A husband and wife operate care homes as a partnership.
Initially, as the business grew, this worked well because losses could be offset against employment income from other sources.
The business is now highly profitable and those other sources have now ceased.
Tax liabilities are increasing, despite drawings being kept to a minimum to retain business capital to purchase more care homes.
At the same time, a different type of care may be provided in future, in addition to the current activities, as legislation in this sector changes.
The ideal scenario would seem to be to operate through one or more limited companies, with the properties themselves being owned personally between the husband and wife as they are now, with rent being paid by the companies for the use of the properties.
This seems to present a number of issues.
First, who should bear the significant cost of refurbishment after each initial property purchase?
Presumably this would need to be borne personally and allowances/repairs claimed where possible against the rental income.
This perhaps nullifies the proposed solution as large dividends would be required to fund such expenditure.
Secondly, presumably a transfer of the business to the limited company would give rise to a transfer of goodwill.
We are aware that Pinders’ valuations, prepared for the purposes of the bank, value the business of each home well in excess of the stand-alone property value.
What value should be used and would this give rise to a market value capital gains tax disposal and potentially large tax bill?
Finally, what are the tax implications when the business is sold?
It is assumed that entrepreneurs’ relief will apply (assuming it still exists at the time) on the sale of the properties even though they are part of a rental business being rented to the trading companies.
Readers’ comments would be helpful.
Query 17,601 – Speedy.
Reply by Thicket
With the advent of higher rates of personal taxation, business structures are again under close scrutiny.
However, income tax is not the only issue and the matter needs to be looked at in the round.
As Speedy points out, financing a capital intensive business, such as operating a care home, will also be important.
By and large, there are no tax allowances for the cost of structural alterations – although plant and machinery allowances should be claimed where possible.
The cost of repaying personal bank loans, even if interest is tax deductible, will also be costly. If these are paid out of income taxed at personal rates, this can be quite expensive.
It would be more efficient for the company to bear these costs out of income taxed at corporate rates.
However, I do not see any point in transferring an existing care home from the partnership to a limited company – the stamp duty land tax charge will be based on open market value and will in many cases be prohibitive.
Generally, where a tenant occupies a property, the freeholder will carry out structural alterations, while the tenant will be responsible for repairs.
Note that if a tenant is required to carry out work on the premises, the increase in value to the landlord may be treated as a premium assessable on the landlord.
Goodwill in relation to property-based businesses is currently a ‘hot’ topic. HMRC have revised their views on this – see www.lexisurl.com/GITRP.
However, it is understood that this is not necessarily accepted by the Royal Institution of Chartered Surveyors (RICS) and others.
One important point to note is that HMRC do not accept that goodwill can pass without a simultaneous transfer of an interest in the property.
One potential downside of incorporation with the property kept in personal hands is the potential reduction in business property relief relief for inheritance tax from 100% to 50%.
Entrepreneurs’ relief may be available on the disposal of a property owned personally, but used in a care home business carried on by a company, if the disposal is ‘associated’ with a material disposal (see TCGA 1992, s 169K).
HMRC’s Capital Gains Manual at CG63995 et seq. gives further details and examples. Relief will be restricted to the extent that rent is paid post-March 2008 and examples of calculations are shown at CG64145.
Speedy might want to consider two possible ways to develop the business.
- Use a company to acquire any new business; or
- introduce a company into the existing partnership.
Reply by The Dude
This question covers a wide area and I think that, to some extent at least, the answer is ‘do the numbers’.
To start with, I must admit that I am a little confused by the first point that ‘tax liabilities are increasing despite drawings being kept to a minimum’. In a partnership, unlike in a limited company, limiting the drawings is not going to affect the tax liability.
Looking at the first question, if a tenant carries out substantial improvements to a property there might be a question of this being treated as a premium.
I would refer Speedy to HMRC’s Business Income Manual at BIM 41085, ‘Fitting out costs’, which explains that ‘Fitting out costs means expenditure on the provision of fixtures and chattels to equip the building to serve the tenant's particular needs.
Such expenditure is normally the tenant's responsibility. If the landlord undertakes to meet the cost, the tenant is receiving a reverse premium’.
To the extent that capital improvements are made to the property – and of course regarding the purchase price itself – no immediate relief will be available, but this will of course be true in the limited company format.
Entitlement to capital allowances will also need to be considered.
With regards to any interest payments, this will be allowed in either format.
If the property is owned personally, the company can pay rent which would be taxable on the clients, but they would be able to deduct the interest.
Specialist advice might be recommended on the subject of goodwill specifically with reference to whether this can be transferred without a transfer of the associated property.
If the company makes a payment and it subsequently transpires that goodwill has not been transferred, then the revised tax treatment of that payment will need consideration.
Rumours abound of the proposals for capital gains tax in the forthcoming Budget.
However, entrepreneurs’ relief should be available, although the potential for a double charge in the company should be remembered if assets rather than shares are sold.
