Will new property tax erode tax efficiency?

Rent vs dividends

Dividends are not the most tax-efficient way to extract cash from a company, that’s a fallacy. Generally, if you can extract cash from a company as a genuine business expense, e.g. rent for use of the trading premises then, overall, the arrangement will be more tax efficient compared to a dividend once you factor in the corporation tax deduction (CT).

Example. Tony, a higher rate taxpayer, owns the unit from which his company, Acom Ltd, trades. It pays Tony the full market rent of £2,500 per month. For simplicity, assume Tony has no expenses and pays £12,000 income tax (£30,000 x 40%), leaving him with £18,000 (£30,000 - £12,000). Acom gets a CT deduction for the rental payments, reducing its tax liability by £7,500 (£30,000 x 25%). The net cost to Acom is therefore £22,500 (£30,000 - £7,500). If instead, Tony extracted the same amount of cash as a dividend, i.e. £30,000, the net cost to Acom is £30,000. After tax at 35.75% Tony would be left with £19,275. By paying rent instead of a dividend Acom is £7,500 better off but Tony’s net income is £1,275 lower (£19,275 - £18,000). It does of course mean that Acom has an extra £7,500 that can be distributed to Tony when required.

If Tony doesn’t need to extract further income from Acom, he can leave the cash savings in the company. Tony can then extract it at a later date at lower rates, e.g. when he retires or winds up the company.

New rates

From 6 April 2027, property income will be taxed at separate rates to other income. For 2027/28 the rates will be 24%, 44% and 49% for basic, higher and additional rate taxpayers respectively.

Whilst this does reduce the tax advantage of rental income compared to dividends, rent is still more tax efficient overall.

Example. As in the previous example but using the new property rates for 2027/28. Tony will pay 44% income tax on his £30,000 rental profit, leaving him with £16,800 net. The net cost to Acom doesn’t change. This means the overall tax advantage is reduced by £1,200 (£18,000 - £16,800).

Given that landlords’ costs will increase due to the increase in tax rates, the market rate of rent may also increase. Review the market rate regularly as it may be possible to increase the rent to cover the additional income tax cost.

Capital gains

Before purchasing a property to rent to your company you’ll also need to factor in the impact of capital gains tax (CGT).

Charging your company rent adversely affects the amount of CGT business asset disposal relief (BADR) you would be entitled to if you ever sell the property in connection with the sale of your company. BADR reduces the CGT rate from 24% to 18% on up to £1m (reducing to £500,000 from 6 April 2027) of capital gains. BADR is proportionately reduced for the period for which you charge the company rent. The amount of rent can also be a factor when calculating BADR. This won’t be an issue if you’re unlikely to sell the company or sell the property with the company.

In practice, you’ll need to crunch the numbers to determine whether it’s more tax efficient to charge rent or potentially benefit from 6% CGT relief on any increase in the property’s value.