Two key options being considered by many developers as a way of generating some cash flow are:-

1. Letting of new homes

2. Taking homes in ?part exchange? when selling new homes

Whilst both of these options can ease cash flow and help a developer survive there are pitfalls for the unwary which can result of significant repayments of VAT ? just when a developer wishes to avoid all such liabilities.

The building and sale of new homes is a ?zero rated? supply for VAT ? which means a developer can reclaim all of the VAT on his building costs. If no sale is made (because the property is let) the developer moves from making a ?zero rated? to making an ?exempt? supply.

Similarly if a developer takes a house in part exchange for one he has built the subsequent sale of the part exchange property is exempt from VAT.

Both of these actions take the developer into the regime of ?partial exemption? and the repayment of VAT reclaimed (unless the VAT recovered during the building of the original property falls below the de minimis level of £7,500 per annum and 50% of the total input tax of the business).

However a little advance planning can avoid these problems.

If a developer is letting his newly built property he should consider selling it first to another group company, before letting.

Similarly where properties are being taken in part exchange a developer should take ownership of the part exchange property in another group company.

This article deals only with VAT. When undertaking any tax planning all taxes should be considered with professional advisors before implementing any proposal.

For the investor Capital Allowances allow tax bills to be reduced and increase cash flow. If the initial investment in a building is reduced by virtue of paying less tax the yield increases.

About Kingston Smith’s property team

Kingston Smith is the fastest growing top 20 firm of Chartered Accountants. Our property team have considerable experience in the property sector and work with clients in property development, construction, investment and management. We help clients run their businesses more successfully by providing practical advice such as planning ownership structures to minimise their tax exposure. We provide accounting services ranging from bookkeeping and management accounts to the preparation and audit of year end financial statements, as well as helping to improve financial efficiency and source alternative methods of funding.

To find out more about Kingston Smith?s bespoke services to the sector please visit: www.kingstonsmith.co.uk/kingston-smith/sectors/property.html

We are, of course, talking about Gordon Brown, heir apparent to Tony Blair’s throne and Budget 2007 was, perhaps, his last big chance to demonstrate his election-winning potential to his colleagues before the long-anticipated Labour leadership contest.

All of this was already well known before the Chancellor began his Budget speech in its new lunchtime slot at 12.30pm. What few people knew before that moment, however, was just what a radical shake-up he had in store for us. I, for one, had anticipated little else but political spin in the speech and reams of technical gobbledegook in the press releases which followed. (I’m the poor sap who has to read, digest and explain those press releases, after all!)
Well, I wasn’t entirely wrong; the speech certainly did contain its fair share of political spin.

The Chancellor began with a few jokes about his long service in the post (he is the longest-serving Chancellor since 1827) and some interesting comments about his ‘comrades’ at the Treasury.

Josef Stalin?

But references to his earlier comparison with Josef Stalin soon faded away as he began to announce some fairly major tax reforms and even one or two headline tax cuts (more of that later). When he also announced that he was proposing to sell off £36 Billion in State-owned assets over the next three years, I began to wonder if the last twenty years had been just a dream and it was actually still 1987 after all.

Amazing, isn’t it, just when you think the Government has sold off everything they can, they still keep scraping up a few more things from the bottom of what must surely be an endless barrel. The student loan book, worth £6 Billion, is apparently now up for sale. It makes me wonder how long it will be before our sons and daughters find that they are now in debt to some rather unsavoury characters in New Jersey, Nevada or Sicily!

Amongst the political spin and flowing rhetoric, however, it must be admitted that this year’s Budget had more real substance than we have seen for several years. Taxation’s place at the heart of the Budget speech seemed to be restored after an enforced absence of several years. “If that’s the size of the tip�, I thought, “I’d better brace myself for the iceberg!� I wasn’t disappointed – as soon as the Chancellor had sat down, the Treasury immediately released a staggering 81 press releases together with more than 40 pages of Budget notes, more than 230 pages of technical material in all.

So it seems that for this, surely his last Budget, Gordon Brown has rediscovered the power of the tax system to win over the electorate (or so he must hope) and, as he closed his speech with the shock announcement of a two pence in the pound reduction in Income Tax, to its lowest rate in 75 years, I had to admit (grudgingly), that he is certainly going out in style!

But who is going to pay for it?

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Rates of Tax
Let’s start with the basics. A company pays corporation tax at 19% on its profits up to £300,000. Above that level, the rate of tax goes up on a sliding scale, but the maximum a company will pay on all its profits is 30%.This sounds excellent when compared to income tax at 22% up to income of £33,300 per year and 40% above that, but the problem is that the money is still in the company, and there will be further tax to pay when it is taken out for the shareholders’ use.

“The Corporate Veil�
This is an expression used by the courts to describe the relationship between a company and its shareholders, though for some reason it always reminds me of exotic dancers!

The point is that a company is a separate legal person from its shareholders and its employees, it pays its own tax on its profits and gains, it can be sued for its debts, and it is the legal owner of the money it makes. If the shareholders want to take money out of the company, getting it through the corporate veil will usually create a tax charge.

Getting the Cash Out
Broadly, there are five ways you can extract cash from your company. Starting with the most obvious, they are:

 Wages, salaries, and bonuses
 Dividends
 Benefits in kind
 Loans
 Liquidations or share sales

Wages, salaries, and bonuses
Generally speaking, this is the most expensive way to extract cash from a company, because both you and the company will have to pay National Insurance Contributions. For 2006/07, yours will be at 11% up to a salary of £33,540, and 1% thereafter. The company will pay employer’s contributions of 12.8%, with no upper limit.

If the company is your only source of employment, however, don’t forget that no National Insurance is due on wages of less than £97 per week. In these circumstances, it makes sense to pay yourself (and any other shareholder or family member who genuinely works for the business) this much per week. Because the company can claim the cost of your salary as an expense against its profits chargeable to corporation tax, there will be a saving of just over £958 (£97 times 52 weeks = £5,044. £5,044 reduction in company’s profit (taxed at 19%) saves £958.36p) as a result of paying a salary just below the NIC threshold. The income tax payable on the salary is neither here nor there, because if you were trading as an individual you would still have had to pay that.

Dividends
If a company “distributes� its profits to shareholders by paying dividends, it cannot get a deduction from its taxable profits for doing so, so the sums are rather different.

Because dividends are paid out of profits already charged to corporation tax, they come with a “tax credit� that can be offset against any income tax due from the shareholder who receives the dividend. The arithmetic is complicated, but basically what happens is:

If the company pays a dividend in cash (say, £900), you have to add one ninth (£100) to it to arrive at the taxable amount, so in this case you are treated as receiving £1,000 of taxable income, which includes a “tax credit� of £100.

If you do not pay tax at the higher rate, the tax credit is enough to cover the income tax due, so you do not need to pay any further tax.

If you are a higher rate taxpayer, you will pay income tax at the “dividend rate� of 32.5% on your dividend of £1,000, giving a tax bill of £325. From this you can deduct the tax credit of £100, so you have to pay a further £225 in income tax.

It’s much simpler to look at it this way – a higher rate taxpayer will pay income tax of £225 on a dividend of £900 cash – that’s 25%.

Benefits in kind (cars, holidays, TVs, etc)
These used to be a good way to extract value from your company, because generally speaking, no National Insurance Contributions were due on benefits that were not in the form of cash, but the company could still deduct the cost from its profits.

Unfortunately, the rules are now much tighter, and as a general rule, the company will have to pay NIC on the value of any benefits in kind it provides, so there is no real point in serious “BIK� planning.

There are a few benefits that are tax free, and thus worth considering. Some common examples are:
 Childcare (up to £55 per week, and subject to various conditions)
 Car parking at the workplace
 Mobile phones (only one per employee, thanks to this year’s Budget!)
 Staff parties up to a cost of £150 per head per year

Loans
There is some quite complex planning that can be done here.

First of all, when setting up a company, it is often wise to lend it the money it needs to get started, rather than putting this in by subscribing for shares, because the company can repay that loan in the future with no income tax charge on the lender.

The other side of the coin is if the company lends money to you. Generally speaking this is unwise, because the company itself has to pay a form of “deposit� to the taxman, of 25% of the amount loaned – this is repayable when the loan is repaid.
If the company lends more than £5,000 to you, you will be charged to income tax on the difference between the interest on the loan you pay to the company, and the “official rate� of interest (currently 5%) – so if you have an interest free loan of £5,001 for a year, you will pay income tax on £250, meaning £100 tax for a higher rate taxpayer.

That may sound rather a good deal, but beware – there are Company Law problems to consider.

More sophisticated planning involves the company lending money and then writing off the loan – but this is an area where you must have specialist advice to avoid getting into serious trouble with both the taxman and Company Law.

Sales and Liquidations
If you sell your company to someone else, you are selling them the shares in the company. If you liquidate your company, the shares cease to exist, and you become the owner of the company’s assets.

In either case, you will realise a capital gain, based on the difference between the cost of your shares and the price you get for them, or the value of the company’s assets in the case of liquidation.

Capital gains are taxed as if they were income, but there are some reliefs that will reduce the taxable amount. The first £8,800 of your capital gains for the tax year 2006/07 is exempt from tax – this “annual exempt amount� increases each year.

There is also “taper relief�, depending on how long you have owned your shares, and on whether the company was a “trading company� or not.

In the case of a trading company, the capital gain is reduced by half if you have owned the shares for one year and by 75% if you have owned the shares for two years.

Putting this together with the “annual exempt amountâ€? means that you could realise a gain of £35,200 on your shares in a trading company, and if you had owned them for two years you would pay no tax – £35,200 reduced by 75% is £8,800.

For other companies, taper relief does not start until you have owned the shares for three years, and then it only reduces the gain by 5% for each year, until it reaches its maximum reduction of 40% after you have owned your shares for ten years.

The definition of a “trading company� is a strict one, and unfortunately, a property investment company is not a “trading company�. Property development companies (which buy or build properties for resale), or property management companies (which do not own property, but deal with the collection of rents, repairs, finding tenants, and so on) can be trading companies, however, so there are planning possibilities for them.

So, should I use a company or not?
There is no simple answer, and I hope this article has helped explain why, but here are two general guidelines:

 If you do not expect to be paying income tax at the higher rate, there is probably little tax advantage in using a company – the difference between 19% corporation tax and 22% income tax will probably not justify the cost of running the company.

 If you expect to pay tax at the higher rate, and you intend to reinvest some of your profits to grow your business rather than taking them all for your personal use, you may well be better off by using a company – the 19% rate of corporation tax is a real advantage if the profits are to be retained in the company rather than taken out using one of the methods described above.

About the Author
James Bailey (CTA) is author of the newly released guide – ‘How to Use Companies to Slash Your Property Taxes’, which is available through the Property Tax Portal.

To learn more about his guide click here.

Commercial property qualifies for ‘business asset taper relief’, which means 75% of your profits are tax free. To qualify, you have to have owned the property for at least two years and rent it out to a qualifying business.

When you qualify for full business asset taper relief, your maximum tax rate is 10%, but rates as low as 1%, or even 0%, can be achieved if you sell the property in a year when you have very little other income or capital gains.

Compare that with most residential property which only qualifies for the more stingy non-business taper relief which only shelters 40% of your profits after 10 years.

Some commercial property may get off lightly when it comes to Capital Gains Tax but there is one type of residential property that also qualifies for business asset taper relief.

I’m talking about investment in ‘furnished holiday lettings’, such as holiday cottages in Cornwall and flats in popular tourist destinations such as London and Edinburgh.

BREAK POINT

Apart from business asset taper relief, furnished holiday lettings also qualify for the following tax breaks:

Loss Relief:

Ask any accountant who prepares tax returns and they will tell you that many of their clients are sitting on rental losses. Even if you invest in property with a high rental yield, once you lop off mortgage interest, agents’ fees, repair costs and wear and tear, most buy-to-let investors are in the red.

These losses cannot be deducted from your other taxable income, such as your salary. Instead they have to be carried forward year after year until you have some rental profits to set them off against. For many investors such losses are therefore largely worthless.

Furnished holiday lettings are an exception, however, because you can offset your rental losses against your other income. Why is this so attractive? Because every fl of losses is fl of salary or other income on which you don’t have to pay any Income Tax.

Rollover Relief:

Furnished holiday lettings are the only type of residential property that allow an investor to sell one property and postpone Capital Gains Tax by investing in another.

This relief allows you to sell properties in areas that are underperforming and seek out new properties in up-and-coming ‘hotspots’, without fear of losing profits to the taxman.
A furnished holiday letting business may also be exempt from

Inheritance Tax where the lettings are short term and the owner is involved with the holidaymakers’ activities.

To qualify as ‘furnished holiday lettings’, the property has to be:

- situated in the UK
- furnished
- available for letting to holidaymakers for at least 140 days a year. These must be proper commercial lets, not ‘mates’ rates’
- Actually let for at least 70 days a year
- Not occupied for more than 31 days by the same person in any seven-month period.

Although the property doesn’t have to be in a recognised holiday area, the lettings must be to holidaymakers and tourists to qualify.

Of course, many commercial property investors would wince at the idea of letting a property for just one month, especially those sitting on cushy 20-year leases to government departments and the like. And you should never let the tax tail wag the investment dog.

Nevertheless, there is a thriving market in UK holiday properties and many investors are unaware of the tax benefits.

This article originally appeared in Property Week 12 May 2006 and was supplied to LandlordZONE by Nick Braun the founder of tax guide publisher Taxcafe.co.uk ©TaxCafe