Two friends own a couple of rental properties together. He pays tax at 50%, she pays tax at 40%. Can she charge him a fee for managing the properties, sufficiently large to wipe out his profit each year?
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Yes but...
You'd have to show that the charge was at a commercial rate, ie not just a figure to wipe out his tax. If it can be shown that the prime purpose for a transaction is to reduce tax then it is ignored.
Oh yes, and you must be able to show that she actually did manage the property. Bit like me charging my 50% tax paying client for the accounts (I'm basic rate!) when I don't do the accounts.....I have actully tried this several times but have never managed to get away with it!
Chatmen,
I agree with everything Paul says but as there is a rental business in existnece an alternative would be to create a partnership. This would mean profits can be appropriated to each partner however they wish on a year to year basis. This offers more flexibility and doens't require either party commit to do the management.
I don't believe they need to 'create'
a partnership to appropriate the rental profits in whichever way they see fit.....that can already be done (assuming they are not man and wife).
However if you are going to contend that a mangement fee of £x is an appropriate charge on the properties presumably 'she' will be declaring the income she earned from carrying out this work.....in which case the tax saving will be maximum 10%? Are both properties full furnished? (perhaps do this to get 10% wear and tear write down...) - remortgage both rental properties to the maximum and use funds to pay off any personal debts/mortgage....? Are properties HMO's - any capital allowances available....? Just a few ideas.....
Justsotax,
I see what you are saying i.e.,there's a de facto partnership anyway. But I believe the Partnership Act attributes profits equally between partners unless they specify otherwise. I therefore think a formal agreement is the best option.
Although not relevant in this case there's no reason why husbands and wives can't use a partnership in the same way.
Your suggestion of remortgaging makes good sense from a tax perspective
hmmm...i have seen conflicting treatment in this type
of situation, but for me this is merely two people having a share in an investment property - I don't believe two properties being rented out by the same people constitute a 'trading business' (unless other factors indicate otherwise) - which is the only way i believe a partnership would be relevant in this situation.
Form 17 would be required to 'vary' the income distribution for a husband and wife, but where unrelated people share ownership then i understand that a simple declaration could be completed by all parties agreeing an appropriate % income distribution (which may or may not reflect the actual capital introduced by each party).
I do agree that some people
I do agree that some people wouldn't view property rental as a business. In my view that's wrong on two counts:
Firstly if you've ever been a landlord with bothersome tenants you'll know your running a business!
Secondly HMRC consider it a business (but not a trade) I quote below from their toolkit on the subject
Profits from UK land or property are treated, for tax purposes, as arising from a business. While the rental business profits are computed using the same principles as for trades they are not trade profits and are subject to a different set of rules. The computation is based on commercial accounts drawn up in accordance with generally accepted accounting practice. For Income Tax purposes the profits or losses should be calculated for the tax year to 5 April so this may require apportionment of accounts figures
The Partnership Act allows any persons in business together to constitute a partnership.
Form 17 doesn't, in fact cannot, apply to partnership income (s836 ITA 2007 Exception C). Therefore the Partnership Act determines the profit share except where there's a partnership agreement to say how it should be attributed.
Why bother with an agreement that only specifies how profit should be allocated, that's just a poor partnership agreement. You only need about a page and a half of A4 to draw up a simple but effective one that will be more than adequate for this situation and will cover eventualities like what happens if one party dies or wants to leave the arrangement, etc. For a happeth of effort you can save yourself a lot of pain later, and not just from the Taxman.
beat me to it justsotax
I have frequently seen attempts to say rental properties contituted a partnership and it is not the case.
Form 17 is the only way of varying the rental share - nor do I feel paul that you can charge management fees - how can you manage half a house? If a sole trader asked to charge for his time in his accounts you would say no and this is charging yourself too!!
If there were an added value - extra services for the tenants - that she provided, then that element could be a sole trade in her own right but you would have to be really providing extra services such as fully serviced accomodation.
Not sure what HMO meant - I didn't think you could claim capital allowances in residential properties - certainly worth furnishing to a minimum level to qualify for Wear & Tear allowance
but you have to read on
Looking at all the references they stress that just owning a property jointly is not enough. They do accept that sometimes a partnership may exist - but only in certain circumstances.
extract from PIM1030:
When does a partnership exist?
Whether or not a taxpayer is a member of a partnership depends on the facts. A partnership is unlikely to exist where the taxpayer is one of a group of joint owners who merely let a property that they jointly own. On the other hand, there could be a partnership where the taxpayer is one of a group of joint owners who:
let the jointly owned property, andprovide significant additional services in return for payment.
Much depends on the amount of business activity involved. The existence of a partnership depends on a degree of organisation similar to that required in an ordinary commercial business.
Bear in mind that the existence of a partnership can have important legal consequences quite apart from tax; the taxpayer may be liable for partnership debts for example.
I have highlighted the last paragraph as I had not thought about that aspect.
If you do feel that you can justify a partnership, and want to join the partnership return club, the agreement can specify a prior share of profit.
Marion,
Thanks I see what you're getting at and I was aware of what HMRC say. But actually it's not up to them to decide whether or not a partnership exists, it's a matter of law (not tax law).
While the receipt of rents alone does not constitute a partnership it isn’t precluded. And as soon as you have more than one property jointly owned from which rents are received or there is any management involved in a single property it's likely that a partnership will exist, or at least can exist.
I believe the purpose of s.2 of the Partnership Act concerning receipts of rents not constituting a partnership is there to protect property owners from being automatically being considered as one. This might cause all sorts of problems for them because partners have a joint and several interest in assets and liabilities.
S.3 of the Act says essentially the same thing about profits from business i.e., just because you share profits doesn't mean to say there’s a partnership, These two sections of the Act are intended to exclude the existence of a partnership to stop one from being implied and causing beneficial ownership problems. In other words where you want a partnership you can create one for rent or profit sharing situations but you’re not forced into it.
Where a partnership exists HMRC's role is to decide how to tax it in accordance with the law not to test whether it exists (unless it’s evidently a sham and evasion is involved). On this point it's worth looking at BIM72065 (it's a cracking good read!) about the existence and profit sharing arrangements of a partnership (in that case a husband and wife partnership) - essentially they indicate they cannot dispute its existence where there is a partnership agreement in place.
Isn't tax wonderful!