admittedly, my accountant does handle the finer points of this for me, but I am quite stunned at this...!
The VAT rules for limited companies are no different to the rules as they apply to individuals. It's not the status of the entity that determines whether it needs to register for VAT, but the nature of the activity being carried out.
With that out of the way, does VAT apply to income generated through the renting of a house as a dwelling? The answer is, generally no. Rental of property for residential purposes is normally VAT Exempt.
However, a landlord (whether an individual or a company - or some other entity such as a trust or charity - can exercise the Option to VAT the rental income and start levying VAT on the rents.
By doing this, it allows any VAT incurred on rental costs to be reclaimed. This might be handy if the landlord is intending to expend a large amount of money on the property. Normally, this Option to VAT is only exercised when the tenant is itself a VAT registered trading entity - so that it is able to reclaim the VAT being charged by the landlord. The vast bulk of landlords where the tenants are private, non VAT registered individuals, will not exercise the Option to VAT the rented property.
One of the big disadvantages of exercising the Option to VAT the property is that, when the time comes for the property to be sold, the sale price of the property must have VAT added on to it - which could put off lots of potential buyers.
Regarding loan repayments, of course a loan repayment is NOT a cost as far as the Profit and Loss account is concerned.
If I loaned you £10 and you eventually repaid the £10, as far as the accounting is concerned, you have not had any income and you have not had any expenditure. The accounting for the transaction would have been initially to represent the £10 loan I made to you as a liability of £10 in the balance sheet - and, when you repaid the £10, to return the liability to Zero. In other words, a loan is a balance sheet transaction only with no impact on the profit and loss account.
If, however, I charged you interest or fees on the loan so that you repaid to me £15 rather than the initial £10, the additional £5 paid by you IS profit and loss transaction i.e. £5 loan costs (interest/charges) would be treated as a cost in the Profit and Loss account.
In my accounts, the £5 received by me in respect of those charges would be shown as income.
Croutons said:
The company would not be paying interest on the loan
Interesting thread. Out of interest any reason why a company wouldn't pay interest on the loan? I'd of thought that would be an advantage of a set-up where you are using your own money / capital. Or does it depend on the tax rate of the individual lending the money vs the 19% CT? Phooey said:
Croutons said:
The company would not be paying interest on the loan
Interesting thread. Out of interest any reason why a company wouldn't pay interest on the loan? I'd of thought that would be an advantage of a set-up where you are using your own money / capital. Or does it depend on the tax rate of the individual lending the money vs the 19% CT? a) the company will claim the interest as a cost against their Corporation Tax profits. The maximum rate of Corporation Tax is currently 19% - so the company saves some tax at 19%
b) the interest paid to the director is taxable income in the hands of the director. He will pay Income Tax on that at his top Income Tax rate - which could be as high as 45% (depending on his overall income from all sources).
So you can see, there is a tax DISADVANTAGE in such circumstances.
There are also additional compliance costs involved for the company in reporting interest paid to directors.
Eric Mc said:
Couple of clarifications.
The VAT rules for limited companies are no different to the rules as they apply to individuals. It's not the status of the entity that determines whether it needs to register for VAT, but the nature of the activity being carried out.
With that out of the way, does VAT apply to income generated through the renting of a house as a dwelling? The answer is, generally no. Rental of property for residential purposes is normally VAT Exempt.
However, a landlord (whether an individual or a company - or some other entity such as a trust or charity - can exercise the Option to VAT the rental income and start levying VAT on the rents.
By doing this, it allows any VAT incurred on rental costs to be reclaimed. This might be handy if the landlord is intending to expend a large amount of money on the property. Normally, this Option to VAT is only exercised when the tenant is itself a VAT registered trading entity - so that it is able to reclaim the VAT being charged by the landlord. The vast bulk of landlords where the tenants are private, non VAT registered individuals, will not exercise the Option to VAT the rented property.
One of the big disadvantages of exercising the Option to VAT the property is that, when the time comes for the property to be sold, the sale price of the property must have VAT added on to it - which could put off lots of potential buyers.
Options to tax really only impact non-residential property; you could in theory opt to tax a residential property but any letting or sale of that resi property remains a VAT exempt transaction. https://www.accountingweb.co.uk/tax/business-tax/v...The VAT rules for limited companies are no different to the rules as they apply to individuals. It's not the status of the entity that determines whether it needs to register for VAT, but the nature of the activity being carried out.
With that out of the way, does VAT apply to income generated through the renting of a house as a dwelling? The answer is, generally no. Rental of property for residential purposes is normally VAT Exempt.
However, a landlord (whether an individual or a company - or some other entity such as a trust or charity - can exercise the Option to VAT the rental income and start levying VAT on the rents.
By doing this, it allows any VAT incurred on rental costs to be reclaimed. This might be handy if the landlord is intending to expend a large amount of money on the property. Normally, this Option to VAT is only exercised when the tenant is itself a VAT registered trading entity - so that it is able to reclaim the VAT being charged by the landlord. The vast bulk of landlords where the tenants are private, non VAT registered individuals, will not exercise the Option to VAT the rented property.
One of the big disadvantages of exercising the Option to VAT the property is that, when the time comes for the property to be sold, the sale price of the property must have VAT added on to it - which could put off lots of potential buyers.
As I said, not much point in Opting to VAT a Residential Property.
Matters can get a bit more complex if the residencvy is in the nature of a trade - such as an old folks home.
VAT and Land and Property is an extremely complex area and even top flight firms of accountants have got themselves confused.
Matters can get a bit more complex if the residencvy is in the nature of a trade - such as an old folks home.
VAT and Land and Property is an extremely complex area and even top flight firms of accountants have got themselves confused.
Eric Mc said:
The vast bulk of directors who loan personal money to their own limited companies do not charge interest on the loans. In many ways, it is is not worth the hassle for a number of reasons -
a) the company will claim the interest as a cost against their Corporation Tax profits. The maximum rate of Corporation Tax is currently 19% - so the company saves some tax at 19%
b) the interest paid to the director is taxable income in the hands of the director. He will pay Income Tax on that at his top Income Tax rate - which could be as high as 45% (depending on his overall income from all sources).
So you can see, there is a tax DISADVANTAGE in such circumstances.
There are also additional compliance costs involved for the company in reporting interest paid to directors.
Understood. Thanks for replya) the company will claim the interest as a cost against their Corporation Tax profits. The maximum rate of Corporation Tax is currently 19% - so the company saves some tax at 19%
b) the interest paid to the director is taxable income in the hands of the director. He will pay Income Tax on that at his top Income Tax rate - which could be as high as 45% (depending on his overall income from all sources).
So you can see, there is a tax DISADVANTAGE in such circumstances.
There are also additional compliance costs involved for the company in reporting interest paid to directors.
If you withdraw all profit as repayment of the directors loan. One thing to keep in mind is if you ever sell the property then the proceeds will be stuck in the company. What I mean is if the directors loan has be repaid in full, how are you then going to get the sale proceeds out of the company without paying tax on it as income?
I think a lot who us a Ltd SPV leave the directors loan account outstanding, encase they ever sell the property and need to withdraw the proceeds from from the company.
Its a difficult decision. I think repaying directors loans from profit is often just delaying the tax liability until a later date.
I am not an accountant, but I think they above is the scenario that you would need to discuss with one.
I think a lot who us a Ltd SPV leave the directors loan account outstanding, encase they ever sell the property and need to withdraw the proceeds from from the company.
Its a difficult decision. I think repaying directors loans from profit is often just delaying the tax liability until a later date.
I am not an accountant, but I think they above is the scenario that you would need to discuss with one.
Edited by Mortgage_tom on Tuesday 10th July 11:12
On the other hand, if an individual has personally put large sums of his own money into an enterprise, it makes sense to ensure that they are repaid those amounts without them having to suffer any unnecessary personal tax.
Don't forget, if they had drawn the money out of the company as a dividend (which is normal), the company would not receive any Corporation tax relief on that "cost" either.
Payments of dividends to shareholders are looked on as "Distribution of Post (Corporation) Tax Profits" so do not help reduce the company's Corporation Tax bill.
In that scenario, the company pays the full Corporation tax bill on its profits before dividends and the shareholder/director pays full Income Tax on the dividend amount they have received from the company - a lose/lose situation.
At least by repaying any director's loan only the company will pay Corporation tax. The shareholder/director will pay no Income Tax.
Don't forget, if they had drawn the money out of the company as a dividend (which is normal), the company would not receive any Corporation tax relief on that "cost" either.
Payments of dividends to shareholders are looked on as "Distribution of Post (Corporation) Tax Profits" so do not help reduce the company's Corporation Tax bill.
In that scenario, the company pays the full Corporation tax bill on its profits before dividends and the shareholder/director pays full Income Tax on the dividend amount they have received from the company - a lose/lose situation.
At least by repaying any director's loan only the company will pay Corporation tax. The shareholder/director will pay no Income Tax.
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