Property Developers and the 2015 Budget
George Osborne's final Budget before the election on 7th May had a major unexpected impact on how some property developers will structure their developments in the future; and existing structures need to be reviewed to ensure that important expected reliefs have not been lost.
Since the introduction of Entrepreneur' Relief in 2008, it has been common for property developers to purchase a development property into a limited liability company formed solely for the purposes of the development (and usually known as a "Single Purpose Vehicle" or "SPV"). The SPV would issue shares to the individuals behind the project, and would appoint them as directors. The SPV would then carry out the development and pay corporation tax at 20% on the development profit, leaving 80% of the profit within the SPV. The SPV would then be wound up, and the post-tax profit would be distributed to the shareholders. As long as the SPV had carried on the trade of property development for at least one year, and as long as the individual shareholders owned at least 5% of the shares and were officers or employees of the SPV, then the gain on the extraction of the profit from the SPV would be eligible for Entrepreneur's and its favourable 10% tax rate. The total effective tax rate on the development profit under this structure is 28%, being the corporation tax rate of 20% payable by the SPV plus the further 10% on the remaining 80%. This effective 28% tax rate compares very favourably with income tax rates of up to 45% (or 47% including national insurance) where the development is carried out in the personal names of the individuals.
In fact, the Budget did not affect the tax planning for this basic structure; though it has dramatically affected some common variants, such as where the SPV forms a joint venture company or partnership to carry out the project. This would arise in a number of circumstances, for example where a landowner wanted to share in the development profits rather than sell land outright with planning permission to a developer. The developers would form a SPV which would then enter into a partnership with the landowner; the landowner would contribute his land to the partnership and the developers would pay for and fund the development via the SPV. The profits of the partnership would then be split between the landowner and the SPV in accordance with the partnership agreement. The SPV would pay corporation tax at 20% on its share of the development profit and the SPV would then be wound up as above.
Partnerships are transparent for UK tax purposes, and therefore where a SPV is a member of a partnership that carries on a trade, then until now the SPV is itself deemed to be carrying on a trade, which is one of the critical conditions for Entrepreneur's Relief. Therefore the shareholders would still be able to claim the 10% rate for Entrepreneur's relief, even though the SPV carried on the trade through the partnership, and did not carry on the trade directly itself.
However, the Budget changed the playing field with immediate effect, by requiring a limited company to carry on a trade in its own right if it is to qualify as a trading company for Entrepreneur's Relief. Trades carried on through joint ventures companies or partnerships of which the SPV is a member will no longer count as being a qualifying trade for Entrepreneur's Relief and therefore, the gain arising on the winding up of the SPV will be taxable at 28% rather than 10%, bring the total effective tax rate up to 42.4%.
Property developers who have previously structured their affairs in this way will want to review their existing arrangements and consider carefully how they structure future developments.
Note that the above change only applies for Entrepreneur's Relief and does not affect other reliefs which require a trade to be carried on such as Business Property Relief for Inheritance Tax.