#28 Corporate Structure
In this episode Chris and Ritchie talk the three main corporate structures of setting up in a Serviced Accommodation Business: Sole Trader, Limited Company & LLP. They will discuss the different pro\u2019s and con\u2019s of each legal entity including risk, taxation, VAT, and selling the business.
Chris and Ritchie will also talk about the separation of trade, and why it\u2019s so important.
Show Notes:
The Serviced Accommodation Podcast is a show brought to you by Chris Poulter and Ritchie Mazivanhanga aimed at new and experienced property investors alike. With each show we help you Start, Systemise and Scale your Serviced Accommodation Business.
If you would like to ask us a question or discuss anything in this episode, please join our Facebook group and ask away. To listen to more episodes or get more information go to\xa0www.thesapodcast.com.
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Transcription:
Hi I\u2019m Chris.
Hi I\u2019m Ritchie.
Welcome to the service accommodation podcast.
Today we\u2019re going to be talking about corporate structure.
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What are we going to cover today Ritchie?
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So today we\u2019re going to be talking about the three main entities that you would use in serviced accommodation. You\u2019ve got a sole trader, limited company and LLP which is a limited liability partnership. And the second thing we\u2019ll be talking about today is separation of trade so keeping these trades in different entities where you don\u2019t have the crossover between rent to rent and management in one company, just separating them accordingly.
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So as Ritchie says we\u2019re going to kick off by looking at the three main types of entity you might choose to use for your business. Sole trader, limited company and LLP and I think it\u2019s important to have a think about the key factors which we\u2019ll be looking out when we think about what basis we\u2019re going to kind of make a decision on how we can compare that if that makes sense. So there\u2019s kind of different elements of each really.
So the first area we\u2019re going to look at is control. So what kind of control do you have over that entity type, talking about protection of the trading name and thinking about what impact that has. Allocation of profits as well, very important.
We\u2019ll think about the trading risk associated with each type of entity. You know I talk about it all the time, I think I should coin a phrase and really that kind of breaks down to two key areas really, the financial risk so you know what happens if this business makes losses basically and the legal risk. So what happens if someone sues the business or what happens if God forbid criminal charges are being brought which obviously shouldn\u2019t happen if you are running the business properly right.
So then we\u2019re going to have a look at taxation obviously a very important part of when we\u2019re choosing how we should structure our business and obviously have a profit to tax is very important as well. And from there we can kind of derive how tax efficient is it for what you want to do as a business because there\u2019s lots of different things you might want to do. You might want to withdraw the profits from the business. You might want to kind of retain all the profits in there and go and use that for reinvesting into other things offer for growing the business and as a separate thing if you\u2019re claiming capital allowances and that can have a big impact on the taxation. So what\u2019s the impact if you\u2019re looking to claim capital allowances.
On top of that we\u2019re also going to look at VAT and the impact of VAT in the entity and also selling a business. How easy or hard is that.
As you can see there\u2019s quite a lot of different factors involved in this and that\u2019s why it\u2019s not that easy when you\u2019re kind of working out the best way to do it is it Ritchie?
And so as a whole you can\u2019t really give you specific advice on your situation but we can kind of generalize.
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Yes yeah but based on your personal situation and what you are looking to achieve this.
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Yeah very much and hopefully we can give you an idea around the factors which you might want to might want to consider when you were choosing what you what should work best for you.
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So it\u2019s not one size fits all. It\u2019s basically you need to choose the shoe size that fits your business or fits what you want to do. So we\u2019ll start off with sole trader and this is the most basic form of trade.
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It\u2019s basically just doing it in your own name right?
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Yes income and guest contractors in your personal name and you are fully responsible so personally responsible. And to set this up you just need to register as self-employed. It\u2019s very straightforward really. Yep and you trade under a name without registering it as long as there is no infringement so as long as you\u2019re not using a name like Microsoft you know which is already being used by someone else. And you as a sole trader you\u2019re personally liable for any financial losses. So the business is in your name your sole trader, you\u2019re self-employed so you\u2019re liable. You\u2019re responsible. So if you ever have any like legal disputes as well you\u2019re liable because everything is in your personal name. Not much protection as a sole trader.
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Yeah and that\u2019s probably why it\u2019s the big downside around being a sole trader isn\u2019t it. You know it\u2019s quite quick and easy to get set up, it is not necessarily inefficient for tax as I\u2019ll talk about in a second but it does mean that you\u2019re taking on quite a lot of this kind of risk. So unless you\u2019re happy and comfortable with that risk you might want to think about some of the other structures.
So in terms of a tax situation as a sole trader well it\u2019s essentially personal income. So any profit which you make within the business because of course you can claim all your costs against your turnover, any profit you make in there is basically personal income so of course what that means is that if you are a higher rate taxpayer then that can be relatively inefficient because you are going to be paying 45 percent tax on all that money which is coming in.
Now again there\u2019s other situations where it can be very tax efficient. So for instance if you want to use it as your main income and you\u2019ve not got money coming in at the moment then it can be quite a good way to do it because if you did that through a limited company, you\u2019d also have to pay employers national insurance. So there is quite a cost saving there in terms of being a sole trader if you want to kind of live off the income which it generates if that makes sense.
Now another strange quirk around the sole trader is that if you hit the VAT threshold then it means that you as a person go VAT registered.
So any income you make above that from other sources in your name is VATable. Yeah yeah absolutely once you register for VAT, any income other than wages obviously which is separate would be would be VATable and that might not affect a lot of people but other people might you know maybe do a bit of freelance work here or there whether that\u2019s kind of I.T. or consulting or anything really it would mean that even that, even though it\u2019s a different trade they would then have to charge VAT on it. So again I think it\u2019s it\u2019s an important consideration in terms of will that affect you personally, will that have an impact on what you\u2019re doing and therefore something you should avoid.
I think another aspect to consider when it comes to sole trader is that it is quite tricky to sell the business.
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You can\u2019t just sell your name.
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Well that\u2019s the thing because the upside is you can use any name. But the downside is you\u2019ve not really got any rights over that name that anyone could come along and go oh they\u2019ve set up a good business, start a business called that and basically nick it off you. So there\u2019s not a lot of protection around it and it means when you come to sell the business well you know the name might not be protected and you have to essentially sell the individual component parts so you I\u2019m selling on my client list, I\u2019m selling you know how I create my product or whatever it is that you do within the business and so on. So it does make life very tricky compared to a limited company for instance.
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Yes definitely. And that is a second trader we\u2019re going to be talking about and with a limited company, setting it up is very easy. You can do this online in a matter of hours really and the costs are quite low, cost about \xa320 I would say.
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Yeah and HMRC or any of the other sites that you can do, you can set up for less than that. Personally I would say don\u2019t use HMRC site. It has all the options in there but some of the other sites just have a few extra defaults for you to use, you know sample documents and it\u2019s little stuff like with the HMRC website last time I set up a business through there I had to retype the same address three or four times just like you know what I don\u2019t care about paying a couple of quid extra just to save time. It does save a little bit of time doing that.
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And when it comes to control of a limited company it\u2019s controlled by one or more directors and owned by shareholders. So you can have a director as a shareholder as well but yeah it\u2019s owned by shareholders.
So with the limited company your company name is protected, it\u2019s your name when you register that company yet no one else can use their name elsewhere.
The good thing with a limited company is in the name really, limited. So you\u2019ve got limited liability and you\u2019re not personally liable for any legal disputes other than criminal actions including things like fraud when obviously defraud money or any wrongful trading so when you\u2019re not solvent so there\u2019s no future for the company like no potential as you guys making a profit and then you continue to trade anyway. And if you\u2019re not minimizing risk to creditors as well, that is deemed wrongful trading as well. So if you see a company going downhill and you know you\u2019re going to be losing money you\u2019ve got creditors your money too but you then go out and make an extravagant purchase without any consideration for your creditors, that is wrongful trading.
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Yeah absolutely. I\u2019m hoping that no one listening to the podcast would ever get involved in kind of wrongful trading or criminal actions but still it seems worth pointing out that you know although you do have this limited liability, it doesn\u2019t extend to criminal actions.
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So in terms of tax with a limited company then essentially what happens is at the end of the year you kind of do the usual calculation to work out what your profit is and here you pay corporation tax on your profits now that\u2019s currently at 19 percent and I think it\u2019s going to be until 2020 now. So basically you pay 19 percent on your profits and then you\u2019ve got I mean accountants call it wash money you know where it post tax and you can kind of do what you want with it. Now what you can do and this then becomes very efficient if you want to reinvest that money because you\u2019ve only paid 19 percent tax and then you\u2019re free to reinvest it.
Now you can reinvest it through that same limited company maybe by going and buying assets in there whether that\u2019s assets to help the trade of your company or even property or offices that type of thing. Alternatively you can actually lend that money out into another LTD company which can then or LLP even which can then go and buy the assets so once you\u2019ve paid that corporation tax which is relatively low once you\u2019re talking big numbers compared to income tax then actually you\u2019re very flexible about what you do with that money.
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Chris could also just tell us about what\u2019s was the benefit of things like director\u2019s loans as in the tax benefit?
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Okay so directors loan is a good way to kind of do a short term oh I bought this, I bought that so you know let\u2019s stick on the director\u2019s loan account so that can get paid back at a future point. Now there\u2019s a bit of a danger of you know abusing that because if you think about it, if you take money out the company then you meant to pay tax in one form or another. Otherwise there could be a loophole where basically you go oh I\u2019m not taking money out the company it\u2019s just lending me money at the rate of \xa3100,000 a year, I just don\u2019t plan to pay it back ever. So obviously they have to have rules in place to prevent that. So essentially if is a directors loan in place at the end of a tax year negative balance e.g. you as a director owe the company money then it has to be paid back within I believe nine months at the end of the tax year. Otherwise if you start getting hit with some very very significant taxes which albeit you get paid back when they eventually when you pay off that loan but it makes it an administrative nightmare and it\u2019s a very heavy deterrent from kind of over using that directors loan.
Cool so if you\u2019re not looking to reinvest that money instead you\u2019re looking to withdraw it then you do have to then pay more tax on it. Now the first \xa35000 at the moment it\u2019s tax free. Unfortunately that\u2019s going to down to \xa32000 at the start of the new financial tax year. Yeah yeah unfortunately and of course over a year of that kind of tax perk has been eroded really, dividends used to be extremely tax efficient. And now that in all honesty a lot of the time it\u2019s a little bit marginal although it really still works out a little bit better to take money out through dividends. So yeah at the moment the first \xa35000 is it is tax free on dividends, it\u2019s going to be \xa32000 from April 2018.
Then if you\u2019re a basic rate taxpayer you going to pay 7.5 percent tax are above that and if you\u2019re higher rate taxpayers pay 32.5 percent tax. So you are going to be taxed you know taking money out of the business.
One of the great things about limited companies is just kind of how flexible you are with it because you can decide to sell part or even all of your business quite easily just by selling shares. So it does mean that if maybe you\u2019re growing a business which you plan to kind of grow the IP of, you want to turn it into something valuable in its own right and potentially sell it in future then a limited company is always a good route to go down for that really.
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Another company structure with limited liability so to speak is a limited liability partnership and the limited liability partnerships set up is quite straightforward as well.
You can do that online and it\u2019s not as instantaneous as a limited company set up because this could have a several day delay and it\u2019s a bit more costly because there it\u2019s about \xa340.
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They say it takes a couple of hours but I mean we won we\u2019ve set up an LLP it\u2019s taken a couple of days to go through. Yeah it\u2019s still \xa0not a lot of money. I thought it would be really expensive actually it\u2019s not bad at all.
The same company formation websites will set you up an LLP as well as a limited company
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And the structure of their company is in the name really, it\u2019s a partnership so it\u2019s controlled and owned by two or more members.
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Yes to state is obvious. That means that if it\u2019s just you then you\u2019re not going to be to start an LLP. Now just to complicate things even further, the members don\u2019t actually have to be people you can have companies in there. But it starts to get very complicated once you start to look at entities where you\u2019ve got a limited company as a member of an LLP so we\u2019ll pretend I didn\u2019t just say that and you can move quickly on.
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So with the limited liability partnership, your company name is protected so yet again this is your company name, no one can steal it, no one can use it and you are not personally liable for any financial losses just like a limited company and you are not personally liable for any legal disputes just like we explained just in the LTD company.
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What makes LLPs very different is that from a liability point of view, they are very much like a company. But from a personal attack point of view, they\u2019re almost like a sole trader. So the personal tax is applied to all the profits. So in essence what you get to do with isan LLP is you get you say okay our LLP made \xa350,000 profit this year. How do you want to allocate that across the members and you go well you know \xa320,000 for this member, \xa315,000 for this member, \xa315,000 for this member and then each person is taxed as personal income on that amount of profit that they\u2019ve been allocated.
So that can then be very beneficial if you\u2019re looking to be flexible. For instance if you\u2019ve got a partner or family member who is not earning a lot of money compared to you then you can make it flexible and make sure that you\u2019re taking money out of that LLP in the most tax efficient way.
Another major benefit really around that is if you\u2019re claiming capital allowances and I know we\u2019ve only talked a little bit about capital allowances so far and I\u2019ll try not to go too much into it other than saying it\u2019s a way of saving quite large amounts of tax and you can then apply it to whatever entity is claiming their capital allowances. So for instance if you had capital allowances \xa350,000 that would allow you to essentially not pay tax on \xa350,000 worth of profit so obviously quite beneficial in that respect. And if you look at capital allowances with an LLP there is a very big advantage compared to them compared to a limited company if you want to take the money out because with a limited company if you claim capital allowances that will save you 19 percent on tax which is great if you want a kind of reinvest it, absolutely fine but if you\u2019re looking to take the money out, you still need to go and pay some tax on it. Now with an LLP because it\u2019s personal tax that means that if you apply the capital allowances to the profits from an LLP it means you have no tax to pay at all and it\u2019s now in your name.
That means that if you\u2019re taking money out of it and you\u2019ve got capital allowances then you might actually be much better off with an LLP.
If it\u2019s too confusing then just jump on the Facebook group and let\u2019s have a chat about it.
So one of the downsides I guess of an LLP is again it\u2019s not got shares, therefore it\u2019s quite difficult to sell it as a business. We\u2019ve we\u2019ve looked at a few developments for instance which were struggling and based on an LLPs and developers were looking to sell them off and it does become a lot more difficult and a lot more complicated to sell an LLP than it is a limited company where you can just sell all the shares.
It is worth knowing and understanding that so if you are looking to build something which you think potentially one day you might want to sell on then probably the LLP is not going to be the right route for you to go down.
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If you have a rent to rent business and then you\u2019ve got a serviced accommodation business or serviced accommodation management business, it is always good to have a separation so separate these trades into different entities because you\u2019ve got various risks and things that may affect them so first and foremost things like trading risk.
If you have an issue with a problem in the guaranteed rent business, someone falls over whatever, the liability and then it\u2019s the whole company that\u2019s impacted you know. If there\u2019s rents that haven\u2019t been paid or people haven\u2019t been paid that\u2019s a risk on both your entities, both your businesses that could have been divided into separate entities with various different liabilities.
And then you\u2019ve also got things like bookkeeping and accounting. Yeah we\u2019ve seen quite a few books and it does get a bit messy. It\u2019s a very strenuous activity as it is on the serviced accommodation side of things but if you\u2019ve got the rent to rent business as well it\u2019s just very complicated. It becomes very extremely long winded and can be very expensive because you\u2019re paying for someone\u2019s time to do that.
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You\u2019ve also got things like a VAT. So if you\u2019ve got a rent to rent business, rent to rent as we know that\u2019s not liable for VAT because it\u2019s residential property whereas serviced accommodation is a business and as a serviced accommodation business you are liable for VAT, you can go over the VAT threshold. So if you\u2019ve got all your income in one business and then shoots you up to the VAT threshold, your rent to rent business is also liable for VAT.
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Yeah if you\u2019re doing flat rate and otherwise well it might not be rent to rent or it\u2019s exempt, you might have for instance an SA rent to rent business and a management business both of which are VATable turnover so if you\u2019ve got them in the same entity then you\u2019re going to hit that threshold a lot quicker.
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Exactly. Whereas if you\u2019ve got separation of the management business or the money coming in, your holding in the trust of people doesn\u2019t constitute as part of your turnover then yeah it\u2019s going to take you a lot longer to hit the VAT threshold in that business.
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And they\u2019re genuinely different trades and therefore you\u2019d always want to put them in a separate entity where possible.
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It\u2019s not artificial separation. They are genuinely different trades.
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Exactly so I think the key question you\u2019re likely to ask is what type of entity would you use in what situations. And again we said we can\u2019t really give advice but we can make some generalizations. So for instance if you\u2019ve got a rent to rent serviced accommodation business then generally you\u2019re going to be looking at a limited company to state the obvious it kind of limits the liability but it also does mean it\u2019s quite tax efficient and flexible.
So whether you\u2019re kind of looking to keep funds in there or take them out as profits it can work quite well. You know either way from a tax perspective, it is also quite a flexible structure so it means that you can work with joint venture partners or maybe you want to sell a share of the business or even the entire business and that type of structure will allow you to do that. So generally but that\u2019s probably the structure we\u2019d look at for a rent to rent business.
So for a management business again for all of the same reasons generally you\u2019d be looking at a limited company in terms of limiting your liability, tax efficiency, structure everything like that. Again you know it\u2019s probably more chance of you selling a management business I would guess because if you look at the property world and agents for instance then it\u2019s kind of well-established that letting agents have quite a high value compared to their turnover in terms of business valuation. So if you looked at SA management businesses in a similar light then you would say a management business with say 100 clients is probably going to be valued relatively highly. It could be at some point you want to cash in and go retire to that yacht in the Mediterranean right.
So it\u2019s quite important I think from that point of view.
Now if you think about purchasing and you\u2019re specifically purchasing for serviced accommodation then perhaps you might want to be looking at an LLP type structure instead. Now this is still going to limit your liability but the key thing here is that it\u2019s going to maximize the capital allowances which you most likely going to be able to claim. And it\u2019s really going to be very tax efficient for bringing the profits through to you personally.
And again for the same reasons an LLP can work very well for development. A lot of the time we see developments going on even when they\u2019re not going to serviced accommodation for instance if it\u2019s a commercial conversion then often you\u2019re able to claim capital allowances on commercial building which you\u2019ve purchased and so they\u2019ve done an LLP because it\u2019s much much more tax efficient.
So just to confuse things even further if it hasn\u2019t been complicated enough already so then you can kind of get to multi entity structures which is really where we\u2019re kind of combining different legal entities together to kind of really optimize what you\u2019re doing. Now I think maybe the easiest way to understand that is the type of scenario where for instance you already own a portfolio of properties lets say maybe five or 10 properties which you\u2019ve purchased over last 10 years and they\u2019re all in your personal name and then you\u2019re looking at what\u2019s the best way to operate serviced accommodation.
So this would really be a multi entity structure because what you\u2019ve got is you\u2019ve got the properties owned in your own name and you\u2019re probably going to want to put another another company of some form in place. So really if we start to think about this situation and what you could do with this specific scenario you\u2019ve probably got two main options. So first of all you could set up a new Ltd company and then you could rent those properties off yourself and that way all the trading would actually be going through this new Ltd company so you\u2019d essentially be rent to renting or guaranteed renting from yourself. Now when we do this and we have a company which is operating directly with the customer so that\u2019s that\u2019s the company who is ultimately responsible for the customer then we call that an OPCO. So if you hear us chucking that around here there and everywhere that\u2019s what we mean it\u2019s a company which ultimately has responsibility for the booking when it comes to the guest you know.
And so with these OPCO then the advantage is that actually all the trading risk and I know we\u2019ve talked about that a lot today but that\u2019s real critical when we\u2019re talking about corporate structure, all the trading risk both financial or legal is passed from you in your personal name into that business.
Now that\u2019s really really critical because if you own assets in your own name and you have a serious financial issue with that business then potentially they could go after your properties and repossess them to pay off your debts. Now if you\u2019ve passed that financial risk into a separate trading company then that can\u2019t happen as long you play by the rules.
It\u2019s exactly the same as legal issues. You know if you have a major legal issue to do with your serviced accommodation business and that\u2019s been separated out into an OPCO then the buck stops with that and ultimately the worst case scenario is that you have to shut down that company but you still have your properties. Now if that was in your own name then again potentially banks could come after repossess your properties in order to to repay court settlements. So you know that\u2019s a great reason to kind of put it in an OPCO.
Of course it also means that you\u2019re taking another profit away from you in your personal name and putting it into a Limited Company, which if you\u2019re going to be reinvesting those profits or if you don\u2019t need to be taken out on a monthly basis as income to live on can be very tax efficient way of doing it.
Now the alternative to the OPCO where you\u2019re kind of rent to renting it off yourself, would be a management company or sometimes we call that that an agent because that\u2019s what essentially they\u2019re doing, they\u2019re acting as an agent on behalf of the owner. Now the reason this can be very beneficial is because if you\u2019re dealing with multiple entity. So for instance you own some properties in your name, your partner has some property then their name, maybe a family member or a friend. It\u2019s much easier to be dealing with one company which deals with all the operational aspects of the businesses and that would be this management company.
The other thing is that it can be a lot more VAT efficient when you\u2019re dealing with multiple entities. So for instance if I have some properties in my name and Ritchie has some properties in his name and we have a management company together then each of those properties have got a separate VAT status which is depending on how much we\u2019re turning over. Yeah if we had an OPCO together so rent to renting them then that would actually mean that the combined turnover would push us over the VAT threshold where separately it might not. So it does mean that VAT efficiency can be better if you\u2019ve got an agent company or a management company in place instead.
But of course the downside of that is as we\u2019ve discussed throughout the episode today that means you\u2019re taking on the trading risk yourself so you need to be relatively comfortable with that and what I would generally say is that a lot of the legal risk can be covered by insurance but that means don\u2019t skimp on the insurance, don\u2019t just get the cheapest cover. Use a really good broker and make sure that they know what risks there are associated with it and that they\u2019re genuinely covered because in my understanding having spoken to people in insurance is that 50 percent of policies aren\u2019t worth the paper they\u2019re printed on because they\u2019ve just got clauses here there and everywhere that they\u2019ll be able to get out of anything. And if that\u2019s you know going to take away your home, your portfolio, your livelihood it\u2019s really not a good place to be.
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It\u2019s also about being very open and honest as well when doing the fact finding and explaining the details of how you work. You don\u2019t want it to be just generalized like this is how we work and in serviced accommodation we\u2019re doing this but you have to be specific about how you operate and work so that the insurance policy is very personal and covers your business accordingly.
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Yeah and also working with someone who does understand serviced accommodation because you\u2019ll find a lot of insurance brokers don\u2019t. So very very important to work with someone who specialises.
So if you can cover off that risk the legal risk you know that probably 99 percent of it covered then it just comes down to the financial risk. Is that something that you\u2019re comfortable with, is it a completely new model? Now we always talk about build test scale, is it a model you\u2019ve done before and you know how it performed financially and you\u2019re comfortable with that financial risk? Or is it actually something completely new and you don\u2019t really know if it\u2019s going to work or not? And I would suggest that if it\u2019s something completely new then maybe you don\u2019t want to be doing it and taking that financial risk in your name because again as we say if those debts start to pile up cause it\u2019s not working out you are going to be personally responsible.
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I hope this episode hasn\u2019t been too confusing, very comprehensive very detailed and I\u2019m sure it\u2019ll help you guys moving forward.
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Yeah and it is it is a critical area to get right. I think it is one thing we always cover in the strategy review because when you\u2019re looking at you know what you want to achieve and how you\u2019re going to achieve it then obviously getting the right structure right is critical and can save you tens of thousand pounds worth of tax, even hundreds you know as time goes on and you grow your business.
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