Your company’s shareholders own a property the company uses for its trade. By letting it rent free, subject to conditions, they’ll pay a reduced rate of capital gains tax when they sell the property but might they save more in income tax if they charged rent?
Tax planning conflicts
If you personally own the property your company occupies for its business there are several tax planning angles worth considering. Two of the main contenders are capital gains tax (CGT) business asset disposal relief (BADR) and profit extraction through rental income. The trouble is they conflict with each other. If you charge your company rent it can reduce the overall income and corporation tax (CT) bill, but as a result you’ll sacrifice at least some of the BADR you may be entitled to.
Income and corporation tax savings
Although dividends are generally the most tax-efficient way to extract income from your company, depending on the rate of income tax you pay, rent can be more efficient.
Example. Pat, who is a higher rate taxpayer, owns the workshop from which his company, Acom Ltd, trades. It pays rent of £2,000 per month (the market rate) and is liable for the maintenance costs. After tax relief the annual cost of the rent to Acom is £19,440 (£24,000 – 19% CT relief). After tax Pat receives £14,400 (£24,000 – 40%). The comparable figures for a dividend of £24,000 are: net cost to company £24,000 net income for Pat £15,900. By paying rent rather than a dividend Acom has an extra £4,560 in the bank while Pat is £1,500 worse off because of tax.
Net tax saving
Overall there’s a net tax saving of £3,060 between Pat and Acom. Of course, for Pat to extract the extra money from the company he will have to pay tax, which could be anywhere between 0% and 45%, but whatever the rate is he will be better off as a result of taking rent instead of a dividend.
Loss of BADR
The trouble with charging your company rent is that if you sell the property (as part of the sale of your shares in your company) for more than you paid for it, the gain which qualifies for BADR is reduced to take account of the period for which you charged rent and the rent you charged by comparison to the market rent.
Example. In March 2023 Pat sells his shares in Acom and the property to a third party. He makes a capital gain of £100,000. Assuming Pat has no other capital gains or losses for the year he’ll pay CGT of £17,540 (£100,000 – £12,300 exemption x 20%). However, had Pat not charged rent the gain would have qualified for BADR and Pat would have paid CGT at 10% resulting in a tax bill of £8,740 (£100,000 – £12,300 x 10%).
Which is more tax efficient?
Pat is better off by £3,060 per year (before tax) by charging Acom rent but £8,740 worse off in terms of CGT. The calculation needed to determine which is more advantageous is simple, but in practice it’s more difficult. We’ve assumed facts for the sake of our example but in real life you would need educated guess work and predictions to decide. You could take the proverbial “bird in the hand” approach and charge rent, but if you prefer a more scientific approach you’ll need to crunch the numbers.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.