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  • Tax

    Paying less tax in a company (part 1)

    There is a common misconception that withdrawing an income from a company is always more expensive than in personal names. I intend to debunk this myth. In certain circumstances it can be but my point is that it isn’t in all cases. I’m going to prove my point in 2 parts. 

    Firstly I’m going to look at what happens when money is not withdrawn out of a company. In part 2 I will look at what happens when money is withdrawn from a company as income.

    For the purposes of what follows I’m going to assume we’re talking about higher rate tax payers and that interest relief has been fully restricted from April next year. I’m also going to assume that companies that own rental property  pay 17% Corporation Tax on all their rental profits (new rate from next year). 

    Higher rate tax payers pay 40% tax on their rental income and may also suffer other tax charges including  the High Income Child Benefit Charge (income over £50,000), withdrawal of their personal allowance (income over £100,000) and the 45% additional rate of tax (income over £150,000).

    I contend that property investors with large taxable rental profits may therefore end up with significantly more after-tax income if the properties are held inside a company. Some or all of this extra income could then be reinvested to grow the business.

    I’m going to demonstrate by way of examples how a higher rate tax payer can be better off in a company. Firstly let’s assume in 2020/21 Joe earns a salary of £50,000 and his property business has net rental income of £125,000 after deducting all costs except mortgage interest. His mortgage interest comes to £40,000 per year.

    If Joe owns the properties personally he’ll have a taxable rental profit of £125,000 and none of his interest will be tax deductible. His total taxable income will be £175,000 (50,000 salary + 125,000 rental income).

    This amount of income means he will lose his Income Tax personal allowance and will pay Income Tax at 20% on the first £37,500 (the basic-rate band in 2020/21), 40% on the next £112,500 and 45% on the final £25,000. This adds up to a tax liability of £63,750. He is entitled to a tax reduction equal to 20% of his finance costs which comes to £8,000 (40,000 interest x 20% tax reduction = 8,000). Therefore his final Income Tax bill will come to £55,750 (63,750 - 8,000).

    If instead the properties were held inside a company, all the interest would be tax deductible and the taxable rental profit would be £85,000 not £125,000 (125,000 rent less 40,000 interest). Corporation tax at 17% would come to £14,450 (85,000 x 17% = 14,440).

    If using a company for his rental income Joe would also have to pay Income Tax on his salary. The first £12,500 would be tax free (the personal allowance in 2020/21) and the remaining £37,500 would be taxed at 20%, producing a total Income Tax bill of £7,500.

    To summarise, Joe’s total annual tax bill will be £33,800 lower if he uses a company to hold his properties (55,750 personal tax - 14,450 company tax - 7,500 salary tax = 38,300). This is a huge saving and this money can be rolled up inside the company and could be used to invest in further  properties.

    Over many years Joe’s portfolio could increase at a much faster rate in a company as he will have considerably more money to reinvest each year.

    In part 2 I will prove that Joe will have more income in a company than in personal names should he choose to withdraw money from the company rather than reinvest in further properties.

    EDIT: Joe’s salary is from another job and is not related to his property business.
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    Thanks for taking the time to compile this thread. I am very interested and look forward to part 2.
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    Hi there. Thank you for this. So far I’m understanding but look forward to Part 2 which is the bit that I never fully understand if, as a company, you need to use the profits to live on rather than reinvest, put into a pension etc
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    Thanks for putting this together Joe.  Could you just clarify if you have any tax qualifications or professional credentials or this is a "lay man's" guide?

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    I’m a lay man that likes to try to know more than my accountant. I welcome scrutiny of my thread from the other professionals on this forum. As demonstrated in a previous thread I started, I don’t always get it right.
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    Fair play to you!

    And, as above, thanks for taking the trouble to lay this out for everyone to chew on.

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    If using a company for his rental income Joe would also have to pay Income Tax on his salary. The first £12,500 would be tax free (the personal allowance in 2020/21) and the remaining £37,500 would be taxed at 20%, producing a total Income Tax bill of £7,500.

    Nicely put together YoungJoe.  You have not allowed for though are NI, which can work out at around 24% by the time you take both employer and employee contributions into account.  

    Also the fact that company mortgage rates are generally higher than personal rates.  These all affect the bottom line. 

    One way to work around the NI issue would be to simply take a dividend instead for amounts over the NI threshold.  Also pension contributions up to £40k per person can be very beneficial but that may well be included in your part 2 so apologies if I am jumping the gun.

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    His salary is from another job and is not related to his property business.
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    I should have clarified this point. Please accept my abject apology.
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    Good point about LTD company mortgages

    I posted this comparison on a diff thread a few weeks ago

    https://www.propertytribes.com/showthread...lid=396849


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