Do you have a company for your main business activities?

Are you paying heavy taxes on the money you take out of the business and invest in property?

The problem: taxes on the money you take out of a company

The problem I see with many real estate investors who own limited partnerships is that they don’t take into account the amount of tax they pay when taking salaries or dividends from the company. If you are a higher rate taxpayer, you will pay an additional 22.5% tax on money you take out of the company as dividends.

I have worked with some clients who had a loss on an investment after taking taxes into account. Why would he go out of his way just to pay HMRC?

You may want to claim relief from entrepreneurs in your commercial business activities, and therefore do not want to jeopardize this by investing in residential property that you plan to keep long-term and rent out. As such, you could have two limited partnerships:

One for commercial business activities.
One for investing activities.

Scenario 1: Current structure

Let’s say you pay yourself £100,000 from the limited company. For simplicity, let’s imagine you’re using £50K of this money for a property investment as follows:

Investment of £50,000
-£11,250 tax on dividends at 22.5%
£38,750 net cash to invest

You then buy a property using the above money making a profit of £500 per month:

£6,000 annual profit
£2,400 tax at 40% on the above amount
£3,600 net cash

As you can see in the scenario above, you’ll pay £13,650 in tax. This doesn’t even take into account the fact that mortgage interest relief will soon be capped at 20%. This topic is further explored on our budget announcements blog.

Scenario 2 – Suggested Limited Partnership Structure

Instead of buying property in your own name, you can buy property in a new limited partnership, one that is separate from your business activities. You as an individual create the company with a £1 share, or £2 if you are creating the company with your partner. This way, you can take advantage of relief from entrepreneurs if the business goes out of business.

Company A (your trading company) loans Company B (your investment company) £50,000. No taxes are paid on this loan.

Now let’s take another look at the numbers.

£6,000 annual profit at company B
£1,500 interest paid to Company A
£4,500 profit
£665 tax based on 19% corporate tax (for 2017)

You can see from the above that you will pay just £665 of tax in Scenario 2 compared to a Scenario 1 tax liability of £13,650.

Interest from one company to another: commercial arrangement

Since company A lends money to company B and both are separate legal entities, the interest on the loan must be at commercial rates. So it should be around 3% above the Bank of England interest rate, which at the moment would mean a 3.5% interest charge on the loan.

• 3.5% annual interest from a limited partnership
• Interest income will be taxed at Company A
• The interest charged to the second company will be a tax deductible expense for company B

Also, I would advise against charging a limited company an interest charge if you personally loan them money, as you would then be paying taxes on the interest.