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Property Syndicates - what's the right structure?

Syndicates could be the solution to property affordability

19 August 2008 · Staff Writer

By Wouter Scholtz, Mazars Moores Rowland

The current environment of ongoing interest rate hikes and spiralling inflation can make it difficult to raise sufficient funds to purchase property or to develop or improve it.  Whether you're an individual investor, a company or a trust, banding together to form a property syndicate can be a solution.  This strategy spreads the attendant risks, but also invites certain tax and legal implications particularly if not properly planned.

Three syndicate alternatives to consider are a partnership, a company or a trust.

Partnerships

The main advantage of a partnership is that if losses are incurred, these can be deducted from income or from any capital gains the partners derive from other sources. 

Because of this, using a partnership to form a property syndicate is particularly advantageous where most, or all, of the money needed is borrowed at interest and where it's likely that it will take several years before the income from the property, for example rental, exceeds interest and other expenses.  

The biggest disadvantage of a partnership is that partners are jointly and severally liable for debts and losses. If one of the partners can't meet his share, the others will have to make up the difference.

A partnership also should not be used if it's likely that a further partner will have to be introduced at a later stage to raise funds to develop or improve the property.  This is because in order to admit a new partner the original partners need to dispose of some of their interests in the building acquired by the partnership.  This results in a capital gain and therefore CGT exposures for the original partners.

Compare this to the scenario where the building is owned by a company, and the company raises further capital by issuing additional shares to a new shareholder (or existing shareholders) - the issue of the additional shares would have no CGT consequences. 

Using a company as the syndication vehicle

Using a company as the syndication vehicle has the following advantages:

  • At 28% the corporate tax rate is significantly lower than the peak individual marginal rate of 40%.
  • A company can freely raise capital by issuing shares to shareholders, without incurring any CGT liabilities.
  • Shareholders, unlike partners, are not jointly and severally liable for the debts of the company, unless they have extended guarantees to creditors that make them liable, either jointly or severally. 

If the shareholders want to borrow money to take up an issue of shares in the company, they will not be allowed a tax deduction for the interest paid on the borrowed money.

So if you're using a company as a syndication vehicle, it's important that any debt is raised at the level of the company, and not at the level of the shareholders.

But if the company borrows money at interest to purchase an income-producing property, or to develop a property, the interest is tax deductible.

The main disadvantage of using a company is that any losses will be locked up in the company and can only be offset against the company's income.

Joint ventures

The term ‘joint venture' is often used loosely - and dangerously so. A perception exists that the perils of partnership can be avoided simply by calling the arrangement a joint venture.  But if the partners share in a common pool of profit, it's a partnership. 

With a joint venture, on the other hand, the parties make joint contributions to a common project, but do not share in a common pool of profits.

A well drafted joint venture agreement will provide the benefits of partnership - the ability to offset losses from the project against other sources of income - without the peril of joint and several liability.  (peril)

In conclusion, the parties to any of the three structures can be individuals, companies or trusts.

Using a company or trust confines exposures to any risks to the company or the trust. However, there is little sense in using a company or trust to screen off the shareholders or beneficiaries if, under the agreements concluded with the bank, the shareholders or beneficiaries accept unlimited liability for the debts of the company or trust.

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