Often a company’s trading premises is held separately from the trade - either personally, in partnership, or in a bespoke company which may or may not be grouped. Here we are specifically considering OpCo/PropCo (Operating Company/Property Company) structures, although some of the issues discussed have wider implications.
There may be strong commercial reasons for such structures, including separating property from an inherently risky trade and enabling advance exit planning.
However, there are some pitfalls for the unwary, which we point out in this ezine.
To understand the tax position, it is first necessary to appreciate how English land law determines ownership.
- Principally it is not possible to separate ownership of buildings from the land on which it stands. Similarly, ownership of fixtures and integral features physically attached to the building rests with the landowner, i.e., PropCo.
- In the absence of a lease, OpCo has no rights over the land or buildings thereon.
- But where a lease exists, OpCo has a right to occupy and use the property.
Potential problems – capital expenditure
A very common set of problems arises where OpCo has paid the cost of enhancing the land or buildings, usually due to a mistaken belief that it can reclaim the VAT thereon.
- VAT: OpCo cannot reclaim input VAT on the cost of capital improvements unless there is an obligation to pay the sum under a lease, or it can recharge the costs to the landlord, with VAT thereon. PropCos are usually not VAT-registered, and cannot therefore reclaim input VAT.
- Capital allowances: Where there is a formal lease giving OpCo an interest in the property, it can claim CAs for the cost of fixtures it installs for use in its trade. However, in the absence of a lease, CAs will not be available.
- Capital gains: On sale of the premises, no deduction will be available to PropCo for capital expenditure incurred on improving the property if it did not itself incur those costs. For OpCo, where a lease exists, improvement costs may be an enhancement to the lease asset, but the available cost for Capital Gains purposes will diminish over the life of the lease due to the wasting asset rules. In the absence of a lease OpCo has no asset, cannot make a capital disposal and is unable to claim a deduction for improvement costs, even on a wasting basis.
- Shareholder benefits: If OpCo incurs capital expenditure to enhance a PropCo asset, value may pass out of OpCo and into PropCo, representing a constructive distribution by OpCo to its shareholders.
Where OpCo and PropCo are not within the same group, the individual shareholders would then be subject to Income Tax at dividend rates when the capital expenditure is incurred. Where the shareholders are also the directors of OpCo, HMRC may argue that an employment benefit has arisen on which income tax and NIC is due.Within a group structure, such a distribution to a corporate shareholder is likely to be exempt.
Where there is no lease and the property is occupied under licence, the distribution will be the full value of capital expenditure incurred.However, where OpCo occupies the property under a lease, the tenant has the right to occupy the property and therefore the value passing to the landlord will be the residue at the end of the lease, which may be small. And if the lease requires the property to be ‘made good’ no value will pass to the landlord on the basis that the OpCo will have to remove any such enhancements at the end of its lease.
- Non-tax issues:
- Determining how capital expenditure should be reflected in the accounts can be complex and maybe subject to new Financial Reporting Standards on leases – are they GAAP compliant?
- A company is prohibited in law from divesting itself of assets to the detriment of the creditors and shareholders. By effectively ‘giving away’ assets of OpCo, the directors may need to consider whether they could be in breach of their fiduciary duties.
Potential problems – revenue expenditure
Under a tenant repairing lease OpCo is responsible for repairs: the cost will be deductible for corporation tax, and the input VAT will be claimable. Otherwise, for corporation tax purposes it may be possible to demonstrate that repair costs have been incurred wholly and exclusively for the purpose of OpCo’s trade (and therefore deductible) but, if OpCo occupies the property under an informal licence or a landlord repairing lease, the lack of obligation to bear such costs means that associated Input VAT may not claimed by OpCo.
- Loan relationships: If OpCo and PropCo are connected, loans are carried at amortised cost for tax purposes (i.e. not fair value), and impairment of debt is ignored for tax purposes of both companies. But, where OpCo and PropCo are not connected an impairment will result in a loan relationship debit and credit arising in the respective companies for corporation tax purposes, unless relief applies. ‘Connected’ for this purpose is separately defined as essentially companies under common control of a person (or persons acting together).
- Shareholder tax: A release of a company’s loan to a non-corporate shareholder represents a distribution by the lending company to its shareholder equal to the value of the loan released. If the loan is considered irrecoverable its value may be low or negligible, meaning shareholder tax is minimal, but if there is no reason to doubt eventual repayment of the loan, the distribution will be the full value of the loan released. If the shareholder is also a director or employee, the release will give rise to Class 1 NIC employee and employer liability.
Death of a shareholder
Business Property Relief (BPR) may not necessarily be available in a two company group (i.e. with PropCo owning OpCo). HMRC may contend that the top company owning a property means it is not ‘wholly or mainly a holding company’:
- BPR will be restricted if the value of the property is more than the value of the OpCo shares – to be ‘mainly a holding company’ more than 50% of PropCo’s value must rest in its investment in OpCo shares
- The fact the property is used in the trade is only a factor when considering if the wider group is trading after it has been determined that PropCo is a holding company.
It may therefore be preferable to have a three company group (i.e. with PropCo and OpCo as sister subsidiaries both owned by the same holding company).
BPR will not be available on shares in a PropCo held outside a group.
- Corporation tax: The sale of an OpCo subsidiary by a parent should qualify for Substantial Shareholdings Exemption (SSE). The sale of a PropCo subsidiary will usually not qualify for SSE. De-grouping charges may arise when a company leaves a group if there has been a prior transfer of assets to that company.
- Stamp Taxes: An acquirer may prefer to acquire the PropCo rather than the underlying property, as Stamp Duty on shares is normally less than SDLT on property. However, there may be an SDLT group relief clawback in the exiting company if it holds property transferred to it intra-group within the previous three years.
- Shareholder Tax: Where OpCo and PropCo are within a group, sale or liquidation of the holding company may qualify for Entrepreneurs’ Relief (ER). However, where PropCo is owned outside a group, ER will not be available on a disposal of its shares.
- Demerger of group pre-sale: HMRC is unlikely to give Transactions in Securities clearance for the demerger of a group if it is in contemplation of a sale.
- Valuations: For certain businesses (e.g. restaurants, hotels and nursing homes) goodwill is likely to be considered inherent in the property rather than the trade. HMRC may challenge the allocation of proceeds between PropCo and OpCo.
OpCo/Propco structures can provide significant benefits, but clients should have a proper understanding and appreciation of both the tax and non-tax issues before setting up such a structure and incurring capital or revenue expenditure on the property.
Where possible, advisers should take the opportunity to discuss property-related proposals and provide proactive advice in order to help clients avoid some of the pitfalls.
Non-resident owners should also review the tax aspects of existing arrangements following the FA 2019 changes to the capital gains tax rules.
For more information, or for assistance, please contact Chris Holmes.
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