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I have acted for a number of domestic residents’ property management companies and have had no problems with treating any surplus in a year as not taxable.
However, I have now been asked to act for a company carrying out the same property management function for the owners of a small block of industrial units.
The memorandum of association of the property management company (the shareholders of which are the owner/occupiers of the industrial units) specifies that no part of the income may be distributed to members by way of dividend, bonus, etc.
The company is likely to have a surplus this year, which I believe should not be subject to corporation tax.
Do any Taxation readers agree?
Query 17,634 – Mutual.
Reply by S.G.
Flat management companies have become a popular way to administer service charges in blocks of flats and apartments, such as security, gardening, and external decoration.
Each occupant/tenant pays a regular charge to the management company; and typically each tenant also holds a share in the management company. This usually means that a trading activity is being carried out, the trade being the provision of services and the profit is the reserve fund in the company.
Historically, HMRC were usually flexible for mutual concerns meaning there was usually no tax charge on the profits of the trade.
Note that if any of the tenants did not subscribe for a share then there could be no mutuality.
Also, if the management company was carrying on a property business (as opposed to a trading business) there can be no question of mutual trading. This is because mutual trading is exclusively a trading concept.
There is specific statutory confirmation of the non-application of the mutuality principle to a property business at TA 1988, s 21C (See HMRC’s Business Income Manual at BIM24782.)
The waters were muddied somewhat by the introduction of Schedule A in 1988 and the interaction with the Landlord and Tenant Act (LTA) 1987, s 42.
HMRC issued a statement on 25 August 2006 clarifying the position on the treatment of taxing surpluses arising in clubs and unincorporated associations (including property management companies).
No corporation tax would be due if the following occurred:
- The company’s business consists of the management, on a non-profit making basis, of a block(s) of flats or apartments for the owners, lessees or tenants of the flats or apartments.
- The company’s articles of association contain rules to ensure only the persons having an interest in the property under management own the shares in the company.
- The company must not be entitled to receive any income from an interest in land.
- The company must pay no dividend or make any other distribution of profit.
However, where a property management company receives service charges which it is obliged to hold on trust for the tenants under LTA 1987, s 42, the company will be liable to income tax on any interest arising on that fund.
The company, in its capacity as trustee, will be within income tax self assessment and may be required to make a return to the relevant HMRC trust office.
HMRC went on to say in the statement that most existing clubs and property management companies that meet the conditions are already likely to be treated as dormant by HMRC.
Refer also to the Property Income Manual at PIM1070 where further guidance can be found on HMRC’s views on taxing occupier-controlled flat management companies.
Mutual’s query concerns the activities of a property management company that manages industrial, as opposed to residential units. Mutual states that the memo of association of the company mentions that no income shall be distributed to the members by way of a dividend.
This is indeed consistent with one of the conditions expressly stated in HMRC’s statement of 25 August 2006; however, more importantly HMRC’s statement made it clear that it applies to residential (flats and apartments) property management companies; there is no mention of it applying to industrial/commercial property management companies.
There does not appear to be any published guidance specifically relating to commercial property management companies; so one has to deduce the end result from first principles, coupled with what is and what is not included in the 2006 HMRC statement.
With residential management companies, the residents themselves are not claiming a tax deduction for the service charge payment they make to the company, a share of which they own.
As far as HMRC is concerned this is more or less a ‘tax neutral’ situation in that one entity isn’t claiming tax relief and the other entity isn’t subject to tax (ignoring the differing marginal rates of income tax and corporation tax that would come into play).
Now consider the situation applicable to owner occupied industrial units.
The occupiers are businesses who would no doubt be claiming a corporation tax deduction for the service charge in their respective corporation tax returns (or income tax returns if sole trader status is applicable).
It seems unlikely that HMRC would accept a tax deduction in the respective business tax computations and not seek to tax the resultant profit generated in the management company.
Even if a pragmatic arrangement could be made with HMRC to say add back the service charge in the tax comps of the different businesses, in return for not taxing any surplus arising in the management company; in practice this would be almost impossible to operate across multiple businesses that more than likely each use a different accountant.
Reply by Southern Man
Generally speaking, we are in the habit of thinking that a property management company is not subject to corporation tax. The stricter reality is that this applies to a company that manages residential property. In fact, there are more stringent requirements to be met before the corporation tax exemption is correctly given and these are set out on HMRC’s website at: www.lexisurl.com/clubs). This states, with regard to the exemption:
‘HMRC may apply this treatment to your property management company if, as well as meeting all the criteria laid out in the previous sections, it meets all of the following additional criteria:
- Your company's business consists of the management, on a non-profit making basis, of a block(s) of flats or apartments for the owners, lessees or tenants of the flats or apartments.
- Your company's articles of association ensure that only people who have an interest in the managed property own the company's shares.
- Your company must not be entitled to receive any income from land.
- Your company can't pay dividends or make any other distribution of profit.
‘But if your property management company receives service charges which it must hold on trust for its tenants, it will be liable to income tax on any interest that arises on that fund. In effect, your company is acting as a trustee and may be required to deliver a tax return to the relevant HMRC Trust Office.
‘Income from service charges for UK properties that's held on trust is chargeable at the standard tax rates.
For example, basic rate in the case of bank interest as trustees are not entitled to starting rate for savings income.
‘Generally, where the income is below £1,000 and taxed at source, you won't need to complete a return every year.’
My first thought was that there was no reason why a similar treatment should not apply to companies managing business properties, but that begs the question of why – if that was the case – the HMRC statement should specifically refer to ‘block(s) of flats or apartments for the owners, lessees or tenants of the flats or apartments’.
Giving some thought to the tax implications made me think that an exemption would not be given.
Unlike the payments into a residential management company, which are presumably made from the leaseholders’ taxed income, the payments to a company managing business properties would presumably be deductible as an expense incurred ‘wholly and exclusively’ in carrying on its business.
Would this not then allow the company to perhaps ‘charge’ higher payments to the unit leaseholders to enable them to defer tax by making higher payments into a company that they also controlled?
Presumably HMRC’s answer to such a claim would be to dispute whether the payment actually was incurred ‘wholly and exclusively’ for business purposes, but I would not imagine HMRC wanting to become embroiled in such arguments on a regular basis.
Perhaps this is also why part of the first condition above is that ‘your company's business consists of the management, on a non-profit making basis …’.
Any company that was building up too much profit on an annual basis would, I presume, not qualify for exemption.
In short I do not think that HMRC would want businesses to be able to shelter funds in a tax exempt company and I believe that the company in the query would be able to claim a deduction for expenditure incurred against the management fees, etc. received, but that it would be liable for tax on any net profit.
