Tax Doctor:
Mark McLaughlin
CTA (Fellow) ATT TEP

Have you got a tax question? Post it on the Tax Tips Forum and it may be answered either by Mark McLaughlin or one of the other Forum contributors.

January 2006

Q:

My wife and I own a shop worth £75,000 let out at £7,500 per annum. I planned to transfer this to a new company, at value, and withdraw the capital over the next ten years, then transfer shares in the company to my children over a few years.
I had planned to retain all income in the company until I had withdrawn my capital. As I would take no income I assumed no personal tax liability, and as all profit would be retained in the company until the capital was repaid, I assumed no company taxes either. Does Gordon Brown's proposed abolition of the Corporation tax exemption of £10,000 for small companies mean that before taking out my capital I would now have to account for corporation tax on the rental income or can the return of capital be seen as a business expense and therefore offset against any tax liability within the company?

A:

There was an announcement in the Pre-Budget Report 2005 that the 0% corporation tax rate on company profits up to £10,000 would be replaced by the small companies' rate of 19% that currently applies to profits of up to £300,000. The date from which this change takes effect was not stated in the press releases at the time, but it is expected to be 1 April 2006. It therefore seems that the company's rental business profits would be liable to corporation tax at 19%. However, it is the company's 'profits' not its rental income that will be subject to tax, i.e. certain expenses of letting the property can be deducted if applicable, such as agent's fees, professional fees and repair costs. Unfortunately, the repayment of capital is not an allowable expense.

Property sale

It would appear that you and your wife intend selling the property to the new company at market value. This is a disposal for capital gains tax (CGT) purposes. Whether you would actually have to pay any CGT depends on a number of factors, such as the original cost of the property, how long you have owned it, the identity of the tenant (i.e. limited company, partnership or sole trader) and whether you and your wife have available your annual CGT exemptions for the year (currently £8,500), or have already used them by making other disposals for CGT purposes. There may also be VAT implications, which are beyond the scope of this reply.

Following the property sale, the company would owe you the sale proceeds. Those proceeds will presumably be left outstanding as a loan. As the company receives the rents and generates income, this would release funds to repay the loan gradually over time. Unless the company is able to obtain another loan from an external lender, it will take some time to repay the amount owed to you and your wife, certainly more than ten years as rental income will be reduced by expenses of running the company and probably maintaining the property. Following the proposed changes mentioned above, the net profit will also be subject to corporation tax.

You and your wife could charge the company a commercial rate of interest on the outstanding capital if you wish, although this interest will be liable to income tax, and may result in you having to wait longer before the company can repay all the capital owing.

Gift of shares

The later transfer of the company shares to your children will constitute a disposal by you and your wife for CGT purposes. The gift will be treated as a transfer at market value, which would broadly be based on the value of the shop (or its rental income value). If the shares are transferred in (say) ten years time or longer, based on the current property market it is likely that the shop will have appreciated significantly in value. This means that the shares will probably have a higher value too. The transfer of the shares may therefore trigger a capital gain, since presumably they only cost you £1 each originally. However, based on current legislation full taper relief is available after ten years (albeit at the non-business asset rate), and hopefully you and your wife will also be able to use your annual CGT exemptions for that year.

An alternative to gifting the shares directly to your children would be to transfer them to the trustees of a discretionary trust in which they are the beneficiaries. There are potential inheritance tax implications (which are outside the scope of this reply, and for which specific professional advice should be obtained), but for CGT purposes this should enable you to elect for any gain to be deferred (or 'held over') until a later disposal of the shares by the trustees. Whilst you and your wife would no longer own the shares, you could still retain a degree of control over them by acting as trustees of the discretionary trust, although you and your wife must not benefit from the trust.

As always, I would recommend obtaining detailed professional advice based on the specific circumstances of you and your wife.

Mark McLaughlin

Your attention is drawn to the disclaimer on this site, which applies to the content in this section.

<< back to Tax Doctor index | go to Tax Tips Forum >>