Reena Kaur Bhatt sat down with property investors and co-owners of TWINS Education, Andy and Chris Gan to explore how one can use an investment holding company (IHC) to build a real estate portfolio and its benefits.
WHAT IS AN IHC?
WHAT ARE THE BENEFITS OF USING AN IHC?
1. Risk Management – It helps you to manage different kinds of risks
Ali and Adam are interested in investing in a piece of commercial property (Property A) in Bangsar
. Assuming that Ali and Adam use their own capacity to purchase Property A, it will be under their JOINT names. However, if Ali and Adam use an IHC as an investment vehicle, the property will be under the IHC’s name. Say in the event of Ali’s death, Adam will now have a problem to dispose of the property somewhere in the future.
It will probably take at least a year of legal proceedings to settle such a transaction. However if an IHC was used, Ali’s death will only affect the shareholding of the company and not Property A. Therefore, Adam will not have any problems in disposing of Property A whenever he wants to. In the event of a conflict between partners, say there is a disagreement over whether or not to sell Property A; it might prove problematic as both parties have equal say.
This will be a great disadvantage for the investment partner who invested a larger sum of capital. In the case of an IHC, whoever holds a larger shareholding in that company will have the final say. The investment partner who invested the larger sum will thus have larger shareholding, therefore reducing his investment risks.
IHCs safeguard your investments from any potential threats. There is the possibility that your partner will embezzle all of the investment money. Setting up an IHC requires the implementation of proper authorization by the banks, thus, avoiding such an event from happening.
2. Financing – It helps you to obtain greater finances
Do you know that you can immediately apply for a loan upon setting up an IHC? In comparison, when an operating company wants to borrow from a bank, it is required to present at least 3 years of audited financial statements. By having some extent of formality, it will be easier to raise finances internally for property investors to buy say, a shophouse. This is because all of the agreements will state clearly aspects such as capital invested, shareholding ratios and who the directors are. This will indirectly help reduce a property investor risks too.
Let’s say there are 3 shareholders involved and one of the shareholder’s businesses went bankrupt. To get himself out of a financial fix, he could liquidate or dispose of his shareholding in the IHC to the other 2 shareholders. Not only is this process quicker and hassle-free but the other 2 shareholders will not be forced to sell off the property as well.
Especially when it is currently generating good rental yield and capital gains! Another example would be – say Ravi owns 10 properties, brings in a high monthly income and have a substantial nest egg. If he wants to purchase another piece of property, most banks will probably only finance him 50% or less due to the high-risk exposure and Ravi’s high personal liability.
By setting up an IHC, Ravi can transfer (or refinance) his existing properties. By transferring his properties to the IHC, Ravi’s risk exposure is reduced automatically and hence, he is now able to borrow further! Furthermore, there will be less legal fee expenditure as Ravi may not need to transfer the SPA under the IHC, but merely the loan agreement.
3. Taxation – It helps you to minimize your overall tax payments to the IRB
When an IHC is used, the Inland Revenue Board (IRB) provides investors with a list of permitted expenses. These could be set against any rental income. Examples of permitted expenses include director fees and management fees. There is also a formula to calculate the number of permitted expenses that are claimable. The general rule is that the amount allowed for deduction should not exceed 5% of the total gross rental income for that basis period.
Malaysia practices a regime of a progressive tax system. This implies that the more income you earn, the higher tax RATE you will have to pay. Assuming that you earn a chargeable income of >/ RM70,000, you will be paying a minimum rate of 21% in taxes. For the year of assessment 2016, the tax rate for companies with a share capital of less than RM2.5 million will be charged a minimum tax rate of 19%, hence, IHCs will help investors to save a MINIMUM of 2% in tax payments.
However, it is not as favourable in terms of Real Property Gain Tax (RPGT) when compared with individual capacity. For individuals, a property held after the 5th year from the acquisition date will not be subjected to RPGT upon disposal, whereas a flat rate of 5% applies for companies.
WHAT ARE SOME OF THE THINGS TO CONSIDER BEFORE SETTING UP AN IHC?
1. Margin of financing for residential and commercial properties
As shown above, IHCs are much more profitable for the investment of commercial properties.
2. Administration cost – auditor fees, secretarial fees etc.
3. It is time-consuming – There is the hassle of filing annual company accounts, etc.
4. Less tax savings – An IHC cannot carry forward losses for the year, if any, and is not able to claim any capital allowance.
A new act, the Companies Bill 2015 is being proposed to replace the existing Companies Act 1965 (pending for approval from the Senate). Once the bill is passed, it will include the following amendments:
• A Sdn Bhd will no longer need a Memorandum and Article of Association (M&A) and instead only a Constitution is required (if applicable).
• A minimum number of two directors no longer applies.
• There will be no more restrictions on object clauses.
• There will be no more need for a Company Seal. With such changes, the administration costs are significantly reduced.
SO IS THE IHC WAY FOR YOU?
An IHC does offer many advantages, but investors should be aware that it is just an alternative vehicle in property investment. It very important that you consult a financial planner, tax accountant and an attorney beforehand as the rules that surround IHCs are complex. Each property investor circumstance will be different, so a careful analysis of the factors involved is advisable prior to deciding on setting up an IHC.
Andy & Chris Gan
DISCLAIMER: The opinion stated in the article is solely of Andy & Chris Gan and is not in any form an endorsement or recommendation by iProperty.com. Readers are encouraged to seek independent advice prior to making any investments.