Is Ground Rent Taxable?

[Julian]

I am on the board of the management company set up for our block of flats which owns the freehold. The leases define a ground rent, currently £150 per flat per year. The company is limited liability and has 25 shareholders, one for each flat in the block.

The company incurs certain expenses each year (building insurance, cleaners and electricity for the common parts, auditor's fees, gardening, minor repairs, etc, etc, etc). In order to cover these expenses we levy a service charge on each flat. In addition to the service charge we also collect an annual reserve fund payment from each flat. The reserve fund payments go into a separate account that grows and grows each year and is used to fund non-annual major works such as scaffolding up and painting the facades every 7 years, totally redecorating the common parts on roughly the same schedule, re-roofing less frequently, any major refurbs of the lifts, etc.

The third item on our invoices to each flat is the ground rent. Historically we have used the ground rent income to subsidise the service charges, i.e. if we were actually spending the equivalent of £1,000 per flat on service charges then, to keep each flat's cost low, instead of billing £1,000 service charge + £150 ground rent we billed £850 service charge + £150 ground rent. This means that all the ground rent income is spent on actual necessary costs hence the company shows no profit and has no corporation tax to pay.

We have been told by our current accountant that if we were to change things, i.e. remove the mechanism of the ground rent supporting the service charges and bill each flat £1,000 service charges + £150 ground rent and put that ground rent into a separate account that grows and grows each year, then the ground rent would need to be declared as company profit and taxed accordingly (19%?). Some of my fellow directors are claiming that they have heard a different story and this (the ground rent being potentially taxable) is not the case. (I think some of these directors have their own agendas and want to build up a ground rent fund which could then be spent at the board's whim, requiring no shareholder approval, on various improvement projects that otherwise might not get enough shareholder support.)

I plan to call HMRC to try and get clarification but where possible in these sort of situations I always like to already know the answer to the question I'm asking, especially when dealing with officialdom, so I'd be grateful if someone could give me their expert opinion, i.e. if we bill the full £1,000 service charges and the ground rent becomes an extra £150 on top, all of which is retained in a separate company bank account and none of it used for day to day running costs, does that then make it taxable income for the company?

- Julian

[pochisoldi]

I am on the board of the management company set up for our block of flats which owns the freehold. The leases define a ground rent, currently £150 per flat per year. The company is limited liability and has 25 shareholders, one for each flat in the block.

The company incurs certain expenses each year (building insurance, cleaners and electricity for the common parts, auditor's fees, gardening, minor repairs, etc, etc, etc). In order to cover these expenses we levy a service charge on each flat. In addition to the service charge we also collect an annual reserve fund payment from each flat. The reserve fund payments go into a separate account that grows and grows each year and is used to fund non-annual major works such as scaffolding up and painting the facades every 7 years, totally redecorating the common parts on roughly the same schedule, re-roofing less frequently, any major refurbs of the lifts, etc.

The third item on our invoices to each flat is the ground rent. Historically we have used the ground rent income to subsidise the service charges, i.e. if we were actually spending the equivalent of £1,000 per flat on service charges then, to keep each flat's cost low, instead of billing £1,000 service charge + £150 ground rent we billed £850 service charge + £150 ground rent. This means that all the ground rent income is spent on actual necessary costs hence the company shows no profit and has no corporation tax to pay.

We have been told by our current accountant that if we were to change things, i.e. remove the mechanism of the ground rent supporting the service charges and bill each flat £1,000 service charges + £150 ground rent and put that ground rent into a separate account that grows and grows each year, then the ground rent would need to be declared as company profit and taxed accordingly (19%?). Some of my fellow directors are claiming that they have heard a different story and this (the ground rent being potentially taxable) is not the case. (I think some of these directors have their own agendas and want to build up a ground rent fund which could then be spent at the board's whim, requiring no shareholder approval, on various improvement projects that otherwise might not get enough shareholder support.)

I plan to call HMRC to try and get clarification but where possible in these sort of situations I always like to already know the answer to the question I'm asking, especially when dealing with officialdom, so I'd be grateful if someone could give me their expert opinion, i.e. if we bill the full £1,000 service charges and the ground rent becomes an extra £150 on top, all of which is retained in a separate company bank account and none of it used for day to day running costs, does that then make it taxable income for the company?

- Julian

Ground rent is income, only profit is taxable - if the company has zero expenses, then the ground rent is 100% profit.

If you have a stream of income for the company, but little or no expenses then you have three options:

1) Reduce the income
Stop demanding the ground rent (however this may still lie on the company's books as income and still leave a taxable profit...)
Vary the leases to remove the provision for charging ground rent (at negligible cost, if you treat this as a minor change whilst granting shareholders a 999 year lease).
The company then invoices a "management fee" to the service charge account to cover the company's expenses (accounts, Companies House etc.)

2) Increase the outgoings
Use the accumulated funds for improvements to the block, especially activities which the lease does not permit to be charged to the service account.
As the money belongs to the company, the company can do what it likes with it (as long as its in the shareholder's interest). (compare this with the service charge fund, which probably restricts spending to repair and maintenance, and is subject to S20 consultations).

3) Pay tax on the profit and distribute it to shareholders.
This is the silly option - at best it's a case of "take money, pay tax, give the residue back".

Care needs to be taken with (2) and (3) especially if the ground rents are not the same, and/or if any company funded improvements benefit one group of shareholders more than another.
For example: if the ground rents vary between flats, paying a dividend could lead to "take money from leaseholders (in varying proportions), pay tax, give each shareholder an equal proportion of whatever's left over" situation.

For the record in my block (unpaid directors, and a managing agent doing the day to day stuff), the option chosen was (1) - stop demanding ground rents, and then when extending the leases, remove the ground rent provision from all leases, and charge a management fee.
If the ground rents are different, and/or the shareholders paid differing amounts for their share of the freehold (for example if they had already extended their lease), IMHO it becomes the most equitable option.