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What are the tax implications of Special Purchase Vehicles (SPV) for property investors?

Discover why property investors are joining forces to save tax!!

The most common way in which property investors pool their resources together is in the form of a Special Purpose Vehicle (known as SPV).

This article looks into both the legal and the tax implications of Special Purpose Vehicles (SPV's).  The most popular are Joint Ownership and Partnerships.

So, let me explain exactly how ‘joint ownerships’ operate…

Because of the significantly challenging UK property market, most property investors are taking the approach of joining forces with other property investors to enable them to begin and understand the tax implications of Special Purpose Vehicles (SPV's) for business tax purposes.

1 Joint Ownership

The easiest option for property investors would be to take on a ‘Joint Ownership’ with additional investors.  Although this isn’t classed as a true SPV, it is definitely worth considering. The rules differ for both English and Welsh property investors compared to those in Scotland.

Joint Ownership - England and Wales

There are two forms of joint ownership in England and Wales.  The first form is known as a ‘joint tenancy’ and the second is known as a ‘tenancy in common’.  If you are a joint tenant, you jointly own the legal title of the property so can therefore only sell the property together. With the ‘tenancy in common’ option, the tenant can sell their own part separately if they so wish.

Joint ownership - Scotland

The laws are different if the property is in Scotland and it is recommended to seek a Scottish Lawyer.  Joint ownership here takes a ‘tenancy in common’ approach but is subject to Scotland’s Property law.

Joint Tenancy on Death

If the property investors have a joint tenancy and one of them were to die, the other joint tenant (or tenants) will receive the deceased ownership. The joint tenancy overrules any Will or ‘Deed of Variation’ thus in turn restricting the joint tenant’s chances to carry out any Inheritance Tax Planning.

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And, oh yes, let’s not forget…

If the joint ownership is owned by a couple, or members of the same family, despite any obstacles for IHT Planning, it might be acceptable that this property portfolio shares could pass by survivorship.

If this is a situation where both investors are seen to be business partners, it is recommended that they invest as ‘tenants in common’ rather than take on a ‘joint tenancy’.

So, you might be thinking what are the restrictions or tax implications?

Restrictions

As there is a restriction to the legal ownership of a property being a maximum of up to four people there could be difficulties. If you have more than four people, legal fees could begin to stack up and although these difficulties can be resolved, it could get messy.

Shares & Tax Implications

You do not have to own equal shares when you are a joint property owner. You can have a combination of these interests (so long as it totals 100%).  Any solicitor will be able to organise this.

However,

It doesn’t matter which form of ownership you take, you are usually only taxed on your own share of the property for both income tax and capital gains tax.

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Non-Married Couples

For non-married couples, joint owners can decide to share their income from rent in different quantities from the legal ownership of that property. (this could as a result of one of them is dealing with managing the portfolio).

Any income tax due will need to be in line with the arrangements from the profit share agreement, so it is strongly advised that your profit share agreement so well documented to ensure there is no future discrepancies.

Married Couples

For married couples, the joint property income is received equally. At the start of the tax year, they might decide to designate a proportion of that rent, but have to do this before the tax year starts. It must be said that having a split equally does provide tax saving opportunities which is why most couples leave it to be received equally.

Purposes for Capital Gains Tax

For the purpose of CGT, the joint owner is taxed on their share of this gain that arises. If there are any exceptions on available reliefs, for example, PPR Relief (Principal Private Residence), the reliefs are given to the individual, not to that of the property.

Let me show you how it works with the example below…

Jack and Ms White purchased a property in May 1998 and therefore owned the property jointly. In May 2004, they decided to sell the property which made them a profit of £120,000 (or 50/50 which equates to £60,000 each). Jack lived in this house (his PPR) from May 1998 to May 1999. The property since then was rented out.

Therefore, Jack can claim £40,000 of PPR relief on his property. This means that he is exempt of 4 years out of the 6 years he owned the property. (Note that the last 3 years’ ownership of a PPR will always be exempt in addition to the actual period of residence). Jack’s residual profit of £20,000 will be covered by PLR (Private Letting Relief), which leaves him having no taxable advantage.

As Ms White didn’t reside in this property, she is not entitled to receive any PPR or PLR. It will be possible for her to claim taper relief and potential an annual exemption, however Ms White will have a taxable gain of a size. There is no advantage to her that it was once Jack’s PPR.

But it doesn’t stop there, what about partnerships?

2 Partnerships

The second SPV to consider is the ‘property investment partnership’.

The ‘Partnership’ combines simply the ‘joint ownership’ option that we referred to above with a profit share agreement.

Plus..

Flexibility

A partnership is considered to be a lot more flexible. Dependent upon the partnership agreements’ terms and conditions, partners are able to leave, join or even amend the profit share whenever they wish.

Scotland
A partnership in Scotland is deemed a legal entity which means it can directly own the property itself.

England and Wales
A Partnership in England and Wales is different. As a partnership is not deemed a legal entity (legal person), it might not own a legal title in the property. This issue is commonly avoided through using nominees. This means that amongst 2 and 4 partners, they usually own the partnership's property as nominees for the partnership. It is sensible (for legal purposes) to make sure that there is a minimum of two interested nominees because if there was just a single nominee they would have the right to the property entirely.

Furthermore…

A new legal entity in 2000 was introduced in the UK which is known as a Limited Liability Partnership (LLP). This means that it is a legal person (entity) that can own the property directly – just like a Scottish Partnership.

Here is something else to keep in mind…

Tax

Dependent upon the partnership agreement and the share of rental income, the partners are taxed on their share of income generated through rent and CG (capital gains).

Then there’s…

Stamp Duty Land Tax (SDLT)

You must be aware of the possibility of incurring SDLT charges on property through investment partnerships. From July 2004, SDLT is payable when:

  • A partner adds another property into that partnership;
  • A partner decides to withdraw property from the partnership, or;
  • A partner reduces his/her profit share

For cases where there is a decrease in a profit share, you need to give some thought to the actual transaction (it could generate a charge, even if it’s accounted for by a partners’ capital accounts).

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Here are some working examples…

Working Example - Part A

Justin is in a ‘partnership’ with four of his friends, James, Bradley, Frank and Geoff, for five years. All the friends have a profit share of 20%. Justin now wants to retire and therefore wishes to get out of the partnership. The other partners are in agreement and as a result of Justin giving up his partnership, they would like to give Justin a property called “Tower A”. This property is worth £1 million.

Because Justin has a 20% share in Tower A, he has attained an 80% share, which is worth £800,000 when he leaves. As such, Justin will incur a SDLT charge of £32,000 (this equates to 4% x £800,000).

Working Example - Part B

A few days later, Frank’s great uncle leaves him £1,000,000. Frank then makes the decision and invests the money into the partnership. Whilst this is happening, James has made the decision to retire. He decides to sell his share in the partnership. Frank decides to purchase James’ 25% partnership share for a total of £1,000,000. This then increases Frank’s share from 25% to 50%.

Before Frank invested the £1 million, the total value (gross) of the property portfolio was £20 million and had £16 million of borrowings. Although the partnership’s net assets were only £4 million, the charge of SDLT is calculated on the gross value of the portfolio.

As Frank’s share has now increased to 50%, this means he has obtained an interest of 25% in property which is worth £20,000,000. As such, Frank is now facing a £200,000 SDLT bill!

(This figure has been calculated as 25% of £20,000,000 which is charged at 4%.)

This means that anybody who uses a ‘property investment partnership’ really must ensure that the profit shares are correct in the first instance and try not to change them further on down the line.

But wait, there’s more…

If you have a simple investment of cash that is made into the partnership, it cannot incur a SDLT charge.  If Frank, therefore had simply put a cash payment of £1million in, and not tried to buy out James’ share, SDLT could have been avoided and would still have been able to increase his profit share to 40%.

What about companies?

3 Companies

The last method we are going to discuss is the term ‘property investment company’.  This is when you have a lot of people investing together.

There are several advantages you can obtain by using a company.  One of which is the low corporation tax rates that apply to all profits. (In most situations, it is between 19% - 30% and is dependent upon the company size).

Another low tax rate that is applied, is that of CGT.  It is important to note that Companies do however have fewer reliefs that are available to them to reduce their taxable gains.  Discover how investing in R & D can save you money.

Considerable savings can be made when applying property investment partnerships.

Finally, how about joining a syndicate?..

4 Syndicates

By joining a property syndicate, it is likely that you are investing through any one of an SPV structure.  These can be anyone of the above or any of the following:

  • Unit Trusts (these are either in the UK or are Offshore);
  • Joint Venture agreement

Don’t forget…

It is best to determine just how you structure your syndicate and we recommend that you seek advice independently.

So, remember…

As with all investments, always ensure that you are extremely careful with whom you trust!

Sarah Aubert