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’s and con’s 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’s so important.
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.
Hi I’m Chris.
Hi I’m Ritchie.
Welcome to the service accommodation podcast.
Today we’re going to be talking about corporate structure.
What are we going to cover today Ritchie?
So today we’re going to be talking about the three main entities that you would use in serviced accommodation. You’ve got a sole trader, limited company and LLP which is a limited liability partnership. And the second thing we’ll be talking about today is separation of trade so keeping these trades in different entities where you don’t have the crossover between rent to rent and management in one company, just separating them accordingly.
So as Ritchie says we’re 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’s important to have a think about the key factors which we’ll be looking out when we think about what basis we’re going to kind of make a decision on how we can compare that if that makes sense. So there’s kind of different elements of each really.
So the first area we’re 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’ll 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’t happen if you are running the business properly right.
So then we’re going to have a look at taxation obviously a very important part of when we’re 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’s 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’re claiming capital allowances and that can have a big impact on the taxation. So what’s the impact if you’re looking to claim capital allowances.
On top of that we’re 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’s quite a lot of different factors involved in this and that’s why it’s not that easy when you’re kind of working out the best way to do it is it Ritchie?
And so as a whole you can’t really give you specific advice on your situation but we can kind of generalize.
Yes yeah but based on your personal situation and what you are looking to achieve this.
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.
So it’s not one size fits all. It’s basically you need to choose the shoe size that fits your business or fits what you want to do. So we’ll start off with sole trader and this is the most basic form of trade.
It’s basically just doing it in your own name right?
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’s 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’re not using a name like Microsoft you know which is already being used by someone else. And you as a sole trader you’re personally liable for any financial losses. So the business is in your name your sole trader, you’re self-employed so you’re liable. You’re responsible. So if you ever have any like legal disputes as well you’re liable because everything is in your personal name. Not much protection as a sole trader.
Yeah and that’s probably why it’s the big downside around being a sole trader isn’t it. You know it’s quite quick and easy to get set up, it is not necessarily inefficient for tax as I’ll talk about in a second but it does mean that you’re taking on quite a lot of this kind of risk. So unless you’re 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’s 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’s other situations where it can be very tax efficient. So for instance if you want to use it as your main income and you’ve 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’d 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’s kind of I.T. or consulting or anything really it would mean that even that, even though it’s a different trade they would then have to charge VAT on it. So again I think it’s it’s an important consideration in terms of will that affect you personally, will that have an impact on what you’re 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.
You can’t just sell your name.
Well that’s the thing because the upside is you can use any name. But the downside is you’ve not really got any rights over that name that anyone could come along and go oh they’ve set up a good business, start a business called that and basically nick it off you. So there’s 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’m selling on my client list, I’m 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.
Yes definitely. And that is a second trader we’re 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 £20 I would say.
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’t 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’s 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’t care about paying a couple of quid extra just to save time. It does save a little bit of time doing that.
And when it comes to control of a limited company it’s controlled by one or more directors and owned by shareholders. So you can have a director as a shareholder as well but yeah it’s owned by shareholders.
So with the limited company your company name is protected, it’s 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’ve got limited liability and you’re 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’re not solvent so there’s no future for the company like no potential as you guys making a profit and then you continue to trade anyway. And if you’re 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’re going to be losing money you’ve 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.
Yeah absolutely. I’m 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’t extend to criminal actions.
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’s currently at 19 percent and I think it’s going to be until 2020 now. So basically you pay 19 percent on your profits and then you’ve 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’ve only paid 19 percent tax and then you’re free to reinvest it.
Now you can reinvest it through that same limited company maybe by going and buying assets in there whether that’s 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’ve paid that corporation tax which is relatively low once you’re talking big numbers compared to income tax then actually you’re very flexible about what you do with that money.
Chris could also just tell us about what’s was the benefit of things like director’s loans as in the tax benefit?
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’s stick on the director’s loan account so that can get paid back at a future point. Now there’s 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’m not taking money out the company it’s just lending me money at the rate of £100,000 a year, I just don’t 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’s a very heavy deterrent from kind of over using that directors loan.
Cool so if you’re not looking to reinvest that money instead you’re looking to withdraw it then you do have to then pay more tax on it. Now the first £5000 at the moment it’s tax free. Unfortunately that’s going to down to £2000 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’s 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 £5000 is it is tax free on dividends, it’s going to be £2000 from April 2018.
Then if you’re a basic rate taxpayer you going to pay 7.5 percent tax are above that and if you’re 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’re 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.
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’s not as instantaneous as a limited company set up because this could have a several day delay and it’s a bit more costly because there it’s about £40.
They say it takes a couple of hours but I mean we won we’ve set up an LLP it’s taken a couple of days to go through. Yeah it’s still not a lot of money. I thought it would be really expensive actually it’s not bad at all.
The same company formation websites will set you up an LLP as well as a limited company
And the structure of their company is in the name really, it’s a partnership so it’s controlled and owned by two or more members.
Yes to state is obvious. That means that if it’s just you then you’re not going to be to start an LLP. Now just to complicate things even further, the members don’t 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’ve got a limited company as a member of an LLP so we’ll pretend I didn’t just say that and you can move quickly on.
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.
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’re 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 £50,000 profit this year. How do you want to allocate that across the members and you go well you know £20,000 for this member, £15,000 for this member, £15,000 for this member and then each person is taxed as personal income on that amount of profit that they’ve been allocated.
So that can then be very beneficial if you’re looking to be flexible. For instance if you’ve 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’re taking money out of that LLP in the most tax efficient way.
Another major benefit really around that is if you’re claiming capital allowances and I know we’ve only talked a little bit about capital allowances so far and I’ll try not to go too much into it other than saying it’s 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 £50,000 that would allow you to essentially not pay tax on £50,000 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’re looking to take the money out, you still need to go and pay some tax on it. Now with an LLP because it’s 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’s now in your name.
That means that if you’re taking money out of it and you’ve got capital allowances then you might actually be much better off with an LLP.
If it’s too confusing then just jump on the Facebook group and let’s have a chat about it.
So one of the downsides I guess of an LLP is again it’s not got shares, therefore it’s quite difficult to sell it as a business. We’ve we’ve 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.
If you have a rent to rent business and then you’ve 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’ve 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’s the whole company that’s impacted you know. If there’s rents that haven’t been paid or people haven’t been paid that’s a risk on both your entities, both your businesses that could have been divided into separate entities with various different liabilities.
And then you’ve also got things like bookkeeping and accounting. Yeah we’ve seen quite a few books and it does get a bit messy. It’s a very strenuous activity as it is on the serviced accommodation side of things but if you’ve got the rent to rent business as well it’s just very complicated. It becomes very extremely long winded and can be very expensive because you’re paying for someone’s time to do that.
You’ve also got things like a VAT. So if you’ve got a rent to rent business, rent to rent as we know that’s not liable for VAT because it’s 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’ve 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.
Yeah if you’re doing flat rate and otherwise well it might not be rent to rent or it’s 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’ve got them in the same entity then you’re going to hit that threshold a lot quicker.
Exactly. Whereas if you’ve got separation of the management business or the money coming in, your holding in the trust of people doesn’t constitute as part of your turnover then yeah it’s going to take you a lot longer to hit the VAT threshold in that business.
And they’re genuinely different trades and therefore you’d always want to put them in a separate entity where possible.
It’s not artificial separation. They are genuinely different trades.
Exactly so I think the key question you’re likely to ask is what type of entity would you use in what situations. And again we said we can’t really give advice but we can make some generalizations. So for instance if you’ve got a rent to rent serviced accommodation business then generally you’re going to be looking at a limited company to state the obvious it kind of limits the liability but it also does mean it’s quite tax efficient and flexible.
So whether you’re 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’s probably the structure we’d look at for a rent to rent business.
So for a management business again for all of the same reasons generally you’d be looking at a limited company in terms of limiting your liability, tax efficiency, structure everything like that. Again you know it’s 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’s 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’s quite important I think from that point of view.
Now if you think about purchasing and you’re 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’s going to maximize the capital allowances which you most likely going to be able to claim. And it’s 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’re not going to serviced accommodation for instance if it’s a commercial conversion then often you’re able to claim capital allowances on commercial building which you’ve purchased and so they’ve done an LLP because it’s much much more tax efficient.
So just to confuse things even further if it hasn’t been complicated enough already so then you can kind of get to multi entity structures which is really where we’re kind of combining different legal entities together to kind of really optimize what you’re 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’ve purchased over last 10 years and they’re all in your personal name and then you’re looking at what’s the best way to operate serviced accommodation.
So this would really be a multi entity structure because what you’ve got is you’ve got the properties owned in your own name and you’re 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’ve 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’d 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’s that’s 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’s what we mean it’s 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’ve talked about that a lot today but that’s real critical when we’re 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’s 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’ve passed that financial risk into a separate trading company then that can’t happen as long you play by the rules.
It’s exactly the same as legal issues. You know if you have a major legal issue to do with your serviced accommodation business and that’s 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’s a great reason to kind of put it in an OPCO.
Of course it also means that you’re taking another profit away from you in your personal name and putting it into a Limited Company, which if you’re going to be reinvesting those profits or if you don’t 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’re kind of rent to renting it off yourself, would be a management company or sometimes we call that that an agent because that’s what essentially they’re doing, they’re acting as an agent on behalf of the owner. Now the reason this can be very beneficial is because if you’re 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’s 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’re 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’re 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’ve got an agent company or a management company in place instead.
But of course the downside of that is as we’ve discussed throughout the episode today that means you’re 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’t skimp on the insurance, don’t 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’re genuinely covered because in my understanding having spoken to people in insurance is that 50 percent of policies aren’t worth the paper they’re printed on because they’ve just got clauses here there and everywhere that they’ll be able to get out of anything. And if that’s you know going to take away your home, your portfolio, your livelihood it’s really not a good place to be.
It’s also about being very open and honest as well when doing the fact finding and explaining the details of how you work. You don’t want it to be just generalized like this is how we work and in serviced accommodation we’re 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.
Yeah and also working with someone who does understand serviced accommodation because you’ll find a lot of insurance brokers don’t. 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’re comfortable with, is it a completely new model? Now we always talk about build test scale, is it a model you’ve done before and you know how it performed financially and you’re comfortable with that financial risk? Or is it actually something completely new and you don’t really know if it’s going to work or not? And I would suggest that if it’s something completely new then maybe you don’t 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’s not working out you are going to be personally responsible.
I hope this episode hasn’t been too confusing, very comprehensive very detailed and I’m sure it’ll help you guys moving forward.
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’re looking at you know what you want to achieve and how you’re 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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