What to do with spare funds held in your property companyFirst Published: July 2018 | Available in: Property Articles Your Property Network
Many property investors now operate a limited company, and may not be able to tax-efficiently take all of the company’s profits out, due to their personal income. This article looks at what options are available to company property investors who want to be tax –efficient by retaining spare funds within their company.
Spare funds in a property company? That sounds nice, how does that happen!
Many residential landlords now invest in property via a company, or may have a property management company, and may have personal income that is already at or above the Higher Rate income tax threshold (or, the investor may have a well-paid non-property PAYE employment and property investing is a side-line).
If the director has a directors loan account in credit – meaning, the company owes the director back for initial funds loaned to the company – the director can then access the company’s profits by treating funds taken from the company as a directors loan repayment – which is tax-free.
However, eventually the directors loan account will be repaid, and then the director would need to take taxable dividends to personally access the company’s profits (for 2019 onwards, only the £2k/person dividend allowance is tax-free. Basic Rate dividends are only taxed at 7.5%, however Higher Rate dividends are taxed at 32.5% – which, combined with the 19% corporation tax payable, makes for an excessive tax burden.
1. Use spare funds to buy new properties
It sounds obvious, but if the company has spare funds, these can be used as deposits for more properties owned by the company. In a company, all the mortgage interest payable is fully tax-deductible so all the usual benefits of using leverage (mortgages) to buy property apply. As the funds are not being extracted from the company, there is of course no tax charge to use the company’s spare funds to buy more property.
2. Make pension contributions
The company can make a gross pension contribution of £40k/person, which is a tax-deductible expense for the company. This can be a very smart use of spare company funds, because the company not only gets a corporation tax deduction for the pension contribution, but the funds within the pension are then very Inheritance Tax-friendly, as pensions can be passed to dependents tax-free. Potentially, over £1m of property profits could be transferred to a pension, and then the pension could be allocated IHT-free to dependent – effectively ‘converting’ IHT-unfriendly profits into IHT-friendly funds.
3. Pay down company borrowings
Most property investors reach a portfolio size that they are happy with, and decide not to expand the portfolio. At that point, spare funds can be used to make lump-sum mortgage repayments, or interest-only mortgages can be converted to repayment loans.
For many investors, a modest debt-free property portfolio is the ultimate goal – for Higher Rate taxpayers, not extracting company profits and instead paying down debt tax-efficiently, is a great way to achieve their ultimate goal.
4. Invest in the company’s properties
It’s a rare property investor who hasn’t got some repairs to spend money on! There are the usual very visible (to tenants) repairs, such as decorating, carpets, kitchens & bathrooms, which can alone add up to serious investment – but also the less noticeable investment into the fabric of the building itself – such as brickwork, pointing, roof, gutters & fascias, electrics, plumbing etc.
For properties that are planned to be held for the long-term, spending spare funds on protecting the building is usually money well spent, and usually pays for itself in terms of lack of future leaks, tenant complaints, voids, rental levels etc.
5. Pay yourself claimable expenses
Some funds can usually be taken from a company as legitimate expenses, which are not taxable income for the director in any event. Such expenses might include business mileage (i.e. the company is paying the director to hire the director’s personal car for business use, usually @45p/mile), home office allowance (i.e. the company is paying the director to use the director’s home for business use), interest on a directors loan, reimbursement for expenses incurred on the company’s behalf etc.
6. Pay salaries to family & friends
It is possible to involve family members, or trusted friends / business partners, if those individuals do genuine work for the company – such as: property management, refurb advice & monitoring, insurance & mortgages review, book-keeping and financial management etc.
A ‘Lower Earnings Level’ (2018: £5,876) salary can be paid to a person without the company needing a formal PAYE scheme, and any self-employed person can invoice a company for services provided. Of course, the recipient of the company’s funds ought to declare that income as income, but that is a matter for the person concerned.
7. Buy new consumable assets
All companies need ‘consumable’ assets to operate, and a property company is no different. Such assets would be computers, phones, tablets, printers, scanners, monitors, office equipment etc. And, even luxury pens (e.g. Mont Blanc), folders, briefcases etc are allowable expenses if genuinely used for business.
The key is that there is a credible reason why the item is a business expense – there is no specific amount as an allowance, although its unlikely that a diamond-encrusted solid-gold iPad is likely to be accepted by HMRC as having no personal ‘dual purpose’ whatsoever!
8. Use the company’s spare funds as your personal savings
Although dividends can’t be permanently taken from a company without tax being paid, it is possible to run up a directors loan account ‘debit’ (overdraft) with a company i.e. to borrow money from your company on a non-permanent basis.
‘Non-permanent basis’ means that the funds have to be repaid to the company within 9 months of the company’s year-end (not within 9 months of having borrowed the money). So, for example, borrowing money in July 2018 from a company with a year-end of 31 March 2019, would mean that the loan from the company needs to be repaid by 31 December 2019 to avoid a tax charge on the loan i.e. the director has 17 months to repay the loan. (Note: some interest must be paid to the company to cover the ‘Benefit-In-Kind’ tax that would otherwise arise, but this is very minimal i.e. 3% per annum).
9. Lend funds to other investors
Many company directors with spare funds are investing those spare funds with other property investors, typically those at an earlier stage in their property investing career, and have made good profits as a result. Sometimes this will be for a fixed % rate return, and sometimes this will be for a share of the anticipated profits of a development of rental investment.
10. Finally – don’t buy or lease a company car!
A fairly common question is ‘should I buy a company car’ – the answer is almost (99.9%) always a resounding ‘no’! The reason is that company cars are taxed on both the director AND the company, which makes for a prohibitive tax bill, unless the car in question is an electric car of very low CO2 emissions car. In practice, most reasonable cars are far better owned personally by the director, and mileage of 45p/mile charged to the company (note – this is an important topic and will be covered in depth in the August 2018 edition of YPN).
In summary …
Using a company is often a very tax-efficient way to invest in property, or manage property, following the ‘Section 24’ mortgage interest relief restrictions that started in tax year 2018. However, for many property investors who use a company and have exhausted their in-credit directors loan account, paying 32.5% Higher Rate dividend tax on funds taken from the company, isn’t an attractive proposition. This article sets out a number of ways in which such investors can retain funds within their company and so grow their wealth as a result.
It may well be that at some future point in life such investors may revert back to being Basic Rate taxpayers, and so extracting company funds at that point becomes much more acceptable. Or it may be that such investors decide that their personally-held portfolio profits are for day-to-day spending, and that their company is for long-term wealth-accumulation, perhaps with estate-planning and succession planning in mind. Either way, Higher Rate taxpayers have to make the classic investment decision – do I take less more from my company and just pay the extra tax, or do I retain profits within my company to build wealth rather than spending it now?