If you own the trading premises of your business, charging rent can be a good way to extract income. The trouble is it can increase any capital gains tax (CGT) payable if you sell the property. Can the income tax saving justify the extra CGT? Kenny Logan from our Edinburgh office takes a closer look.
Although dividends are generally the most tax-efficient way to extract income from a company, if you personally own its trading premises, receiving rent can save more tax. Your company gets corporation tax (CT) relief for the rent you charge which it doesn’t for paying dividends. This in turn leaves more to distribute to you as a shareholder. The downside is that, unlike dividends, rent can affect other taxes, namely capital gains tax (CGT) if you sell the property.
Robert, a higher rate taxpayer, owns the retail unit from which his company, Bruce Ltd trades. It pays Robert rent of £2,000 per month (the full market rate). After CT relief the annual cost of the rent to Bruce Ltd. is £18,000 (£24,000 less 25% CT relief). After tax Robert nets £14,400 (£24,000 – 40%). If Robert took a dividend of the same amount, the net cost to Bruce Ltd for paying it would be £24,000. After tax at 33.75% Robert would be left with £15,900. By paying rent instead of a dividend, Bruce Ltd. is £6,000 better off but Robert is £1,500 (£15,900 – £14,400) worse off. Business asset disposal relief (BADR) is not available for periods when the asset was not used by the business or periods where you charged full commercial rent (some relief should be available if rent was charged below the commercial rates).
Overall, Robert and Bruce Ltd. save tax of £4,500 by taking the rent option. The tax saving is initially all in the company. If Robert wants to access it, he’ll have to pay income tax that will reduce the overall financial advantage. Using the figures from our example, if Bruce Ltd paid the £6,000 CT saved to Robert, he would net £3,975 after income tax. Rent still wins over a dividend.
Rather than take the extra £6,000 and pay tax on it, Robert could allow it to accumulate tax free in Bruce Ltd indefinitely.
While receiving rent instead of dividends seems the best option, there is another factor to take into account. The rent adversely affects the amount of CGT business asset disposal relief (BADR) Robert would be entitled to if he ever sells the property in connection with the sale of his shares in Bruce Ltd. His BADR would be proportionately reduced for the period for which he charged Bruce Ltd rent. The amount of rent can also be a factor when calculating BADR. BADR is not available for periods when the asset was not used by the business or periods where you charged full commercial rent (some relief should be available if rent was charged below the commercial rates).
EXAMPLE – Future disposal of property
In March 2024 Robert sells all his shares in Bruce Ltd and the property he rented to it. He makes a capital gain of £100,000 on the property. Assuming he has no capital losses to reduce the gain, he will pay CGT of £18,800 (£100,000 – £6,000 CGT exemption x 20%). If Robert had not charged rent the gain would have qualified for BADR and Robert would have paid CGT at 10% instead of 20%, so charging rent has cost him an extra £9,400 in CGT. Note that the loss of BADR would be proportionately less if Robert had charged Bruce Ltd rent at less than the full market rate.
In this example, Robert would only have needed to charge Bruce Ltd rent for just over two years for his income tax saving to have exceeded the extra CGT he would incur as a result. In practice, determining if it is more tax efficient to charge rent or benefit from BADR involves many factors so seeking professional advice is recommended.
Rent is usually a more tax-efficient way to extract income than dividends. It provides tangible and measurable income tax savings, whereas not charging rent provides only potential and uncertain CGT savings. Nevertheless, before charging rent you should make calculations to compare both outcomes.
If you would like some more information about Capital Gains Tax or other related questions please do contact the team.