PROFIT EXTRACTION - 31.05.2012

Choosing between income tax and CGT savings

Conflicting tax planning

Tax planning is usually about reducing the amount you pay, but deferring a tax bill for a long time can also be advantageous. However, where you have to choose between one or the other, deciding which can be tricky. For example, you can save tax and NI by taking rent from your company in place of salary etc., but in doing so you’ll lose out, in part or in full, on Capital Gains Tax (CGT) entrepreneurs’ relief (ER) when you sell the property.

Example. Edward owns all the shares in Acom Ltd. In May 2004 it relocated to a new workshop bought by Edward. He charges full market rent to Acom. In May 2012 he sold a 30% share in Acom and the workshop, making a gain of £100,000 and £50,000 respectively. The first gain qualifies for the 10% ER rate of tax, but some, not all (see below), of the gain on the property is payable at 28% because Edward received rent from it.

Pre-April 2008 ownership

Where rents were received prior to April 2008 these are ignored in the ER calculation. In our example 47 out of the 96 months up to the sale in May 2012 will qualify for the 10% ER rate, while the remaining 49 months will be taxed at 28%. The trouble for Edward is that all the time he continues to receive rent from the property this decreases the proportion of any future gain he makes from selling the property which will qualify for ER.

Tip. One alternative Edward should consider is reducing the rent he charges Acom. This is because where less than full market rent is charged, ER is allowed proportionately.

Example. If Edward had only charged Acom rent at 60% of market rate, then of the £50,000 gain he made from the sale in May 2012, £30,000 would have qualified for ER and therefore be taxed at just 10%. The balance of £20,000 would remain chargeable at 28%. This is a saving of £5,400 (£30,000 x (28%-18%)).

CGT v income tax and NI savings

Apart from the extra work involved in establishing the market rent (you’ll probably need a commercial property agent to do the valuation) working out the potential CGT savings of taking a reduced rent is relatively simple. Likewise, so is working out the tax and NI that can be saved by taking rent from your company in place of salary etc. However, the trouble is that you don’t know what will happen to CGT, ER, income tax or NI rates in the future. You also won’t know how much gain you’ll make when you finally sell your property. So how can you plan for maximum tax efficiency?

Tip. We suggest working out CGT savings based on current property and rental values and comparing this to current NI and income tax savings made from receiving rent. If you then assume the tax savings are the same for the next ten years, this should make the picture clear enough to decide which option to go for. This might sound like a lot of number crunching but the good news is we’ve produced a special calculator that will do most of the hard work for you. You’ll just need a few basic figures.

For a spreadsheet showing how to calculate ER and the current tax benefits of rent, visit http://tax.indicator.co.uk (TX 12.17.04).