How Should I structure my JV arrangement? part 1: developersFirst Published: November 2013 | Available in: Property Articles Your Property Network
Many property investors work together with other investors to pool funds and expertise and so enable them to do deals that they may not otherwise be able to. This article looks at the most common way for property developers (rather than landlords) to set up their affairs in the most tax-efficient way while also not entwining their personal and business finances too closely together (other alternatives may be more suitable for more permanent, or family, arrangements for example).
Typical objectives of a JV arrangement
Typical key objectives structure for JV partners working to develop property are as follows:
Flexibility to enable tax-efficient profit distribution to each JV partner – so must not cause tax problems for any partner
Must allow the most beneficial financing of property projects – usually on a BTL basis.
3. Limited financial integration of partners
Must not entwine the affairs of each party too closely – allowing each to leave the JV without causing disruption, and no chance of a credit status issue caused by a JV partner.
introducing the ‘hybrid jv model’ – companies + llp set-up
The most common form of structure for a property-developing JV is to use an LLP (Legal Liability Partnership) as the trading entity, and have (say) two companies and two individuals as partners (assuming two JV partners working together).
This has the following effects and benefits:
The LLP, as the trading entity, makes its profit, and then pays out that profit to the companies, but not the individuals i.e. the profit share is typically:
- Company A 50%
- Company B 50%
- Individual A 0%
- Individual B 0%
The main reason for this is that developing profits – unlike rental profits – are subject to National Insurance (around 10%) – whereas companies don’t pay NI on business profits. And, by running the development profit into the companies, each partner can then decide how they take their funds out (usually a mix of small salary / larger dividends) to avoid paying Higher Rate income tax.
Note – the LLP is just a normal partnership for tax purposes i.e. it doesn’t pay tax on LLP profits, the partners themselves do. Since companies pay 20% corporation tax, rather than National Insurance or Higher Rate (40%) tax as individuals do, there is a significant tax saving to be made.
If the profits are taken by the individual partners, then Higher Rate tax and NI would apply – hence the 0% profit shares for the individuals.
The individuals, being shareholders of the companies, would then pay themselves a tax-efficient mix of salary and dividends – typically producing a zero personal tax bill.
Most small property developers finance their property developments using BTL finance obtained personally – this is far cheaper and easier to acquire than finance for companies. The property is then introduced into the LLP by way of a ‘beneficial transfer’ (documented via a trust deed), so that it is the LLP that accounts for the property and its development / sale.
A key additional benefit of using an LLP is that where property is transferred into an LLP in this way, there is no SDLT to pay – whereas there would be when transferring the beneficial interest of a property into a company.
3. Limited financial integration of partners
Not every JV partner has a clean credit record, and JV partners may also want to ‘test the water’ with a new partner initially. And, of course,most JV arrangements exist in the first place because each partner brings something to the table – typically cash and ‘mortgageability’ from one partner, and expertise / work from the other.
Each partner may not wish to buy their properties jointly, since this would link their credit files together, and any impairment in one partner’s record could cause issues for the other partner. Also, JV partners often join together on an ad hoc basis, and so their financial linkage needs to be easily severed without adverse consequences.
Using an LLP allows each partner and / or their company to link together for a single project, receive their profit share tax efficiently, finance projects personally, yet be able to file the LLP accounts and then dissolve the LLP – a simple and clean end to the JV.
Why not use a single company and just pay dividends out?
For some JVs, this simple option may be entirely appropriate. However, there are two main downsides:
- Each of the shareholders may have a differing incomes / tax positions, and using a company to pay out dividends is an inflexible way of distributing profits, especially for enduring JVs where each project may have a different agreed profit share
- Finance for companies is significantly harder to obtain than for individuals, with a smaller range of lenders to choose from, and often higher rates and fees
A ‘LLP + companies’ hybrid structure allows for flexible and tax-efficient JV arrangements, while allowing personal finance to be used for purchases. A simple LLP provides a limitation to each partners’ personal liability should anything go badly wrong, and can be closed down simply,and cheaply after a JV project is completed.
Of course, the one thing that any JV arrangement by itself cannot do is generate substantial profits – and that’s where JVs really come into their own: leveraging the skills, experience and funds of each partner to produce property profits that otherwise would not be achieved.