Why are Special Purpose Vehicles (SPVs) used for Property Finance?
A Special Purpose Vehicle (SPV) is a type of company that can be set up to hold a property. Where property purchasers/developers want to obtain finance for their projects, an SPV – a company that can be used on one project only – is normally used as it represents fewer risks and liabilities for lenders.
SPVs can also be beneficial for the property purchaser/developer because the assets are isolated and there is therefore limited liability.
What is an SPV?
An SPV is a legal company that is formed for a defined special purpose.
For property investors, an SPV is usually formed in order to purchase buy-to-let properties or for property development projects. The SPV is a separate company with separate assets and liabilities.
An SPV for property investment is usually formed as a private company limited by shares.
Property investment and personal property
Having an SPV separates any personal property from a business or investment property. This can reduce your personal liability if something were to go wrong with the property investment. In extreme scenarios, it could protect the family home from repossession.
Why use an SPV for property investment?
In a property context, one reason an investor may choose to form an SPV is to obtain finance on a property with limited liability.
They may also do so for tax purposes. This is because one of the key advantages of holding a property through an SPV is the ability to achieve a lower overall effective tax rate on any rental income generated from the property.
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.
The lending policies of most mortgage providers means it can be more difficult for a trading company (i.e. one which, in addition to owning property, conducts other trading activities) to obtain mortgage finance. It is usually far easier for a limited company whose sole business relates to property to obtain finance. So, in order to access mortgage finance, it is usually necessary for property investors who use the limited company format to also set up an SPV for property investment and development.
In practice, the use of SPVs for limited companies has two main benefits: firstly, it makes obtaining financing more achievable and, secondly, it offers them the chance to claim mortgage interest tax relief.
Property investors need to bear in mind that the market for limited company mortgages is smaller and less competitive than standard mortgages. Many mainstream lenders do not offer limited company mortgages, and even lenders that do tend to charge higher interest rates (when compared to standard mortgages) and a lower loan-to-value (LTV) figure.
However, one advantage is that limited company mortgages may 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 Registration Office (CRO) Ireland and then a tax return with the Irish Revenue Commissioners. Due to the iXBRL filing requirements, this is a very difficult task for the average person, meaning a professional accountant will need to be paid to file correctly.
As a director, you will be responsible for the annual returns. This is a Companies Registration Office return that informs the public of the nature of the limited company, who is involved, and the registered office.
Why alternative lenders prefer SPVs
Alternative lenders tend to prefer limited company SPVs because it is easier to understand the lending risk(s) 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, and legal claims, which may otherwise affect a lender’s decision on an application. The SPV will also be separate from its owners and directors for accountancy and tax purposes.
As an SPV may well have no income or other assets, lenders lending to an SPV generally look at the financial standing and ability to repay of the SPV’s company directors, rather than the SPV itself. They are likely to require personal guarantees for the mortgage from the directors of the SPV.
How an SPV works: A case study
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, particularly as 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, employees, etc., it may be difficult to find a mortgage lender willing to lend to you.
In this case, setting up an SPV for this purpose should enable you to access commercial property 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 SPVs if you wish for different projects to remain independent of one another. An SPV can be formed for one or a number of related projects. The SPV can be dissolved when the property is sold and 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.
It is important to note that the property in the SPV IS subject to any future changes in legislation, including tax legislation, that may affect this kind of entity.
Personal ownership vs SPV ownership: Tax implications
In principle, rental profit earned on Irish property will be subject to income tax, USC and PRSI. For marginal rate individual taxpayers, therefore, your net taxable rental income could – based on current 2022 rates – be taxed at rates as high as 55%.
In most cases, the individual investor will be liable to 33% CGT on any capital gains or profit made on a sale of their property. However, there are anti-avoidance rules in the Irish tax code that can recharacterise the capital gain into an income tax receipt (liable to higher income tax rates) in certain circumstances. These rules need to be carefully considered at the outset.
Rental profit for a company is subject to corporation tax at a rate of 25%. Where a company is a close company (a company controlled by five or fewer persons), rental income may be subject to a surcharge of 20% if it is not distributed to the company’s shareholders within 18 months of the accounting period in which it was earned. The effect of the surcharge can mean that the overall effective tax rate on such income is as high as 40%, a rate which is still lower than the marginal income tax rate of 55%. Depending on the circumstances, it may be possible to manage the surcharge exposure with the right professional advice.
Where sizeable rental portfolios are involved, the incorporation of a property management company can generate some advantages as a management fee would be charged to the property holding company. This property management company would be a trading entity such that any income earned is taxable at 12.5%, whilst being tax deductible in the property holding company at 25%. Hence, an overall saving of 12.5% on such income is achieved. It also assists in relieving the impact of the close company surcharge.
If Irish property is sold by a company, any gain on the sale will be subject to corporation tax on chargeable gains at an effective rate of 33%.
Extraction of income/gains
Another area of interest for an individual will be the reduced level of available income in their hands, given that the income now accrues to the company. The company will need to operate a 25% dividend withholding tax on distributions made to the individual shareholder. That dividend will also be liable to income tax for the individual (potentially as high as 55%, as mentioned above), with a credit claimed for the 25% tax already withheld at source by the company.
If, after the sale of the property, the individual decides to liquidate the company, any net proceeds received on liquidation would generally be subject to 33% CGT. There are always two layers of tax to bear in mind where a corporate structure is concerned.
A willing purchaser may be open to acquiring the property-owning company as opposed to the company itself, thereby eliminating the double tax exposure for the individual shareholder. However, most diligent purchasers will be educated on the “latent gain” that they will inherit by acquiring the company’s shares and will, accordingly, seek a discount on the purchase price to compensate them for this.
Trading company for property development activities
A corporate structure is usually preferred for investors who intend to acquire property or land for full development with the ultimate goal of a sale, as the 12.5% rate of corporation tax applies to the general trading income of a company. However, profits from certain “excepted trades” are taxed at the higher rate of 25%. This includes profits from dealing in or developing land, other than fully developed land.
In order to avail of the 12.5% rate, the land must have been developed by, or for, the company before it is sold (such that it would reasonably be expected that no further development would be required for another 20 years). It is important to clarify the proposed activities of the company from the outset so that the trading threshold will be met.
Holding property via a company also offers the following advantages:
- Flexibility of retaining profits for future investment, without having to pay marginal rates of income tax on income realised from personally held investments, as well as the opportunity to extract income as dividends or salary as the need arises.
- The possibility of using a holding company structure and segregating property assets from cash. (However, it should be noted that a holding company will not be able to avail itself of the “participation exemption” from CGT where the shares derive the greater part of their value from Irish land or buildings.)
- Limited liability if borrowing for development.
There are additional administrative considerations associated with running a company. For example, the requirement to file annual returns and financial statements with the CRO and corporation tax returns with the Irish Revenue Commissioners.
Transferring property to a company
The company will be liable for stamp duty on the acquisition of a property when the property is transferred by an individual to a company.
If the market value of the property at the time of transfer is higher than the individual’s original tax base then the individual is liable for CGT on the property transfer.
Any capital losses arising where property is transferred to a company owned by the individual are limited in that they can only be offset against gains on future disposals to the same company. Generally, the property will be transferred to the company for an amount owing (e.g. as a director’s loan), thereby enabling them to draw down the after-tax income within the company tax free up to the value of the property.
In summary, if you are considering your next property purchase or property development venture then using an SPV can offer many advantages. However, it is 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, risks, and opportunities. In a nutshell, the process involves setting up an SPV after you find a development, in order to isolate the asset and any risks involved with the purchase. After the property/development project is completed, you either sell it or you keep it, at which point you go through a formal process with your advisors to – if so desired – close that SPV down and possibly establish a new one.
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