On the 6 May Adrian Smale, Associate Partner from Ernst & Young gave a well-received overview of tax considerations for property investors and developers as part of our 2022 Real Estate Seminar programme.
Following the seminar our Partner in Real Estate Craig Burton sat down with Adrian for a Q&A to find out more about the differing tax considerations and discuss the questions and issues commonly raised or encountered by property developers and investors.
Craig: Hi Adrian, it is lovely to see you and thank you for your interesting and insightful seminar. You kept us all engaged with what is a very complex process impacted by a number of factors! You began the seminar with a summary of how the industry has changed over recent years, what are the key changes investors and developers need to be aware of?
Adrian: The tax landscape has changed significantly over the last 10 years or so (both in terms of the different tax rates applying to direct vs corporate property ownership and the extension of the UK tax net to non-UK resident or domiciled owners).
The focus today should therefore be about ensuring your ownership structure is still suitable for the current tax regime and importantly avails of the statutory tax reliefs available.
Craig: You mentioned there are different structures depending on your business model? What are the key differences here?
Adrian: There's a significant difference between the additional rate of income tax at 45% and the current corporate tax rate of 19%. For property developers and traders, particularly where the profits are being reinvested into the business, a corporate structure therefore makes much more sense.
Corporate structures also tend to offer more flexibility from an inheritance tax perspective (as it's easier to gift shares in a company than an interest in a property).
Craig: Why is it important to be aware of and consider these options / holding structures?
Adrian: Most clients I talk to that hold properties personally for investment purposes have struggled with the finance cost restrictions that came into force in full in April 2020, particularly where they are exhausting opportunities for revenue qualifying repairs.
Where the capital gains tax and stamp duty land tax reliefs apply, there can be huge benefits of incorporating a property investment business (including the reduced tax on rental profits, removal of finance cost restrictions and the step up in the base cost of the properties to their current market value).
One of the other ideas we discussed in the seminar was the concept of introducing a "linked investment company" to an existing corporate business which can also offer significant tax savings on a future exit or liquidation (e.g. saving 20% capital gains tax on proceeds / funds that are being reinvested into another business or protecting the value of the underlying business from 40% inheritance tax).
An efficient tax structure can therefore offer significant savings.
Craig: You also spent some time in the seminar examining potential solutions to help mitigate inheritance tax. Whilst I appreciate again this depends on structure, what is your advice here?
Adrian: For whatever reason, the tax regime favours property development / trading activity over property investors, particularly when it comes to inheritance tax. For property investors who are concerned about inheritance tax, early planning is crucial.
Where you have a mixed property development and investment business, care is needed to ensure that as a minimum you qualify for inheritance tax relief on the development business but as discussed in the seminar, it may also be possible to exempt everything depending on the relative size of each business.
Craig: Another question commonly raised is how to address the issue of latent gains? Is there any specific advice you would give around this topic?
Adrian: Yes, I do get asked this a lot by clients. Helpfully there are a couple of opportunities available depending on how the investment assets are held. We've already mentioned the potential to incorporate directly held investment properties to a company at their current market value – the latent gain is rolled into the shares of the company, but often this can be a permanent deferral. Where the investment properties are already in a corporate structure, it may also be possible to remove any latent gains via a corporate restructuring exercise (this is a much more complex exercise though and should only be considered for wider commercial objectives).
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As highlighted above and at the seminar, tax considerations for investors and developers is a complex area, with the best structure dependent on and impacted by a number of factors. It is, however, given the possible tax implications, important to give due time and resource to considering how best to structure your activities significantly ahead of a future sale or a succession event.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.