SHOULD I USE A COMPANY TO HOLD INVESTMENT PROPERTY?
Property investors are often perplexed about the tax implications of using a company to hold their investment properties. Doing so can bring some advantages but the pluses and the minuses need to be weighed carefully.
ON THE PLUS SIDE
A 20% income tax rate. This can give auseful tax saving when personal tax rates are high. As the highest personal tax rate is currently 26%, there is a potential 1% advantage even when the company pays tax on all of its income at the principal rate of 25%. But the real advantage is seen when the company is entitled to use the small company rate of 20% on the first RM500,000 of chargeable income. For a company to be eligible for the lower rate in any year, it must be an independent company with a paid up ordinary share capital of not more than RM2.5 million at the beginning of its accounting year. When the alternative to company ownership is ownership by an individual with a substantial income, there is a potential for tax saving of at least RM30,000 every year (RM500,000 x (26% -20%)).
A simple example:
Mr. Lim, a successful lawyer earning RM1 million every year, is contemplating the purchase of a suite of offices from which he expects to derive a rental income of RM600,000 per annum after deducting expenses of RM200,000. As the top slice of his income, this would attract a tax liability of RM156,000 (RM600,000 at 26%). However, if he sets up a company to hold the asset, the company can expect to pay tax of RM125,000 (RM500,000 at 20% plus RM100,000 at 25%). There would be no further tax implication if the company paid out the after-tax income to Mr. Lim as a dividend.
Another plus (perhaps) – income spreading. Until fairly recently, a property investment company could also be used to spread income around within a family if the shareholdings were arranged so as to give each member the right to dividends. When the dividends came with a tax credit (26% at present rates) shareholders who were taxable at lower rates could claim a tax repayment. Unfortunately that no longer works as virtually all dividends are single-tier dividends which come with no tax credit.
Some spreading can still be achieved where a company is able to pay out directors fees and claim a full tax deduction for them. This would be beneficial when some directors were paying tax at low rates. However, it is easier said than done because a personal investment holding company is usually unable to claim more than a token tax deduction (the permitted expenses deduction) for directors fees or indeed any other expenses of management and administration.
A full tax deduction is possible when the company is eligible to be taxed on the basis that it is carrying on a business of letting properties. (In default the company is treated as carrying on a passive investment activity.) This may be achieved by:
- Obtaining a listing for the company’s shares;
- Providing a sufficient amount of active maintenance and support services for tenants to support an implied presumption that the company’s activities are active and not passive; or
- Owning and renting out a sufficient number of properties of an eligible nature.
Nevertheless, it must be stressed that neither method (ii) nor (iii) will achieve the objective unless the company avoids being classified as an investment holding company. See below.
Tax benefits when rent is treated as business income. These can be very substantial, not only in terms of income spreading. There is much more that can be said about this topic and it will be covered in detail in a later article. The article will elaborate on matters such as loss reliefs, capital allowances and improved expense deductions.
WATCH OUT FOR THE DRAWBACKS
The 20% rate does not apply when the company is involved with another company which has a paid up ordinary share capital of more than RM2.5 million and either company owns more than 50% of the paid-up ordinary share capital of the other; or a third company owns more than 50% of the paid-up ordinary share capital of both of them.
Only the limited permitted expenses deduction is given to a non-listed company which is taxed as an investment holding company. This deduction is given for a proportion of specified expenses including directors’ fees, wages and salaries, management fees and various other professional fees as well as rent and expenses of maintaining an office. The proportion is calculated by reference to the different types of income of the company but the proportion can never exceed 5% of the gross income from dividends, interest and rent chargeable to tax. (Exempt income is disregarded). Consequently, the scope for paying tax-deductible directors’ fees is minimal. Space constraints do not allow for setting out the whole calculation but the following generalised example might help.
Assuming that Mr. Lim in the example given above would like the company to pay his wife (who has no other income) a director’s fee of RM109,000, not more than RM40,000 ((RM600,000 + RM200,000 x 5%) of this would be tax deductible for the company. Although Mr. Lim’s wife would pay tax of RM14,325 (being the tax on RM109,000 minus the personal relief of RM9,000) on her director’s fee, the company would get tax relief of only RM10,000 (RM40,000 at 25%). Not only is there no tax saving, there is a net cost of RM4,325.
An unlisted company may be classified as an investment holding company for any year unless it is able to show that it is not. It can do so by satisfying the requirement that its activities do not consist mainly in the holding of investments. If it is not able to satisfy that requirement, then it may still qualify by showing that less than 80% of its gross income (whether exempt or not) is derived from such activities.
Satisfying the first requirement will depend mainly upon how the company describes itself in its statutory reports. The second test, which must be examined every year if necessary, is a matter of calculation. For this purpose, rents from properties where maintenance and support services are provided are treated as non-investment income.
ABC Realty Sdn Bhd, an unlisted company, describes itself as a property investment company. Its gross income for the year to 31, March 2010 consisted of:
|Rents from actively managed and maintained properties
|Rent from non-serviced properties
Although the activities of ABC Realty Sdn Bhd seem to consist mainly in the holding of investments, it is not an investment holding company for tax purposes for the year of assessment 2010 because its gross income from investments (RM20,000 + RM55,000) does not amount to 80% of its gross income.
For readers who wish to know more, the two books mentioned below are recommended.
Real property gains tax has not been covered as there is little difference between companies and individuals for the purposes of that tax.
Richard Thornton is author of 100 Ways to Save Tax in Malaysia for Property Investors (ISBN978-983-2631-83-5) and 100 Ways to Save Tax for Malaysian Investors (ISBN978-967-5040-42-9) published by Sweet & Maxwell Asia. He is a Fellow of the Chartered Tax Institute of Malaysia.
These two works contain some valuable insights on how to achieve legitimate tax savings for investors in property and other assets as well as dealing with complex issues such as “When can an investor be taxed as dealer?”and “Is it a good idea to use a company?”Written in clear simple language, the books contain helpful examples to explain how the tax planning ideas can be put into action. The books can be found at www.sweetandmaxwellasia.com.my.