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Hoteliers: Beware the tax-saving scheme
In recent months, many hoteliers have requested a revaluation of their investments but such revaluations are seldom straightforward. While it might be tax-efficient to lease your business to a limited liability operating company, the potential loss in the value of your interest can be catastrophic and may potentially outweigh any tax saving.
Roy Hudghton highlights the pitfalls…
In one recent case, a client bought a hotel for £650,000, having secured a mortgage in the usual manner, and then decided to lease it to an operating company at £30,000 a year, at which point his bank requested a revaluation of the interest which had been created. It was only then that the landlord, and his bank, discovered to their horror that the value of the interest had been halved because, by leasing the business, the tenant acquired ownership of the goodwill while the landlord retained only the rental income stream. The revaluation was undertaken over the investment, purely on a capitalisation of the income stream which had been created, and on this occasion the affect on value previously reported to the bank was catastrophic.
This tax-efficient approach can therefore dramatically reduce the borrowing power of the landlord and freeze any equity they think they may retain. This is principally due to the creation of a formal lease agreement and the transfer of the worth of the goodwill and trade fixtures and fittings to the tenant.
Unfortunately, this situation is arising with increasing regularity, largely because the advice of valuers is not being sought until it is too late.
Banks are generally not prepared to ignore this altered position as it can clearly affect the worth of their security.
Should a bank attempt to repossess a business where the tenant is performing all of the obligations contained within the lease, then they cannot simply acquire vacant possession and can only offer the landlord's interest for sale to the market, potentially recouping a significantly smaller sum than that originally advanced. The effects of this must be given due consideration in conjunction with any potential tax saving.
I would caution those considering such a course of action to involve their professional advisers as a team and I urge the surveying and accounting professions in particular to ensure that all factors are taken into consideration when offering clients advice in relation to their most valuable asset.
However, commercial investments in retail or office premises are entirely different, and the creation of a formal lease with a tenant offering a strong covenant could substantially increase the value and therefore release fresh equity to the landlord.
Roy Hudghton
Partner
This article has been edited from its original version. For the complete feature and to view pictures, please see Catering in Scotland magazine May/June 2007.
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