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She wants to build up a portfolio of rented properties, using the profits from the rentals to fund the acquisition of other properties. She begins with a portfolio of 10 buy to let properties, like Bill’s, but instead of taking the profits out of the company, she leaves them there to fund the deposits on new properties. Note that this example assumes that, as announced in the 2008 Budget, the rate of corporation tax for a small company will be 21% for Financial Year 2008, 22% for Financial Year 2009, the same for later years. In the first year, the position will be: Company Direct ownership Profits 20,000 20,000 Cost of company (1,000) NIL Profit after costs 19,000 20,000 Tax payable (3,990) (8,000) Cash for reinvestment 15,010 12,000 If the pattern is repeated in the following year, the cash available for reinvestment in the company will be £29,830, compared to £24,000 if the properties are owned directly. Let us assume that £20,000 is used to fund the deposit on a new property, and that as a result, the profit for the third year increases to £22,000: Year 3 Company Direct ownership Profits 22,000 22,000 Cost of company (1,000) NIL Profit after costs 21,000 22,000 Tax payable (4,620) (8,800) Cash after tax 16,380 13,200 Add cash from previous years 29,830 24,000 Deduct deposit on new property (20,000) (20,000) Cash for reinvestment 26,210 17,200 The company can afford to use another £20,000 to fund another deposit on another property, taking its profits to 24,000. If Jane owned the properties directly, she could not yet afford another deposit, so year 4 looks like this: Year 4 Company Direct ownership Profits 24,000 22,000 Cost of company (1,000) NIL Profit after costs 23,000 22,000 Tax payable (5,060) (8,800) Cash after tax 17,940 13,200 Add cash from previous years 26,210 17,200 Deduct deposit on new property (20,000) N/A Cash for reinvestment 24,150 30,400 The company can afford to spend another £20,000 on the deposit for yet another property, and this year, so could Jane as an individual: Year 5 Company Direct ownership Profits 26,000 24,000 Cost of company (1,000) NIL Profit after costs 25,000 24,000 Tax payable (5,500) (9,600) Cash after tax 19,500 14,400 Add cash from previous years 24,150 30,400 Deduct deposit on new property (20,000) (20,000) Cash for reinvestment 23,650 24,800 For year 6, both businesses can afford another deposit, so here is Year 6: Year 6 Company Direct ownership Profits 28,000 26,000 Cost of company (1,000) NIL Profit after costs 27,000 26,000 Tax payable (5,940) (10,400) Cash after tax 21,060 15,600 Add cash from previous years 23,650 24,800 Deduct deposit on new property (20,000) (20,000) Cash for reinvestment 24,710 20,400 For year 7, both businesses can again afford another deposit, so here is Year 7: Year 7 Company Direct ownership Profits 30,000 28,000 Cost of company (1,000) NIL Profit after costs 29,000 28,000 Tax payable (6,380) (11,200) Cash after tax 22,620 16,800 Add cash from previous years 24,710 20,400 Deduct deposit on new property (20,000) (20,000) Cash for reinvestment 27,360 17,200 For Year 8, only the company can afford a £20,000 deposit, so in Year 8: Year 8 Company Direct ownership Profits 32,000 28,000 Cost of company (1,000) NIL Profit after costs 31,000 28,000 Tax payable (6,820) (11,200) Cash after tax 24,180 16,800 Add cash from previous years 27,360 17,200 Deduct deposit on new property (20,000) NIL Cash for reinvestment 31,540 34,000 In Year 9, both buy another property: Year 9 Company Direct ownership Profits 34,000 30,000 Cost of company (1,000) NIL Profit after costs 33,000 30,000 Tax payable (7,260) (12,000) Cash after tax 25,740 18,000 Add cash from previous years 31,540 34,000 Deduct deposit on new property (20,000) (20,000) Cash for reinvestment 37,280 32,000 In year 10, both can buy one more property: Year 10 Company Direct ownership Profits 36,000 32,000 Cost of company (1,000) NIL Profit after costs 35,000 32,000 Tax payable (7,700) (12,800) Cash after tax 27,300 19,200 Add cash from previous years 37,280 32,000 Deduct deposit on new property (20,000) (20,000) Cash for reinvestment 44,580 31,200 If we summarise the results for the first ten years, we get: Company Direct owned Difference Total income 272,000 252,000 20,000 Total running costs (10,000) NIL (10,000) Total tax paid (57,070) (100,800) 43,730 Total cash benefit 53,730 Number of properties in portfolio 18 16 2 So, by using a company, Jane would be £53,730 better off after ten years, and this is reflected in the fact that her property portfolio has grown by two more properties than it would have done had she owned the properties directly.
By James Bailey
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A company comes into its own when the plan is to reinvest the rental profits in more property, rather than to draw them out for living expenses. Jane has a well paid job, and pays income tax at 40%.