Over the course of the last 15 years, the tax receipts associated with the sale of commercial property have risen at an incredible rate. In fact, figures recorded suggest totals that exceed that of the UK Gross Domestic Product and The Retail Price Index.
In April 2004, commercial property taxes brought in around £21billion to the HMRC. Fast forward to April 2019, and that figure has risen to £29billion, and despite the economic uncertainty that the country is facing at the time of writing this article, all indications are that this figure is set to continue to rise.
Naturally, such staggering revenues demonstrate that the commercial property market presents an excellent target for taxation. The reasons are fairly clear – a well managed commercial property portfolio must be well documented, typically by an appointed accountancy firm, rather than by the commercial property investor themselves.
What is more, the taxable asset in question is static - be it land or property. Whilst market forces will affect market value, the figures involved in the calculation of a commercial property’s tax liability only really come into play once a transaction has taken place. As such, this means that the figures in question are calculated with a much higher degree of certainty, accompanied – for the most part – by a watertight paper trail.
But what are the tax implications for the commercial property investor when selling their commercial property? In this article, we’ll take a closer look at to just what the investor is liable, along with how these calculations are made.
Before we go any further, we must stress that this article is written by way of providing impartial advice for anyone considering selling their commercial property assets. The information provided cannot replace the expertise and experience of a qualified accountant and we would thoroughly recommend anyone operating in the commercial property sector – be they buyer or seller, retain the services of said accountant. Here at Prideview Group, we would be happy to introduce you to the best people to manage your commercial property finances for you, so please do ask us for an introduction.
The advent of more and more on line businesses that require less commercial operating space has led to widespread criticism that many firms are being taxed unfairly. The problem is that the system in place for assessing tax liabilities was never really designed for the business models that so many newer firms now apply. Granted, tax legislation is constantly changing, but the Government and HMRC are often thought of as playing a desperate game of catch-up.
Regrettably, the smaller businesses in question are facing tax bills which they are finding simply too difficult to pay. Business rates continue to escalate, forcing many businesses into administration, simply in order to pay a tax which was unrealistic in the first place.
In 2017, the system was taken under re-evaluation yet those reforms did seem to put a great number of small businesses under even greater pressure. Many small businesses did receive some generous tax relief in the 2016 budget, but a great many more – particular those more entrepreneurial enterprises received no relief whatseoever.
This imbalance has caused the entire system of UK business tax to come under criciticism from the ICAEW – a membership organisation comprising over 150,000 chartered accountants all over the world.
As one would expect, the report goes into extensive detail, but its title really does speak volumes – Business Rates – Maintain, Demolish, Rebuild or Refurbish? breaks down the four options available to businesses to minimise their tax liability in the area of commercial property.
To be clear, these are recommendations being made to the Government that they might consider in the reformation of business property tax.
Maintain – Make small and incremental changes to the system to address particular stresses. Factor in more targeted reliefs or allow local government more flexibility to address local issues or capture growth opportunities.
Demolish – Remove tax on business property and raise revenues elsewhere instead, such as by increasing corporate or sales taxes. This is a double edged sword however. UK business rates raise nearly half as much as corporation tax. A change like this would mean an increase in other taxes.
Rebuild – Replace the business property tax with an entirely new tax, such as a land value tax, and move towards simplifying the assessment and administration of said taxes.
Refurbish – Fundamentally reform elements of the system which are currently proving inefficient or problematic.
Now of course, it could be argued that the option of maintaining – which is actually the system currently in place, does factor in much of what refurbishment would mean. Granted, the system is not perfect – if it were, then this report would never have come into being.
The Tax Implications Themselves
No system of taxation is without its critics, and putting the world to rights is certainly not the point of this article. So let’s take a look at what taxes are levied against the sale of a commercial property, and how in some instances, those taxes can be minimised or possibly even removed altogether.
We’d like to make it clear that we are going to focus here on the tax implications of selling a commercial property only in this article. There are indeed similar taxations to be taken into account when buying, letting or renting out a commercial property and, as always, it is important to seek the advice of a qualified accountant when embarking on any business venture, whether it be the acquisition of a single commercial unit, or the expansion of a commercial property portfolio.
Ownership of Commercial Property in the UK
Let us touch, very briefly, on the tax implications attached to owning commercial property in the UK.
Inheritance tax or IHT is applied to all assets within the UK which are directly owned. Naturally, this also applies to any commercial property, regardless of where the owner is living – if outside of the UK.
Inheritance tax is payable upon death at a rate of 40% of assets held at that point. This tax is also applied to any gifts made within seven years prior to death, although there is a narrowing of the rate for these.
In order to minimise this tax, many financial advisors and accountants will suggest that their clients transfer their commercial property assets into trust. This will have the IHT charge to 20% and those assets will be subject to an ongoing charge of roughly 6% every 10 years. There is also a pro-rated 6% IHT charge on any distributions from that trust.
As long as the settlor of the trust retains an interest in that trust, the commercial property will remain in their estate from the perspective of inheritance tax.
We mentioned earlier that living outside of the UK does not mean that a commercial property owner will be exempt from IHT. However, that commercial property owner can shelter the value of that commercial property from inheritance tax by purchasing or transferring ownership of the property through a non UK resident company. This means that they are treated as owning non UK situs shares and as such, tax relief on these assets can be acquired.
Selling Commercial Property – Capital Gains Tax
The sole purpose of investing in commercial property is to make a profit. Therefore, if the commercial property investor has been successful in this regard, then he or she may be liable for Capital Gains Tax when selling any property which is not their domestic residence.
Naturally, many owners of commercial property have to sell because things have not gone as well as they might have hoped, and therefore they may need to sell to minimise their losses in a falling market. Clearly, in this instance, no actual gain has been made, hence they could not be realistically expected to pay Capital Gains Tax on the sale of their commercial property.
It is worthy of note here that commercial property owners do not have to pay tax on gifts to spouses, civil partners or charities, and they may also be in a position to apply for tax relief if the commercial property in question is regarded as a business asset. This is why it is often considered a wise move to establish a limited company when looking to invest in commercial property, and to put all property transactions through that business. Again, it is wise to seek the advice of an accountant before doing this, because if the purchase is being financed by a mortgage, some lenders may be more inclined to lend to new commercial property investor as an individual, rather than a start up company. It may prove more beneficial to adjust the order in which things are done, and an accountant or business mortgage advisor will be able to help here.
Let’s break down some of the criteria which come into play when looking at Capital Gains Tax. Before we do, we’d like to point out that, at the time of writing, both the current Government and opposing parties have pledged to the electorate that they will be taking the whole issue of Capital Gains Tax under review. Naturally, we will update our information just as soon as it becomes available, but this information was correct as of November 2019.
Up until April of 2019, non UK residents, be they individuals, trustees or companies, have been exempt from UK taxation on any monies received from the sale of any commercial property which was held for investment purposes. This language may seem rather long winded, but it did set about an important distinction.
Whilst it is true that the majority of commercial property in the UK is owned by investors and rented out to other businesses, there is still plenty of UK commercial property which is owned and occupied by the same business. The property has not been purchased as an investment, but essentially as a ‘home’ for a company. This naturally created a legal loophole when it came to these companies’ Capital Gains Tax Liability at the point of selling the commercial property in question.
In addition, any commercial property where said property either was or was going to become a development property attracted specific rules.
Naturally, the system was messy and in April of 2019, the Government declared that the sale of all commercial property became subject to Capital Gains Tax. This also applied, particularly in the case of non UK residents, to the disposal of any indirect assets in such commercial property.
Some small relief was that Capital Gains Tax was rebased to April 2019. What this means is that only the element of gain accruing from that date would be taxable. Regardless of their country of residence, all sellers of commercial property in the UK are liable for taxation at the same rate.
Whilst many commercial property owners operate as either limited companies or PLCs, there are still plenty of owners who operate, and are therefore taxed as individuals. The rate of Capital Gains Tax for the sale of UK commercial property is at 10 or 20% of the gain only. The difference between those two rates depends on whether or not the individual has any basic rate band remaining after the calculation of their income for income tax purposes.
It may seem obvious to many, but it’s an important distinction to make. Capital Gains Tax is exactly that – a tax on the gain, not the value of the sale. If a commercial property investor acquires a retail unit for £250,000, rents it out for five years and then sells it for £350,000, then that 10 or 20% of tax only applies to the £100,000. Whilst it can be argued that the commercial property investor will have been making a profit through rental income, that is subject to income tax, and therefore not relevant here.
Trustees are subject to Capital Gains Tax at a rate of 20% as standard.
Should the commercial property be owned by a company, as opposed to an individual, then that company pays a different tax on the sale of their commercial assets. They pay Corporation Tax at a rate of 19%, set to drop to 17% from April of 2020. Much like Capital Gains Tax, this is still a tax on the profit at the point of sale, and not the operating profit of the commercial property.
Investment in Commercial Property can be an incredibly lucrative business practice, and like all successful business, it’s important to have access to the right people to advise you and navigate you through the maze of UK tax law. The team at Prideview Group really are experts in this arena, and we’re ready to help you, so please do get in touch.