Reducing property tax with a special purpose vehicle

6.6.18 Checked – All info is still relevant to current regulations.

Property development is absolutely in fashion at the moment, with the economic recovery in full swing and a general shortage of places for people to live. There’s no doubt that, for those with the enterprise, skills, and money to undertake developments, this can be a good way to get rich.

Thanks for the lecture, you might say, but what’s all this got to do with tax? Surely we just have to pay our tax on the property development profits, if we make them, and try to look cheerful?

The following case study illustrates, using wholly plausible facts that I personally have seen time and time again in practice, how important it is to plan sensibly for tax when undertaking a development.

The difference between the result for Rock and Sandy, in the examples below, is truly eye-watering, as you will see.


Over the years, Sandy has painfully built up a cash balance in his trading company. He’s not a property developer by background but a widget manufacturer. By saving money up within his limited company, he’s managed to get to the point where the company is sitting on surplus cash deposits, which he doesn’t need for the business, of £500,000.

I don’t know how many of you, my readers, actually do make widgets for a living, but for those of you who don’t I can tell you it’s very hard work. What with all the cheaply manufactured widgets flooding the market from China, and ever more oppressive labour laws and ‘rights’ for workers, the margins are very tight for making these little items, and it takes a long time to build up reserves of half a million pounds.

Sandy’s next-door neighbour, Lucky, seems to have a much easier life. Every now and again he finds a plot on which planning is available, or may be granted, to build a small estate of houses, and Lucky seems to devote quite a small proportion of his time to this activity, and always has a new car to drive to the airport for his long Caribbean holidays.

Sandy’s not a quick thinker (as you will see from what follows), but it eventually dawns on him that doing a development may be a way of shortcutting this slow and laborious process of building up a retirement fund by manufacturing widgets.

One morning the doorbell rings. It’s his next-door neighbour Lucky come to borrow the lawnmower because one of his gardeners has broken theirs.

The two men get talking.

After about half an hour of chitchat about the weather and business, Lucky falls silent for a moment, gazing out of Sandy’s back window at the vast (and rather wild) expanse of his back garden.

“You know what I’d do, don’t you?” says Lucky. “I’d talk to the council about planning permission for building two or three houses at the bottom of your garden. You obviously don’t need such a large plot.”

This is certainly a tip from the horse’s mouth. “This man knows what he’s talking about,” thinks Sandy. So, after talking it through with his wife, he starts doing the sums. The land costs him nothing, planning and building costs, after a lot of head scratching and consultation with a builder, he assesses at up to about £500,000. He can just about squeeze three houses on the site, each of which will net him £300,000, total £900,000. So he looks to make a clear profit of £400,000.

How beautifully it all fits into place! He’s got the £500,000, sitting there in the bank account of his limited company, and so he doesn’t even need to borrow from the bank. In 18 months’ time, so the builder assures him, he could be richer to the tune of the £400,000 profit, which would take him four or five years to earn from the day job.

Sandy has a spring in his step when he goes into the office on Monday morning. He calls in his bookkeeper and tells him to make up a cheque, payable to Sandy, for £500,000, and to do the necessary dividend paperwork to make this legal.

He’s quite acute in some ways is Sandy (although not as far as tax is concerned), and he’s worked out that, rather than paying a lot of money to a large building company to do the work (for which he duly gets planning permission), he could supervise the tradesmen himself, and buy all the materials himself. That way, he avoids paying the builder a 25% profit margin, and keeps the profit for himself: magic. After the usual hassle, he manages to get a credit account registered in his name with the local builder’s merchants. Building begins.

Everything goes according to plan (well, this is a made up case study) until the time comes to market the houses. For some reason, whether to do with a temporary blip in the world economy or because a planned expansion of the nearby town has been shelved indefinitely, he finds it difficult to sell the three ‘executive homes’ that now grace the plot at the end of his garden. The estate agent assures him they will fetch the £300,000 each that he had originally planned, but that it’s a buyer’s market at the moment. (Everyone knows that it’s always a buyer’s market if you are a seller and always a seller’s market if you are a buyer.)

On the other hand, the estate agent is able to provide some rather more practical help, and manages to find tenants to occupy the houses, on six-month tenancies, until such time as they do sell. In the end the houses do all sell, but not until after the tenants have renewed their six-month leases three or four times.

The tax nightmare

All’s well that ends well, then. Well, not exactly. The first unexpected problem that rears its head is when, some months after building has begun, Sandy’s accountant writes him a letter (he’s too frightened to telephone) in which he tells Sandy that his tax bill, payable on 31st January, is £150,000. Sandy is in despair, until he realises there is an unused overdraft facility in the company, which would enable him to take this money out of the firm by way of a further dividend, in order to pay his tax.

In due course, the £150,000 is going to give rise to another higher-rate income tax bill, of course, and at the end of the day the tax spiral operates in good earnest. The accountant works out that the total tax he ends up having to pay is arrived at by grossing up the £500,000 at his effective 30% higher-income tax rate. That is, the total cost of taking the money out of the company ends up being £214,000 or thereabouts.

The whole idea of building houses at the bottom of the garden now seems much less attractive, now Sandy knows the tax downside. But worse is to come.

After all of the costs have been paid, to the solicitors and estate agents, Sandy banks the £400,000 profit in his personal bank account and breathes a sigh of relief – premature, because the accountant has another bombshell for him. Because of all of the other income he has taken from the company, both to live on and to fund tax bills, he’s in the 45% rate of income tax, together with National Insurance at 2%, making an overall rate of 47%.

So Sandy has to wave goodbye to nearly half of his £400,000 profit, that is £188,000.

Then the VATman arranges a visit.

With all the inevitability of a Greek tragedy, where the hammer blows of fate strike down the hero one after the other, the VATman points out that he has reclaimed tax of nearly £100,000 on the building costs, on the basis that, as everyone knows, someone building new houses can ‘zero rate’ the proceeds. Zero rating is a very strange concept of tax, where tax is prima facie chargeable, but at a zero percentage rate. The effect of this is that new-home builders can claim back all of the VAT charged to them on building materials, etc., and not have to pay any VAT on their ultimate sale proceeds.

The problem is, if you end up letting out the completed houses, rather than selling them, as Sandy was forced to do by the market conditions, you’ve suddenly got exempt income rather than zero-rated income, being rents from letting out the houses.

VAT is a bad tax to be exempt from, because the effect is that any VAT you have reclaimed, thinking that your outputs are going to be taxable, gets clawed back by the VATman.

The VATman, according to his lights, treats Sandy fairly. He doesn’t ask for the whole of the VAT back, because the houses were, eventually, sold. However, he agrees a proportion with Sandy’s accountant which, together with interest and penalties, amounts to about £40,000 – which Sandy has to take out of the company, pay higher-rate tax on, etc., etc.

If anyone thinks this story is contrived, and nobody could possibly be as unlucky as my fictional hero, I can correct them. These are all situations that I have seen happen in real life.

Let’s tot up the total tax bill at the end of this unfortunate saga. First of all, there’s the higher-rate income tax on taking the money out of the company to fund the development: £214,000 at the end of the day. Then there’s the 47% effective ‘tax’ rate on the profit: £188,000. Then the last-minute sting in the tail being the cheque on account of VAT, together with ‘extras’: £50,000. In total, the taxman is richer to the tune of £452,000 as a result of Sandy’s venture. The only one who has got rich quick is George Osborne.


OK, you can put away the box of Kleenex now. Rock is an individual who thinks about what he’s doing before he does it and, in particular, thinks about the tax effects of what he’s doing. On the face of it, he ought to fare as badly as Sandy, because, by an incredible coincidence, his basic financial situation is exactly the same as Sandy’s. He too has a plot to develop at the bottom of his garden, and in his case the three houses will come in at a total overall cost of £500,000 and yield £900,000 net proceeds, giving him a profit of £400,000. Rock also has a limited company with £500,000 ‘spare’ cash in it.

There is only really one big difference between Rock and Sandy: Rock asks his accountant/tax adviser how he should structure his development.

The tax adviser suggests setting up a limited company as a special purpose vehicle (SPV) to carry out the development. This is funded not by way of taking a dividend out of Rock’s manufacturing company, which is then put into the SPV, but by way of an interest-free intercompany loan to the SPV. The SPV doesn’t take ownership of the land but acts as a kind of captive building contractor for Rock, who continues to hold the land personally.

Rock is as switched on as Sandy in the financial sense, and he has also worked out that by managing the development himself he can avoid paying a profit element to some external building contractor/developer. So the SPV goes and gets an account at the builder’s merchant, contracts with all of the tradesmen and charges Rock personally for its services. Effectively, the whole profit from the development goes into the SPV, because it charges its costs with a mark-up.

At the end of the day, when the houses are ultimately sold, the SPV company is left with all or virtually all of the £400,000 ‘profit’ on the development in its own bank account. Rock himself makes little or no profit, certainly not enough to pay any substantial amount of tax on.

Assuming for simplicity’s sake that the company realises the full £400,000 profit, it will obviously have to pay corporation tax on that profit, at 20%. So the company has a liability of £80,000: which you will notice is the first tax liability that has had to be paid in this much happier story. Rock then decides to put the SPV into liquidation as its commercial purpose is at an end. He takes out the £320,000 cash remaining in the company’s bank account, and pays capital gains tax (CGT), which we will assume is on the full amount because he is using his CGT annual exemption elsewhere. CGT on winding up a trading company, which has been trading for at least a year, is generally eligible for entrepreneurs’ relief, so the applicable rate is no more than 10%: giving a further personal tax bill for Rock of £32,000.

So the total tax that has been paid all along the line here is £112,000.

When the VATman visits, which he does just after leaving Sandy a smouldering ruin, he gives the SPV a clean bill of health. It has zero-rated its services to Rock, quite correctly, because these are the services of a building contractor constructing new dwellings. So the VAT on all of the costs is correctly reclaimed and the VATman has nothing to claw back in this case.

The overall result is that the taxman has had £452,000 from Sandy and less than a quarter of this, £112,000, from Rock. The one thing I should point out, to be rigorously fair between these two scenarios, is that Sandy has, of course, had the benefit of moving the £500,000 cash out of corporate ownership and into his personal ownership, at a substantial cost in terms of tax. But the old saying is “A tax deferred is a tax saved” and it may be that Rock never has to pay anything similar on the possibly distant date when he takes the £500,000 out permanently for his personal use: or the tax rate he does eventually pay may be very much less than 30%.

Indeed, it’s more likely that Rock, with his pleasant experience of dealing with property developments, will plough the money back again into another development in future. Sandy is much more likely to go back to manufacturing widgets after his experience.