Tax Implications of Purchasing property.

When purchasing business or commercial property one should always consider the tax implications. It is important that before purchasing a commercial property one establishes the potential tax liability. Note that the details below only provide to serve as an outline and if you are in any doubt, it is recommended that you consult a properly qualified tax advisor on the tax issues raised.

Income Tax:

Rental profits from commercial property are taxed in the same way as any other rental income, whereby you pay income tax at 10 per cent, 22 per cent or 40 per cent, depending on your overall income level. You will get a deduction against your rental income for general costs of running the property; repairs, interest costs etc. If you set up a company to run your property, the company will pay corporation tax, probably at 19 per cent.

You do not get an annual ‘wear and tear’ allowance of 10 per cent on commercial property in the same way as on furnished property that is rented out but instead, you become eligible for a series of capital allowances.  The rates of allowances vary: you will get 25 per cent (reducing balance) on ‘plant and machinery’ (which might cover various fittings in the building) but only 4 percent (straight line) ‘industrial buildings allowance’ on the buildings fabric, and, as the title suggests, only if the building qualifies as industrial (so a shop doesn’t usually qualify). This whole area of capital allowances needs careful investigation if it is important to your calculations.

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Capital Gains Tax:

Selling the property will be a disposal for CGT purposes.  The gain will be computed in the normal way with no prospect of a CGT exemption parallel to the ‘main residence’ relief

There will be tapered relief which can be a major advantage of investing in commercial property, as there is the possibility of a 75 per cent CGT exemption, for ‘business asset taper relief’, allowable after owing the property for two years.  To qualify you must have let your property to a qualifying trading business.  Examples include any of trade carried on as a sole trader, a partnership involving at least one individual or an unquoted company.  Where your tenant is a quoted company, this relief may apply if you work for the company.

If the property doesn’t qualify as a business asset, you will be inline for the less advantageous non-business asset taper.  That leads to a reduction in the gain chargeable after the first three years of ownership of 5 percent each year to a maximum of 40 per cent, and base rate taxpayers of 12 percent after the full ten years.

If you own your property via a company, on disposal, there is no taper relief; instead the company gets an indexation allowance and pays corporation tax (at the normal 19 per cent, rate if its profits are below £300,000). You may have GCT to pay on your shares in the company if you sell them.

VAT:

Rents are in principle exempt from VAT, so the usual starting point is that VAT is irrelevant.  However, if you (or the company, if it owns the property) are registered for VAT, you have the choice whether to charge VAT on top of your rent.  If you do, you can recover VAT on the costs and expenses which relate to the rents, such as building, renovating and redecorating costs.  Charging VAT on commercial property rent is usually known as ‘exercising the option to tax’.  If your tenants themselves are registered for VAT then they will be able to recover at least some of this tax.

The problem comes when the tenants cannot recover VAT in full, either because they are not registered (perhaps their annual turnover is too low, or more likely, because their business or profession does not attract VAT, such as an NHS medical practice) or they are partially exempt (for example an insurance business).  The stumbling block here is that you are unable to change your option to tax: once exercised, it can’t be revoked for 20 years though if the building is sold, the purchaser can start again on opting.  This complicated VAT option requires care and professional advice.

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