Mark McLaughlin warns that company shareholders who personally own the trading premises and charge their company rent for occupying it to achieve income tax and National Insurance contributions savings may be faced with a future capital gains tax headache.
The government’s reform of the taxation of dividends from 6 April 2016 is likely to mean that some shareholders start looking for other ways to extract profits from their company.
Many company shareholders (and business partners) personally own the trading premises from which their company (or partnership) operates. Charging the company rent may be considered attractive. For example, unlike salary, rent does not constitute earnings for Class 1 National Insurance contributions (NICs) purposes. Furthermore, an individual who only rents out a single business premises is unlikely to be liable to NICs on the basis of carrying on a business. In addition, rent to occupy a business premises is generally an allowable trading deduction for a company.
Disposing of the property
When the business premises are eventually sold (e.g. on the individual’s retirement, or the cessation of business), the owner may be faced with a capital gains tax (CGT) liability if the property has increased in value over the period of ownership. The CGT rate in most cases will be 20% (for 2016/17), based on changes in the Finance Bill 2016.
Generally speaking, if entrepreneurs’ relief (ER) is available on an ‘associated disposal’, an ER claim can result in a CGT rate of 10% instead. The associated disposal rules are relatively complex, and outside the scope of this short article. In broad terms, ER may be due where there is a disposal of an asset (e.g. business premises, as in the above example) owned by an individual, but used for the purposes of a business carried on by a company, which is the individual’s ‘personal company’ as defined (or a partnership in which the individual is a partner). Such a disposal will be an associated disposal (i.e. a ‘disposal associated with a relevant material disposal’) if certain conditions are satisfied (in TCGA 1992, s169K).
Let us assume for the purposes of this article that a shareholder disposing of the company’s premises satisfies those ER requirements.
Unfortunately, that is not necessarily the end of story as far as claiming ER is concerned. The gain eligible for ER on the associated disposal of the property in the above example is subject to restriction (on a ‘just and reasonable’ basis) in certain circumstances, with the balance remaining a chargeable gain without the relief.
One such circumstance is where, for all or part of the period in which the property was used for business purposes, it was available for that use only on the payment of rent (s169P(4)).
What is ‘just and reasonable’ in the context of rent will depend on the extent to which any rent paid is less than an open market rent (s169P(5)(d)). Estimates of a market rent are likely to be referred by HMRC to the Valuation Office Agency for their agreement or view.
Not always bad news?
However, what if rent was charged in the past, but subsequently ceased? A transitional rule from when ER was introduced (FA 2008, Sch 3, para 6) may be useful in some cases. It broadly has the effect that, for the purposes of calculating the above ER restriction, only periods for which rent was paid after 5 April 2008 are taken into account.
HMRC’s guidance (in its Capital Gains manual, at CG64145) includes a helpful example of an ER calculation. It should be noted that if (for example) a company shareholder has owned the property for many years, but ceased charging the company any rent for periods after 5 April 2008, the rent restriction for ER purposes should not apply.
The above HMRC guidance also includes an example which indicates that only rent charged by the individual who is disposing of the property needs to be taken into account, even if other family members charged the company rent before the present owner acquired it. However, it should be remembered that HMRC’s guidance is non-statutory, and HMRC may not necessarily follow it, particular in cases involving tax avoidance.
Aside from CGT, other tax implications of owning the premises personally (e.g. inheritance tax) and possibly charging rent (e.g. stamp taxes) need to be carefully considered.
Mark McLaughlin CTA (Fellow), ATT (Fellow), TEP runs Mark McLaughlin Associates (www.markmclaughlin.co.uk), is Managing Editor of TaxationWeb (www.taxationweb.co.uk) and is General Editor of Bloomsbury Professional’s Core Tax Annuals and Tax Planning and co-author of Incorporating and Disincorporating a Business.
This article was originally written for Tax Insider in May 2016.