Property Focus. Laying the foundations to future prosperity. Contents: Liquidation - not always a bad thing! Inheritance Tax and Property Businesses

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1 Autumn 2013 Property Focus Laying the foundations to future prosperity Contents: Liquidation - not always a bad thing! Inheritance Tax and Property Businesses VAT on storage - the true extent of the new self-storage provisions High Value Residential Properties - a trap for the unwary

2 Liquidation - not always a bad thing! Normally, the word liquidation gives thoughts of business failure and is generally not something that someone in business wants to be associated with. However, there are times when a liquidation can be an incredibly useful tax planning tool, particularly where property businesses are concerned. Firstly, let s dispel the myth that liquidation means business failure. Whilst that is often the case, liquidations come in different shapes and sizes. It may be that a company has just ceased to trade (perhaps following a sale) and the shareholders want to distribute out the surplus assets. This is a solvent liquidation and is not being forced on the shareholders, it is their choice. This type of liquidation is called a Members Voluntary Liquidation (MVL). So how can this be used for tax planning? Property developers Given the difficulties of obtaining bank finance, developers are turning to private individuals to provide finance for development schemes. Often, the starting point will be for an individual to lend money and receive a favourable return, perhaps on some kind of profit sharing agreement. A return on loaned money would be taxed as interest, therefore giving an income tax liability of maybe 40% or 45%. Instead, what if a new company is formed specifically for the scheme. The investor injects some of their money as share capital (of an agreed proportion) and the balance as a loan (interest free). The investor is appointed a director of the company. The development is carried out in the new company. The units are sold, any profits taxed at the lower corporation tax rates (20% for a small company at present). Providing the scheme has been ongoing for more than twelve months, the company could be placed into an MVL. Liquidators would then distribute the surplus cash to the shareholders in the relevant proportions (after repaying any loans). Under the tax legislation, a distribution by a liquidator is a capital sum, subject to capital gains tax. Providing the qualifying conditions are met, any capital sum received by the investor should qualify for Entrepreneurs Relief, such that a tax rate of 10% applies. When combined with the corporation tax paid, this gives an overall effective rate of 28%, which is significantly lower than the income tax rates above. Property extraction Consider a company that has been carrying on a trade (not necessarily property related) for a number of years. They have decided to call it a day, but have surplus cash and a trade related property on the balance sheet. When ceasing to trade, you have three years to liquidate the company to qualify for Entrepreneurs Relief at the 10% tax rate. If the shareholders place the company into MVL, they could distribute the surplus cash as a capital sum, and also distribute the property to themselves, as a distribution in specie. The market value of the property would then be treated as a capital sum received, on which the shareholders pay 10% tax, which is significantly cheaper than extracting by way of a dividend, or through incurring a benefit in kind charge. Furthermore, the distribution of property by way of a winding up is exempt from Stamp Duty Land Tax, which is another benefit of an MVL. Splitting property from trade Given the uncertain economic climate, many business owners are taking a view to split their property from their trade, to protect it should anything go wrong with the trading side of things. Just transferring property out of a company can give rise to significant tax liabilities, so alternative arrangements need to be considered. It is possible to enter into a scheme of reconstruction using an MVL, which results in a new company being formed to own the property. It is best not to get into the complexities of how the reconstruction works, but it can be done, depending on the circumstances, without giving rise to corporation tax, capital gains tax, income tax or stamp duty land tax. As with everything though, it s important to get advice to ensure it is implemented correctly. Conclusion So, as you can see, a liquidation is not all doom and gloom. Sometimes, it can be an incredibly effective planning tool to mitigate your tax liability. For more information, contact Nick Haines on or nick.haines@hazlewoods.co.uk

3 Inheritance Tax and Property Businesses One of the most valuable reliefs for Inheritance Tax ( IHT ) purposes is Business Property Relief ( BPR ) because, if the qualifying conditions are met it can be worth 100% of the value of the shares in the company or the business interest. Qualifying assets include:- A business or an interest in a business Unquoted shares in a company However, the business, or the company, must be a trading one. All trades qualify for BPR except dealing in shares, securities or land and buildings. Also the business or the company must not be mainly one of holding investments. So, for example, a company which owns some commercial property, which it lets is not eligible for BPR because its main activity is one of holding investments. This leads to some interesting situations for property businesses. For example:- What is the difference between dealing in land and buildings and property development? What if a company buys a property for development, but then, because of changing market conditions, sells it with little or no improvement? HM Revenue & Customs (HMRC) very helpfully in their manuals say they will not deny BPR relief to a company which: Is carrying on a construction or building business, or holding a number or properties as stock in trade; or Is a property development company provided: The land is acquired with a view to the development and disposal of the completed development, and Most of the profit is derived from the enhanced value of the property from the development, rather than increases in land value because of obtaining planning permission Or alternatively What if the business is providing serviced offices rather than simply renting out space? There has been a recent case where this was considered (The Trustees of David Zetland Settlement). In this instance property comprised a commercial building divided into units, let to about 50 tenants, for periods ranging from one to five years. In addition to office space, the tenants also had use of a restaurant, gym, cycle track, WiFi, 24 hour access, meeting rooms, media events, outdoor screens for film shows and sports events, as well as a coffee shop and gallery area. Some of these additional services were charged for separately and provided additional income to the owner. One might think that this type of business model is moving towards an operation more akin to an hotel, which would qualify for BPR. However, the Upper Tribunal, which considered this case, said that it was not sufficiently dissimilar from being mainly an investment type activity to enable BPR to be claimed. In these circumstances it is difficult to envisage what extra could have been done to qualify for BPR. Or alternatively What if a company has developed a property but because of market conditions, cannot sell it at an acceptable price and so decides to let the property, until market condition change? Provided the intention is still to sell the property then there is still an argument that the property was acquired with a view to realising a profit, and the property is not an investment. Hence BPR is preserved. If that is the case then the property should still be shown in the accounts as stock and work in progress. Also it is good practice, at least once a year to record at a directors meeting, that the intention regarding the building has not changed and that it will be sold when market conditions change. Or alternatively What if the company has a mixture of development properties and investment properties? To qualify for BPR the company s activity has to be mainly that of trading. This means that more than 50% of the activities must be trading. This means looking at asset values, levels of income, profitability and management time. So if the minority element is investment then potentially the whole of the company value could qualify for BPR. But the BPR claim may be restricted to the trading part of the value if the investment properties are classified as excepted assets. However some BPR is better than none. If the property company does not qualify for BPR are there any steps which can be taken to reduce the IHT burden? A couple of ideas are as follows:- 1. Give shares up to the value of 325,000 to a Trust. This removes these shares from the Estate. Provided there have been no other chargeable gifts in the previous seven years there will be no IHT charge on the transfer to the Trust. Any IHT benefit from this arrangement will only be realised if the donor lives seven years after the gift. As the

4 gift to the Trust is potentially subject to IHT, although none is payable, the capital gain that might otherwise arise can be held over. The alternative of giving the shares directly to another individual will crystallise a capital gain if there has been an increase in the share values, hence the need for a Trust. If the spouse also gives shares up to the value of 325,000 to a Trust this will double the potential saving. 2. Use freezer shares to pass the future growth in the value of the company to another individual. In very simple terms the existing shares will take all the value to date, and new shares, which take the future growth are given to, say, a child. These steps mean that future growth accrues outside of the Estate of the current shareholder. Consequently the inheritance tax problem does not get any worse. Obviously these issues can only be discussed in brief terms in this article. Any tax planning should therefore only be undertaken after discussing specific circumstances. For more information, contact David Pierce on telephone or david.pierce@hazlewoods.co.uk VAT on storage - the true extent of the new self-storage provisions HM Revenue & Customs (HMRC s) proposals to introduce a compulsory VAT charge on supplies of self-storage were first announced in a document entitled VAT addressing borderline anomalies which was published on 21 March 2012 to accompany the Chancellor s Budget Statement. The proposals were seen as a direct reaction to two earlier Tribunal decisions where self-storage providers had argued successfully that what they were in fact providing to the customer was a VAT-exempt licence to occupy land. It was perhaps unfortunate that one of the other measures announced in the same document raised the horrendous prospect of a VAT charge being added to certain hot food products, and this so-called pasty tax grabbed most of the headlines at the time! Another reason for the muted reaction to the self-storage changes was that HMRC claimed that the new policy would affect no more than an estimated 250 VAT registered self storage businesses that do not opt to tax their supplies and around 50 unregistered suppliers of self storage that will have to register as a result of the change. However, when the draft legislation was published, the true scope of the measures became apparent! A compulsory VAT charge is to be applied to the grant of facilities for the self storage of goods which is further defined as meaning the use of a relevant structure for the storage of goods by the person(s) to whom the grant of facilities is made. In other words, it does not matter whether the occupier of the unit / building is an individual storing surplus household possessions, or the largest multi-national corporation storing goods for its manufacturing or trading activities, as long as the principal use of the facility is for storage, then with effect from 1 October 2012, VAT must be applied to the rental charge for the facility if it is not already opted to tax. This goes far beyond the notion of selfstorage as most of us would understand it! The new legislation brings with it many practical difficulties, such as how the landlord is meant to ascertain what the occupier s use of the facilities actually is, if the lease or licence does not impose any restrictions. HMRC did provide a period of consultation prior to publishing the legislation, however in the main this only served to identify further borderline anomalies and it is a pity that more issues could not have been resolved prior to the new measures being introduced. And ironically, one of the original Tribunal decisions has now been reversed, indicating that there was probably no need for HMRC to introduce the new legislation in the first place! For more information, contact Julian Millinchamp on telephone or julian.millinchamp@hazlewoods.co.uk

5 High Value Residential Properties - a trap for the unwary You may have seen in the commentary on the 2012 Budget that the government were going to introduce legislation so that non-uk domiciles who owned residential property through overseas companies, to avoid Inheritance Tax issues, would pay an annual tax charge. The relevant legislation has been introduced with effect from 6 April Why is this relevant for property development and investment companies? Because the actual legislation means this charge will apply to all companies and partnerships owning UK residential property valued at over 2m. So in practice it will apply to UK companies which acquire a residential property valued at more than 2m, for development purposes, or to investment companies which acquire such properties for a rental business. If the property is valued at 2m the annual charge is 15,000. This charge increases, depending on the value of the property, to 140,000 for a property valued at in excess of 20m. The charge is reduced on a pro-rata basis for ownership in only part of the year. An exemption is available if the company is involved in:- A property rental business and the property is held for the purposes of the rental income it will generate; or Property development and the property is to be used as part of that activity. However, whilst such companies are exempt from the charge, the exemption has to be claimed on a specific return which needs to be made. Unfortunately it is not a case of saying I don t need to do a return, because it does not apply to me. So there is yet another form to complete for HM Revenue & Customs (HMRC). Even if you only owned the property for part of the year, the return will still have to be completed. Normally the return will need to be submitted by 30 April, and cover the period up to 31 March. The return also needs to be submitted at the beginning of the return period. So for the year 1 April 2014 to 31 March 2015, the return needs to be submitted and payment made by 30 April For the first period of the new tax which runs from 1 April 2013 to 31 March 2014, the return needs to be submitted by 1 October 2013 and payment made by 31 October If you acquire or construct a new dwelling which will be in the new regime, during the course of a period then you have to submit a return within 30 days of the acquisition, or 90 days if it is a new build. As you might expect with HMRC, if you do not submit a return, or submit it late, or make a mistake in the return, then a penalty can be imposed. HMRC will know whether a return is due for any acquisition from SDLT returns, so they will be able to check whether all returns they expect are being made. It will be easy to overlook making this return, especially if no payment is due, but this would still result in a penalty. For more information, contact David Pierce on or david.pierce@hazlewoods.co.uk

6 David Pierce Partner Nick Haines Partner Richard Pontin-Medes Manager Julian Millinchamp Senior VAT Manager Accountancy and bookkeeping Taxation planning Management accounts Strategic planning Audit Services The services we provide include: Raising finance Sage advice and training Financial planning Payroll assistance to include bureau service VAT Stamp Duty and SDLT mitigation Inheritance Tax and estate planning Transactions, planning and support Benchmarking and profitability advice Incorporation Hazlewoods Property Team Cheltenham Office: Windsor House Bayshill Road, Cheltenham, GL50 3AT Tel: Fax: Staverton Office: Staverton Court, Staverton, Cheltenham, GL51 OUX Tel: Fax: This newsletter has been prepared as a guide to topics of current financial and business interest. We strongly recommend you take professional advice before making decisions on matters discussed here. No responsibility for any loss to any person acting as a result of this material can be accepted by us. Hazlewoods LLP is a Limited Liability Partnership registered in England and Wales with number OC Registered office: Staverton Court, Staverton, Cheltenham, Glos, GL51 0UX. Hazlewoods is a member of International. A list of LLP partners is available for inspection at each office. Hazlewoods LLP is registered to carry on audit work in the UK and Ireland and regulated for a range of investment business activities by the Institute of Chartered Accountants in England & Wales.