HOW SHOULD YOU STRUCTURE IT?
We recently had a client approach us who was looking to purchase a commercial property for their growing business.
Their initial thought was simply to buy the property through their existing trading company. However, before proceeding, they asked an important question:
Is there a better way to structure the purchase?
For many business owners, the answer may be yes.
Buying Through Your Trading Company vs a Separate Property Company
One option is for the existing trading company to purchase the premises directly.
While this is simple, it also means that a valuable property asset sits within the same company carrying on the day-to-day trade.
An alternative is to establish a separate property company (often referred to as a PropCo) to purchase the building. The trading company then occupies the premises under a commercial lease and pays rent to the property company.
A simplified structure might look like:
Business owners → Property Company → Commercial Property
Property Company → leases property to → Trading Company
There can be several advantages to this structure.
Most importantly, it separates the property from the risks of the trading business. It can also provide considerably more flexibility in the future. For example, if the trading business is eventually sold, the owners may be able to retain the property and continue receiving rental income rather than having to sell the building with the business.
Depending on the wider plans of the shareholders, a holding company sitting above the trading and property companies may also be worth considering.
What About the Rent?
The property company would normally charge the trading company a commercial rent under a formal lease.
Provided the premises are being used for the trade and the arrangements are commercial, the rent should normally be deductible when calculating the trading company’s taxable profits.
The property company will then recognise the rent as income and can generally deduct allowable costs associated with its property business, including qualifying mortgage interest, repairs, insurance and professional costs.
Don’t Forget VAT
VAT can be one of the biggest considerations when purchasing commercial property.
For example, a property costing £280,000 plus VAT requires an additional £56,000 of VAT to be funded at completion.
Where appropriate, the new property company may register for VAT and opt to tax the property. This can allow it to recover VAT incurred on the purchase, subject to the relevant conditions.
The property company would subsequently charge VAT on the rent it invoices to the trading company. Where the trading company is itself fully VAT taxable, it should ordinarily be able to recover that VAT.
It is important that the VAT position is established before the property purchase completes. The seller’s own VAT and option-to-tax position should also be checked to make sure VAT is actually being charged correctly.
Capital Allowances Can Be Valuable
Another area that is easily overlooked is capital allowances.
Part of the purchase price of a commercial property may relate to qualifying fixtures and integral features such as electrical systems, heating, air conditioning and other equipment.
The seller’s existing capital allowance position should therefore be investigated and, where appropriate, a Section 198 election agreed between the buyer and seller.
The value agreed can have a significant impact on the tax relief available to the buyer, so a nominal £1 election should not simply be accepted without understanding the consequences.
For newer commercial buildings, there may also be an entitlement to Structures and Buildings Allowance (SBA). Any existing SBA allowance statement should therefore be requested as part of the purchase process.
Corporation Tax and Associated Companies
Creating another company can have Corporation Tax consequences.
Where the trading company and property company are under common control, they will normally be associated companies for Corporation Tax purposes.
This can reduce the thresholds at which the Corporation Tax marginal and main rates apply, so the additional tax cost should be calculated before deciding on the structure.
There are also additional annual accounts, Corporation Tax returns and administrative costs associated with operating another company.
What About SDLT and Finance?
Stamp Duty Land Tax will normally be payable on the commercial property purchase regardless of whether the purchaser is the existing trading company or a new property company.
Finance also needs to be considered early.
Many lenders are comfortable lending to newly incorporated property companies where an established connected trading company will occupy the premises. However, lending criteria vary and lenders may require personal guarantees, a guarantee from the trading company or additional security.
The proposed structure should therefore be discussed with the mortgage broker before contracts are exchanged.
Getting the Structure Right Before You Buy
Commercial property purchases can involve substantial sums of money, and the structure used at the outset can have consequences many years into the future.
At Tax Compute, we can advise on the structure before the purchase takes place, including:
- whether the property should sit within your existing business or a separate company;
- whether a holding company structure should be considered;
- Corporation Tax and associated-company implications;
- VAT registration and option-to-tax considerations;
- capital allowances and Section 198 elections;
- Structures and Buildings Allowance;
- commercial rent and intercompany arrangements; and
- the tax implications of eventually selling either the property or the trading business.
Getting advice before you buy is much easier than trying to restructure afterwards.
Buying a property through the wrong entity, failing to deal with VAT correctly or overlooking valuable capital allowances can result in unnecessary tax, lost reliefs and significant costs when the business or property is eventually sold.
If you’re considering purchasing commercial premises for your business, speak to us before contracts are exchanged. We can review the proposed purchase and help you put the right structure in place from the outset.