Property Planning with an Excepted Asset

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A couple purchases a commercial property from their limited company as part of their tax planning.

The Challenges

Prosper Ltd is a family-run mortgage brokering business run by shareholders and directors. Bob and his wife Laura, both in their early 50s, were the founding directors and between them own acontrolling shareholding. Their daughters Donna and Stella are also directors, and Prosper Ltd also has several employees.

The business owns two properties: 42 High Street and the leasehold to a ground floor office at 43 High Street. Up until a few years ago Prosper Ltd traded from both offices, but with more online business and staff working from home, it now only operates from 42 High Street. The ground floor at number 43 is now let to a florist.

Bob recently had a health scare, which has caused him to reduce his working hours. His illness has also prompted Bob and Laura to get their financial affairs in order. They would like to ease back from the business and spend more time with each other, and call their financial and tax advisers to discuss these plans.

Laura and Bob have pension funds as well as other investments, and take dividends from their business. They don’t want to sell their shares in Prosper Ltd as they don’t need the capital and are reluctant to relinquish control. The dividends also provide an ongoing source of income.

Laura and Bob are interested in inheritance tax (IHT) and estate planning. They intend to pass their shares in Prosper Ltd on their deaths in the expectation of benefiting from Business Relief. They also anticipate that there could be a short-term drop in revenue when they step back from the business, as some of their best referrals come from Bob’s close contacts.This shouldn’t causesignificant problems for ProsperLtd, but having additional cash reserves in the business would be reassuring.

Laura and Bob each have £200,000 in pension savings. Donna and Stella’s pensions are worth £50,000 each.

The Actions

The couple’s advisers explain that Business Relief is available in respect of relevant business property. Typically this will mean shares or an interest in a trading company: in other words, a company wholly or mainly engaged in trade (as opposed to the holding or trading of investments).

Prosper Ltd is a trading company, so their advisers believe Business Relief should be available in respect of Laura and Bob’s shareholding. However, they point out that 43 High Street might not be regarded as relevant business property. They explain that certain assets, even ifowned by a trading business, may be excluded for Business Relief purposes. Such assets are referred to as ‘excepted assets’.

They go on to explain that assets are excepted assets iftwo conditions apply:

  • They were not usedwholly or mainly for business purposes during the two years before the transfer
  • At the time of the transfer, they were not required for future use in the business.

The advisers give some examples of business property that might be regarded as excepted assets to help Laura and Bob understand:

  • Large cash balances in excess of the requirements of the business
  • Investments, stocks and shares, and investment funds (especially if passively owned and not directly managed by the directors)
  • Property rented to third parties and not used by the business.

Prosper Ltd could continue mortgage brokering without renting 43 High Street to the florist, so the advisers conclude that it is likely to be an excepted asset.

Laura and Bob ask their advisers whether they could use their pensions to buy the office at 43 High Street from Prosper Ltd.

Their advisers explain that this should be possible, despite the fact that there are two residential flats above the ground floor office. Prosper Ltd only owns the leasehold on the office, and the flats are entirely separate, with separate access and their own leases. This means that even though the freehold includes residential property, the leasehold for the flat can be held by a pension without being classed as taxable property.

The Results

Laura and Bob decide to proceed with the property purchase.

As a limited company, Prosper Ltd will be liable to corporation tax on the gains realised from selling the office at number 43. Prosper Ltd bought 43 High Street in October 1998 for £65,000. The property is currently valued at £180,000.

The couple’s advisers confirm that they may be able to use indexation allowance to mitigate the corporate tax liability. Indexation allowance is a mechanism to allow the original cost of an asset to be increased in line with the Retail Price Index (RPI), in order to only tax real term gains above inflation. It is available to companies that are subject to corporation tax, although it has been frozen since 31 December 2017.

Laura and Bob’s advisers calculate that with indexation allowance, the gain that Prosper Ltd would be deemed to receive from the sale would be reduced to £70,085. With corporation tax at 19%, this would give a charge of £13,316.15 and leave Prosper Ltd with net proceeds of £166,683.85.

Laura remembers that one of the other examples of excepted assets was large cash balances, and wonders if they still need to consider further action to avoid this issue.

The advisers suggest that Laura and Bob might want to consider making company pensioncontributions from Prosper Ltd. Assuming they meet the ‘wholly and exclusively’ requirements, company contributions will be an allowableexpense for corporation tax purposes. If they contributed £70,085 between Donna and Stella’s pensions, this would reduce the company’s taxable profits by £70,085 and save the £13,316.15 of corporation tax, negating the liability from the sale of 43 High Street.

This would still leave Prosper Ltd with £109,915 of the sales proceeds, which Laura and Bob could consider using to make further contributions if they feel this is too much to hold as a cash reserve.

Laura and Bob’s SIPPs now own 50% each of 43 High Street. Over time, Donna and Stella could consider purchasing some of the property from their parents using their own SIPPs. This could then help create additional liquidity in Laura and Bob’s pensions, either to diversify their pensions further, or perhaps in order to provide pension benefits as they approach retirement.

Laura and Bob have achieved their aims of creating additional liquidity within Prosper Ltd, solving their excepted asset issue, and furthering their retirement and IHT planning.

Case Study

Property Planning with an Excepted Asset

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