Investment structures covers any investments held on a collective basis. There are various different structures that can be use when the investment asset is owned by several investors.
The legal structure is a tool to allow several people, companies or businesses to invest in the underlying asset. The type of structure used has implications for the investors, including tax payable, fees charged and what happens if the investment fails.
An example of this could be a hotel investment that is structured as a limited partnership, corporate bond, direct partial ownership or membership of a company limited by guarantee. Each of the structures listed will offer different returns, despite the asset remaining the same.
There are five main structures to think about: personal ownership, an investment company, pension scheme, Limited Liability Partnership (LLP) or a trading company.
When making your decision you also need to take into account that there are typically four types of tax to think about with each structure:
1. Stamp duty land tax (SDLT).
2. Capital gains tax (CGT).
3. Inheritance tax (IHT).
4. Taxation of rent (corporation or income tax).
Here’s a quick summary of the five main structures:
Personal or partnership ownership
Partnerships, LLPs and sole traders all come under the same umbrella of rules. If property is owned in this way, it’s considered good from a CGT point of view. This is because sales can be made with relatively low rates of CGT (18%), after the capital gains tax allowances for each partner are deducted.
However, the downside is that tax on rental income will be at the individual investor’s highest rate of tax (up to 45%). So, this structure is best for a short-term property ownership scheme aiming to make capital gain. It could also work for individuals who are taxed at basic rate and operating a small portfolio.
When it comes to IHT, properties held like this are part of the individual’s estate. If an estate exceeds the nil rate band (£325,000), the rest is subject to inheritance tax at 40%. That is unless no inheritance tax is liable until the death of the spouse.
Investment company
This is for a strategy of long-term retention of properties, where profits are used to buy more. The main goal is therefore to get the lowest income tax rates possible to leave more money in the business to buy more. This means a limited company structure is best, with 80% of profits being retained.
There is a small market for selling companies with big property portfolios, rather than selling properties from within it. This would mean less SDLT for the buyer (at 1-2% for company shares rather than 7% for individual purchases of property).
However, there is a downside to this type of investment. When an investment company owns a portfolio, problems can arise when individual properties are sold. The company would take the hit of 20% corporation tax on the sale itself. The shareholders would then get a dividend of the proceeds, which would incur up to 36.1% income tax for high earners. This puts the overall tax at around 50%.
Although a company provides limited liability to the owners, this isn’t as valuable as it could be. As the risk presented by property ownership is more modest than other trading assets, it means insurance policies for the usual commercial risks should be taken out.
If there isn’t a shareholder agreement, and where properties are owned by people who aren’t connected with each other, the company ownership creates some responsibilities and rights automatically. This is down to the Companies Act and gives it a formality that will suit some people.
Some lenders aren’t prepared to give residential property mortgages to a company. Several banks have specialist departments who will go ahead.
Trading company
When shareholders work in a profession or trade, they can use the trade profits to buy a property within their existing company. This means they don’t have to set up a property business separately and will avoid income tax.
On retirement, the trade can be sold separately to the property, with only the corporation tax kicking in. The property is left in the company, which is now deemed an investment company. The shareholders can then take a retirement income from the business as tax free basic rates dividends up to £36,000 per annum.
Pension fund
This is a very tax efficient way to own property. However, these funds can only own commercial properties and are prohibited from investing in residential properties.
Unit Trust, including Exempt Property Unit Trust
This is where investors receive units that represent their investment into the fund. Therefore, the amount of capital and income they make is based on the number of units they hold. Authorised unit trusts are regulated by the Financial Services Compensation Scheme (FSCS). They are open ended and must provide some liquidity to investors. Unauthorised unit trusts are not covered by the FSCS and often have limited liability.
Open Ended Investment Company (OEIC)
Similar to unit trusts but they are set up like companies. Investors buy shares and the company then uses the money to invest. The return for the investor depends on how many shares they hold.
Risk must be spread across multiple assets and investors have to be able to reasonably expect to redeem their shares in a decent span of time, for an OEIC to qualify under the FCA definition.
They can be regulated or not and are often incorporated into tax exempt jurisdictions. This means investors only pay tax on the capital and income they receive.
Investment Trust
These are a type of collective investment set up as public limited companies. The shares are traded on a recognised market. While investment trusts invest in other company’s shares, Real Estate Investment Trusts (REITs) invest in property only.