Nick Wright explains why business owners should be cautious about holding investment property in a trading company and explores more suitable structures for investing excess profits, balancing tax efficiency, asset protection and long-term succession planning.
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When a profitable trading company starts to accumulate surplus cash, investing in property can appear attractive. However, buying investment property directly within the trading company is not usually advisable.
First, there is asset protection. Trading companies are exposed to commercial risks, including claims from customers, suppliers and lenders. Holding valuable investment property on the same balance sheet means that those assets are potentially available to creditors if the business fails.
Secondly, investment activity can contaminate the company’s status. A company that holds substantial non-trading assets or undertakes significant investment activity risks ceasing to be regarded as a trading company. This can have serious consequences, including the loss of capital gains tax (CGT) reliefs, such as business asset disposal relief (BADR) (TCGA 1992, Pt 5, Ch 3) and gift relief (TCGA 1992, s 165), and also the loss of business property relief (BPR) (IHTA 1984, Pt 5, Ch 1) for inheritance tax (IHT) purposes. For many owner-managed businesses, these reliefs underpin long-term exit and succession planning.
For these reasons alone, property investment should usually be kept out of the trading company.
Why extracting cash personally to invest is often inefficient
An alternative approach is to extract surplus cash as salary or dividends, then reinvest personally or through a new property company. In practice, this is rarely tax-efficient.
Salary extraction triggers income tax and National Insurance contributions (NICs). Dividends avoid NICs but still suffer dividend tax at up to 39.35%. Once that tax leakage has occurred, significantly less capital remains available for investment.
Although this approach achieves separation between the trade and the property investment, the upfront personal tax cost often makes it unattractive unless funds are required personally in any event.
A simple holding company structure
A common solution is to introduce a holding company above the existing trading company by a process known as a ‘share exchange’ (see figure 1). Dividends can then be paid up to the holding company free of corporation tax, and the holding company can use those funds to invest in property, either directly or via a subsidiary property company.
Figure 1:
This structure has clear advantages:
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Excess cash can be moved without personal tax charges.
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Property assets are separated from the trading company.
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Future group planning is simplified.
Furthermore, the implementation of this structure can be achieved without any tax charges. For CGT purposes, TCGA 1992, s 135 allows for the gain to be held over, and FA 1986, s 77 provides relief from stamp duty provided the conditions are met. An HMRC clearance procedure is also available in advance of the transaction to seek their confirmation that the share exchange is not being carried out for tax avoidance purposes.
However, it is important to recognise the limitation in this structure, which is that the shares now held in the holding company are still at risk of failing to qualify for the CGT and IHT reliefs identified above due to the group being ‘tainted’ with non-trading assets.
Lending surplus funds to a separate company
Another option is for the trading company to lend surplus cash to a separate property company owned by the same shareholders. Provided the loan is genuine, documented and on commercial terms, the trading and investment activities are legally separated (see figure 2).
Figure 2:
This approach can work, but it has two important drawbacks.
First, asset protection is incomplete. The trading company still has an asset in the form of the loan. If the trading company becomes insolvent, a liquidator may seek to recover that loan, indirectly putting pressure on the property company.
Secondly, advisers sometimes assume that the loan can simply be written off at some point in the future with no wider consequences. While the loan relationship rules (see CTA 2009, Pt 5) can mean that a write-off is tax neutral for corporation tax purposes where companies are connected, there is a risk that the release of the debt is treated as a distribution to shareholders where companies have common ownership, as a result of ITTOIA 2005, s 382. This states that there is an income tax charge ‘on dividends and other distributions of UK resident companies’.Turning to the definition of a distribution (CTA 2010, s 1000), this can include any ‘distribution out of assets of the company in respect of shares’. In other words, TradeCo has written a loan off that has reduced the value of its balance sheet in favour of a company under the same ownership, meaning the shareholder’s value of PropCo shares has increased accordingly.
Separating property from an existing trading company: Capital reduction demerger
Where a trading company already owns investment property, a more sophisticated solution may be required. One option is a capital reduction demerger.
In simple terms, this involves:
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inserting a new holding company above the existing company;
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transferring the investment property into the holding company (or a property subsidiary); and
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reducing the company’s share capital to separate the trading and investment activities into two companies.
Figure 3:
When structured correctly, this can be achieved without immediate tax charges and results in a clean separation between the trade and the property. However, demergers are complex, require careful legal and tax analysis, and are not suitable in every case.
Using a new company with a minority shareholding
A further alternative is to create a new investment company with a separate class of shares held by the same shareholders but representing a minority interest. Excess profits can be paid to that company as dividends on those shares and reinvested in property. See figure 4.
Figure 4:
Dividends paid between two UK resident companies are usually exempt under CTA 2009, s 931B for small companies or CTA 2009, s 931E for not small companies.
It is important that the shares owned by PropCo are ordinary shares for this treatment to apply and not a ‘debt-like’ type of share (e.g. certain preference shares). The case Wroe and Ors v The Commissioners for HMRC [2022] UKFTT 00143 (TC) illustrates the importance of share rights (particularly, preference or special share classes) being genuine equity rather than fixed‑value debt.
The key advantage is that the original trading company remains clearly trading. Provided the structure is implemented carefully, this helps preserve access to BADR and BPR, while also extracting surplus assets from the trading company for asset protection purposes. Importantly, from an asset protection perspective, the companies should not have any cross-charges or cross-guarantees.
This approach requires careful drafting of share rights and a clear commercial rationale, but it can be an effective planning tool for growing businesses.
It will also be necessary to carefully consider the impact of the transactions in securities provisions (ITA 2007, Pt 13, Ch 1) in ensuring that this structure does not fall foul of anti-avoidance rules.
Conclusion
There is no single ‘best’ structure for business owners investing excess profits in property. However, simply buying property in the trading company or extracting cash personally is rarely optimal. The most suitable approach depends on balancing tax-efficiency, asset protection and long-term reliefs, with careful attention to the often-overlooked risks around inter-company loans and distributions.
Practical tip
Before investing surplus profits in property, business owners should review their long-term exit and succession plans. Preserving trading status and CGT and IHT reliefs is often more valuable than short-term simplicity, and restructuring early is usually far easier than trying to unwind poor decisions later.
