What is the correct accounting treatment for the purchase of the freehold by 3 resident leaseholders? This is the company's first year.
The block consists of 4 flats. 3 flats bought in and have varied their leases to extend and reduce their ground rent to a peppercorn. The fourth flat did not buy in, and the small ground rent (£250pa, rising) from his flat is the only income for the company. The only asset is the freehold, which I have valued at cost (£16000 including conveyancing fees). There is no cash on hand.
Total net assets therefore £16000 + £3 = £16003.
Shareholders' funds must = £16003. Of course £3 will be placed in called up share capital column.
As for the remainder, should I:
(a) Place £16000 in the share premium account, or
(b) Place £16000 in the director's loan account, or
(c) Place £16000 in some other kind of reserve?
Our objective is that if, in the future, the 4th flat does decide to buy in (or when he needs to extend his lease, or if there is any other future gain from this freehold) the sum can be returned to the 3 shareholders, be that us or a future purchaser of our flats to whom we must sell our share.
The reality is that at the time of the freehold purchase, we each posted cheques for £16000 / 3 to our solicitor. There was no "loan" arranged. Should there have been? Is there anything that can be done now? Surely such a loan would need its own separate agreement (agree not to call the loan in at whim? interest payable?). Surely if there is a loan then that loan must be transferred to any future purchaser of our flats, which sounds like a legal nightmare to me?
N.B. Service charge funds are being held on trust and as such will not form part of the company accounts, save for a mention of their presence in the notes.
I greatly appreciate your answers.
Replies (12)
Please login or register to join the discussion.
Probably Loans
The accounting entries should reflect what actually happened. It appears that you expect to get the money back from the company when it has some cash. This indicates that you were lending the money to the company rather than using it to pay a premium on the issue of the shares, as that could not easily be repaid to you. This would be confirmed by what was filed with Companies House when the shares were issued which probably show the shares being issued for £1 each.
Having established that it was a loan, you could draw up a simple Loan Agreement now setting out the terms of the loans. This could include how and when you get repayment.The loans do not have to be transferred as such to a purchaser of a share in the company. As part of the sale of lease and share, they pay money into the company as a new loan and you draw it out in repayment of your loan and they agree to be bound by the terms of the original Loan Agreement in respect of the new loan.
Presumably you have a Shareholders Agreement dictating that a share has to be sold if the lease is sold and the new purchaser would also need to enter into that Agreement.
Loans
I agree entirely that the surplus of £5,333 over the £1 cost of one share should be credited to loans from the 3 shareholders. If the fourth occupier ever joins in, he would be required to pay in £4,000, which would then be paid out £1,333 to each of the original shareholders to reduce their loans to the same £4,000 as the 4th shareholder.
N.B. Service charge funds are being held on trust and as such will not form part of the company accounts, save for a mention of their presence in the notes.
Are you sure about this? Assuming that the company is contracting as principal for the communal services, the transactions should appear in the company's accounts, matched by sufficient income from service charges to produce a nil profit/loss. Only the balance of service charge funds are excluded from the company's figures, but disclosed in a note.
Variable service charge?
I agree with Euan re the loans,
Regarding the service charges, then, assuming they are variable in nature, then I guess we're talking about ICAEW technical release 03/11 which states that any money held by the company will be held in trust and is not an asset of the company. Contracts entered into by the company, though, could result in creditors at a period end (e.g. monthly window cleaning invoice paid after date): then there would be a corresponding debtor being funds due from the trust to pay the invoice. So there will always be nil net assets.
Whether or not transactions on the trust bank account should appear in the P & L Account is still to be decided (!), but my feeling is in favour of excluding them (if they are included, then income should be accrued/deferred to give zero profit).
Any interest earned on the bank account will be subject to tax, but not corporation tax: it will be income tax to be declared on a trust tax return.
Some people, though, don't accept all this, even though counsel's opinion has been taken on it, and of those that do think it is correct, many ignore it. In any case, there is an additional legal requirement for service charge accounts (separate from the company's statutory accounts) to be prepared to show details of income and expenditure and to be sent to all members.
Forgive me if I am wrong, up here we don't deal with this freehold/leasehold stuff.
Now I presume the company purchases the freehold for £16,000. 3 individuals put money into the company. and there are four flats. Presume at that point the company has a right to income of 4x250. Now three of the leaseholders get their ground rents reduced- so surely they need to pay the company for this? Can the Freehold still be worth £16,000?
Accordingly is not part of the contribution of each of the three actually buying additional rights from the company re their individual flat?. Surely each reduction is worth circa £4,000 and the freehold is diminished by 3x£4,000?. (Numbers for illustration purposes)
Or am I missing some nuance of how you all deal with property down south?
Good point, but if the freehold were to be sold, then would not the existing leases be cancelled and higher rents become payable again, hence the open market value remains unchanged?
How does a lease get cancelled
Good point, but if the freehold were to be sold, then would not the existing leases be cancelled and higher rents become payable again, hence the open market value remains unchanged?
How does a lease get cancelled?
Do the leaseholders not have any rights/ say in such a matter?
It seems logical to me that the company has passed value to 3 of the leaseholders who are also its shareholders, by varying their leases, surely the company requires to receive market value payment for transferring these rights.
As I said, we do not have residential property under leasehold in Scotland, the law here does not permit, so my comments are based on my rank ignorance but what I perceive as common sense. If an asset at point A earns £1,000 a year and at point B £250 a year it surely must have reduced in value?
@DJKL
The question was how to account for the injection of funds into the company for the purchase of the freehold in the first place and we agree that it should be treated as loans.
The lease extensions were separate transactions and I agree with you that the logical conclusion is that the value of the company's freehold interest has been reduced by the substitution of a peppercorn rent for £250 a year. It would be rather pointless to treat that only as an impairment of the fixed asset because that would result in accumulated losses in the company, balanced by the existing loans.
A better solution would be to treat the 3 tenants as having paid for the right of a peppercorn rent, so that the impairment would be matched by a reduction of their loans, but the OP made no mention of any payments being due.
Is this what ought to have been done?
The question was how to account for the injection of funds into the company for the purchase of the freehold in the first place and we agree that it should be treated as loans.
The lease extensions were separate transactions and I agree with you that the logical conclusion is that the value of the company's freehold interest has been reduced by the substitution of a peppercorn rent for £250 a year. It would be rather pointless to treat that only as an impairment of the fixed asset because that would result in accumulated losses in the company, balanced by the existing loans.
A better solution would be to treat the 3 tenants as having paid for the right of a peppercorn rent, so that the impairment would be matched by a reduction of their loans, but the OP made no mention of any payments being due.
That was what I was, rather badly, trying to get at, the payments made are surely better seen as a combination of payment for share/shares and a loan which is then part used to buy the lease variation from the company. In a crude manner if each put in £16,000/3, £5,333.33, £1 is for a share, £5,332.33 is a loan. Each loan then gets part used purchasing the lease variation, say £4,000 re each flat.This leaves balance sheet:
Freehold £4,000 (with income of £250 pa)
Loans £3,997
Represented by shares £3
Appreciate these are not correct numbers, but it looks to make logical sense as to what possibly ought to have happened.
Of course what was documented/ agreed is another matter.
As an aside re tax, rather than accounts, would the transfer of value (reduction in value of the freehold) to the three leaseholders, who are also directors of the company, be considered as a taxable benefit reportable to HMRC?
No idea if this is relevant, just thought I would raise it in case it might be?
Earlier article/thread on A Web touches on valuation issues etc
https://www.accountingweb.co.uk/article/flat-management-companies-get-de...