You and your fellow directors own your company’s trading premises. Currently it occupies the property rent free. If this is the case, you should probably think about charging rent to your company as a tax-efficient source of income. But what is the income tax efficiency versus entrepreneurs’ relief? Tax expert Helen Johnstone takes a closer look.
Tax planning conflicts
If you personally own the property your company occupies for its business there are several tax planning angles worth considering. Two of the main contenders are capital gains tax (CGT) entrepreneurs’ relief (ER) and profit extraction through rental income. The trouble is they conflict with each other. If you charge your company rent it can reduce the overall income and corporation tax (CT) bill, but as a result you’ll sacrifice at least some of the ER you may be entitled to.
Income and corporation tax savings
Although dividends are generally the most tax-efficient way to extract income from your company, depending on the rate of income tax you pay, rent can be more efficient.
John, who is a higher rate taxpayer, owns the workshop from which his company, ABC Ltd, trades. It pays rent of £2,000 per month (the market rate) and is liable for the maintenance costs. After tax relief the annual cost of the rent to ABC is £19,440 (£24,000 – 19% CT relief). After tax John receives £14,400 (£24,000 – 40%). The comparable figures for a dividend of £24,000 are: net cost to company £24,000 net income for John £16,200. ABC has an extra £4,560 in the bank while John has £1,800 less in his.
Overall there’s a net tax saving of £2,760 between John and ABC. Of course, for John to extract the extra money from the company he will have to pay tax, which could be anywhere between 0% and 45%, but whatever the rate is he will be better off as a result of taking rent instead of a dividend.
Loss of ER
The trouble with charging your company rent is that if you sell the property (as part of the sale of your shares in your company) for more than you paid for it, the gain which qualifies for ER is reduced to take account of the period for which you charged rent and the rent you charged by comparison to the market rent.
In March 2020 John sells his shares in ABC and the property to a third party. He makes a capital gain of £100,000. Assuming John has no other capital gains or losses for the year he’ll pay CGT of £17,600 (£100,000 – £12,000 exemption x 20%). However, had John not charged rent the gain would have qualified for ER and John would have paid CGT at 10% resulting in a tax bill of £8,800 (£100,000 – £12,000 x 10%).
Which is more tax efficient?
John is better off by £2,760 per year (before tax) by charging ABC rent but £8,800 worse off in terms of CGT. The calculation needed to determine which is more advantageous is simple, but in practice it’s more difficult. We’ve assumed facts for the sake of our example but in real life you would need educated guess work and predictions to decide.
Charging your company rent is definitely worth considering. It’s likely to save tax until you sell the property, when it might result in a higher capital gains tax bill. Unfortunately, there’s no one answer that fits all. You need to consider many factors as they are now and what they might be in future.
As ever, do contact one of the team at JRW to discuss your own individual situation and we will be happy to advise.