Investing in Property Using an SPV (Special Purpose Vehicle)
The SPV or special purpose vehicle has become more popular as a way to invest in property in recent years. In this article, we will look at what SPVs are, how property investors can use them, and at how to form an SPV.
What Exactly is an SPV?
An SPV is a business entity and one that is formed for, as the name suggests, a closely defined special purpose.
So far as the property investor is concerned an SPV is usually formed for purchasing buy-to-lets or for a property development project. But SPVs can be formed for other purposes too.
A special purpose vehicle is most usually formed as a private company limited by shares. But it does not have to be. An SPV can be any kind of business format including a limited liability partnership (LLP) or a public limited company (Plc).
The Reasons for Using an SPV
In a property context a reason investors may choose to form an SPV at the present moment in time, maybe for their plans to re-sale easily in the future, arrange finance on a property and keep the asset and liability clear or for tax purposes and with the aim of reducing your tax bill.
Here’s how an SPV can potentially offer tax benefits: Section 24 of the Finance (No. 2) Act 2015 introduced restrictions on the amount of mortgage interest that could be claimed as a tax allowance. The amount of the allowance has gradually been reduced in recent years and is now zero.
From the 2020-21 tax year onwards rental profits will be taxed with a maximum deduction for finance costs at the basic tax rate, currently 20%. This has increased the tax liability and operating costs for many property investors who are sole traders and who use mortgage finance. As a result, it has made some investments including buy to lets unviable or even loss-making.
However, limited companies are still able to claim tax relief on the mortgage interest they pay, meaning a limited company can be a more financially attractive way of operating a property business today.
It is important to note that an SPV can only offer these possible tax advantages under current legislation which is, as with all legislation, subject to change.
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SPVs, Limited Companies and Mortgages... What you Need to Know
For property investors who decide to operate their business through a limited company, however, the reason for setting up an SPV is a little more complicated. It can be more difficult for a trading company – one which has other trading activities as well as property – to obtain mortgage finance, due to the lending policies of most mortgage lenders. However, it is usually easier for a limited company whose business is, solely property, to obtain mortgage finance. So, in order to access mortgage finance, it is usually necessary for property investors who use the limited company format to also make those companies special purpose vehicles.
In practice, the use of limited company SPVs involves two separate situations – the ability of limited companies to claim mortgage interest tax relief and lending policy whereby SPVs can obtain mortgages more readily – which are combined for a greater potential benefit.
Property investors need to bear in mind though that the market for limited company mortgages is smaller and less competitive than standard mortgages. Many mainstream lenders do not offer limited company mortgages. With lenders that do, the interest rate charged is usually higher than for standard mortgages and a lower LTV or loan to value may be applicable too.
However, one advantage is that limited company mortgages may only require a lower level of rental coverage or interest cover ratio than regular buy to let mortgages. This is the amount by which the monthly rental income must exceed the monthly mortgage payment. This can make it viable for investors to purchase buy to let properties with relatively large mortgages even if the rental income potential is low.
It's best to remember that the paperwork in filing accounts is much more cumbersome than a personal tax return. You will have to file accounts with Companies House and then a tax return to HMRC. Due to the iXBRL filing requirements, it makes this very difficult for the average person and a professional account will need to be paid to file correctly, which is an extra cost.
As a director, you will be responsible for the annual confirmation statements. This is a Companies House return that informs the public what the purpose of the limited company, who is involved and the registered office.
Why Mortgage Lenders Prefer SPVs
Mortgage lenders tend to prefer limited company SPVs because it is easier to understand the lending risk involved. For example, a new SPV for a property project will be a new business with no previous trading history. It will be free from any pre-existing obligations, debts, charges or legal claims which may otherwise affect their lending decisions. The SPV will also be separate from its owners and directors for accountancy and tax purposes.
Lenders lending to an SPV generally look at the financial standing and ability to repay of the company directors of the SPV, rather than the SPV itself which may well have no income or other assets. They are likely to require personal guarantees for the mortgage from the directors of the SPV.
How a Special Purpose Vehicle Works – An Example
Assume that you are a building contractor and are already trading as a limited company. It may seem to make sense to purchase buy-to-let properties with a mortgage through this company, and you would be able to claim mortgage interest tax relief as a result. However, as this is a trading company with existing assets and liabilities, debtors and creditors, and employees etc. it may be difficult to find a mortgage lender willing to lend to you.
Setting up an SPV for this purpose should, however, mean that you can access mortgage finance more easily.
Some Other Advantages of Using an SPV
SPVs can have a number of other possible advantages, including:
- Placing a property within an SPV can be used to separate and reduce business risk. If, for example, a trading company you own fails (or you wish to dissolve it) this will not affect the property assets within the SPV. Similarly, if a property SPV is unsuccessful it will not affect your trading company.
- SPVs can provide a practical and safe way of working with other investors on a specific property project while keeping it separate from your other property projects or other businesses.
- SPVs offer flexibility. It is possible to form several and many SPVs if you wish so different projects remain independent. An SPV can be formed for one or a number of related projects, dissolved if you wish to (ie. when a property is sold) and further new SPVs formed for any further projects.
- Placing a property within an SPV means that the property can be sold or transferred by selling or transferring ownership of the SPV.
You should note however that placing a property within an SPV does make that property subject to any future changes in legislation, including tax legislation, that may affect this kind of entity.
How to Form an SPV
Special purpose vehicles do not exist as a legal company format as, for example, a limited company or partnership does. You cannot register an SPV as such. The usual way to form an SPV is to form and register a limited company, just as for any other company, but in such a way that it is clearly a special purpose vehicle.
You can form a limited company yourself and register it with Companies House. However unless you are confident about doing this correctly, and in order to achieve the full benefits of a property limited company SPV, you may prefer to use a limited company formation service, solicitor or accountant to do this for you.
The registration details of your company, including the Memorandum of Association and Articles of Association, should clearly define the business of the company and make it clear that the company is an SPV for the purposes of a property business. This is important for the purposes of obtaining a limited company mortgage or mortgages.
If you wish to transfer funds from an existing trading company into a property SPV in order to provide it with working capital then this is possible. However, careful consideration should be given to the most effective way to do this and to the tax implications.
Which SIC Codes to Use
It is particularly important that the SIC code or codes that you register your limited company under are relevant to property. Again, this is necessary for mortgage finance purposes. SIC’s are a Standard Industrial Classification of economic activities and consist of five digits. They are the standardised method by which Companies House requires you to describe your limited company’s nature of business.
You can search for the most appropriate SIC codes to use here from the condensed list of SIC codes which are the only ones Companies House accepts. However, the most relevant SIC codes for property investment companies are generally 68100 (Buying and selling of own real estate) or 68209 (Other letting and operating of own or leased real estate).
Special Purpose Vehicles and Tax... What you Need to Know
As we have already mentioned, property-related limited company SPVs can be useful for the purposes of obtaining mortgage finance and for tax efficiency. However, there are some other considerations you must bear in mind before using this strategy.
Will an SPV Cut My Tax Bill?
While a limited company may still claim mortgage interest tax relief a limited company mortgage will probably attract a higher interest rate, lender fees and legal fees than a standard mortgage. There will also be a cost attached to operating the limited company SPV including compiling annual accounts. So, it is important to ensure that these increased costs do not outweigh the tax savings depending on your particular circumstances.
In some circumstances, it could effectively cost a property investor more overall to own property via a limited company SPV than as a private individual.
Property investors setting up a limited company SPV for property investment or a portfolio should consider the wider tax implications too. There can be both tax advantages as well as some disadvantages of operating as a limited company, including in relation to Corporation Tax and Capital Gains Tax.
Limited companies are tax-efficient as it only pays 19% compared to basic rate taxpayers that pay 20% and 40% for high rate taxpayers. However, there is a double taxation issue should you wish to withdraw money out of a limited company.
It is cheaper to take dividends out of the limited company rather than pay yourself a significant salary. The income tax rate by withdrawing dividends from a limited company is 7.5% for basic rate taxpayers, 32.5% for high rate taxpayers and 38.1% for additional rate taxpayers.
The above income tax rates are in addition to the 19% corporation tax paid by the limited company.
Transferring Property Into an SPV
If you wish to transfer a property you already own into an SPV limited company, in order to claim mortgage interest tax relief, then this is possible. It is usually undertaken by selling the property to your newly created SPV. However, you should take into account the conveyancing costs, Stamp Duty costs and other fees involved in doing this, and carefully consider the tax implications too.
In summary, although using a special purpose vehicle can offer many advantages to property investors it is absolutely essential to take professional advice on the overall implications of using an SPV before going ahead so it is tailored and specific to your individual needs.