Managing Personal Debt Tax Efficiently
During the period of strong economic growth in the early part of the previous decade, many individuals acquired properties personally. In many cases, loans were drawn down to finance these acquisitions. These purchases were made during a buoyant property market and often without consideration as to how the debt would be repaid without a sale of the property. A sale of the property may now be impossible due to substantial negative equity. To compound the situation, banks continue to pressurise borrowers for interest and capital repayments, which may have to be financed by the client from their own personal income, often resulting in significant tax costs. For individuals with ownership of a trading company, in order to repay the capital and interest on these loans, it is necessary to draw funds from their company which are subject to income tax at a marginal rate of up to 55%. An individual with a debt of €1m will require up to €2.2m of income to repay that debt. Of that €2.2m in income, €1m will go to the bank and €1.2m will be paid in income tax.
Transfer to a company
In the above circumstances, consideration should be given to the shareholder selling the property to the company for the current market value. Therefore the loan repayments may be made to the bank out of income subject to tax at 12.5%, rather than personal income tax rates of up to 55%. Taking the above example, if a company has a debt of €1m it will require approximately €1.15m of profit to repay that debt. Of that €1.15m of profit, €1m will go to the bank and approximately €150k will be paid in corporation tax. This should dramatically reduce the time necessary to repay the bank and also lower the debt burden of the shareholder. The consent of the bank will, of course, be required and without their cooperation the implementation of the transaction will be difficult.
Legal and tax issues on the transfer
There are significant legal and tax issues that arise in respect of the transfer of property to a company by a shareholder which require careful consideration prior to the sale. In respect of Capital Gains Tax, where a property is sold by a shareholder to their company at a loss (as is probable in these cases), the loss would be incurred on a sale to “a connected party” and would therefore only be available to offset gains arising on transfers to the same company and not gains realised on other disposals. As the transfer is to a “connected party” it will also have to be at market value.
The rate of stamp duty on residential properties is 1% on all sales of properties up to a value of €1m. Where the value exceeds €1m a 2% rate of duty will apply on the excess value over €1m. The rate of stamp duty on commercial property is 2%. This duty would be payable by the company purchasing the property. The VAT status of the property subject to the transfer should be identified and the correct treatment determined. In some cases, VAT will have to be charged by the shareholder. This should, in turn, be reclaimable by the company. If the property in question is a residential property and the owner had no waiver of exemption in place, there should be no VAT implications on the transfer. Company law provisions must also be given thorough consideration. For instance, the company is legally prohibited from acquiring the property for greater than the market value of the property.
This transaction can be a very effective way of reducing the debt burden where an individual holds property in their personal name and also runs a trading company which is generating excess cash. Clients with unincorporated businesses may consider incorporation to avail of the benefits offered. The tax saving over the life of the loan will greatly enhance the capacity of the borrower to complete repayments and will be very attractive in many cases. Expert tax and legal advice should be sought before implementing such a transaction.
This above example is for illustrative purposes only and is not personal advice. You should consult your investment advisor before making any financial planning decisions.