If you own a limited company and also control another business (perhaps a property company or a management company), you might be wondering whether paying a rent charge between them could reduce your overall corporation tax bill. The logic is straightforward: one company pays rent to another, the paying company deducts the rent as an expense, and the receiving company pays corporation tax on the income instead. If the receiving company is taxed at a lower effective rate, or if it has losses to shelter the income, the group as a whole pays less tax.
But HMRC has specific rules that prevent you from setting the rent charge at whatever figure you choose. The rent charge connected company corporation tax rules are governed by transfer pricing legislation, and they require that any transaction between connected companies is priced at arm's length. That means the rent must be the same as what you would pay to an unconnected third party. Get it wrong, and HMRC can adjust the price, add interest, and charge penalties.
This article explains how the rules work, what counts as a connected company, how to determine the market rent, and the common traps that catch business owners out. As ICAEW qualified accountants, we see this structure used effectively by property-owning groups and trading companies with separate property holding vehicles. But we also see it done badly.
What Is a Connected Company for These Purposes?
The definition of a connected company under the transfer pricing rules is broad. Two companies are connected if one controls the other, or if both are under common control. Control here means the ability to secure that the company's affairs are conducted in accordance with the controller's wishes. That includes direct shareholding control (over 50% of shares or voting rights) and indirect control through a chain of companies or through associated individuals.
For most owner-managed businesses, the connection is obvious. You own 100% of the trading company and 100% of the property company. They are connected. The same applies if your spouse or a close family member holds shares in one of the companies. HMRC can look through family shareholdings and treat them as connected under the "acting together" rules.
The key point is that the transfer pricing rules in Part 4 of TIOPA 2010 apply automatically to all transactions between connected companies. You do not need to elect into them. They apply whether you are aware of them or not.
How Does the Rent Charge Reduce Corporation Tax?
The mechanism is simple. The trading company pays rent to the property company. The trading company deducts the rent as an allowable expense in its corporation tax computation. That reduces its taxable profits and therefore its corporation tax liability. The property company receives the rent as income and pays corporation tax on it.
If the property company is taxed at a lower rate than the trading company, the group saves tax. For example, a trading company with profits of £200,000 pays corporation tax at an effective rate of 25% (the main rate). A property company with the same profits also pays 25%. But if the property company has brought-forward losses or capital allowances that shelter the rental income, its effective tax rate could be much lower. In that case, shifting profit from the trading company to the property company through a rent charge saves tax.
Even if both companies pay the same rate, the rent charge still defers tax. The property company can claim capital allowances on the building (structures and buildings allowance at 3% per year) and on any plant and machinery within it. Those allowances reduce the taxable rent income further.
The Market Value Test: Arm's Length Pricing
Here is where most people get it wrong. You cannot simply decide that the rent charge will be £50,000 per year because that is the number you want. HMRC requires that the rent is at arm's length. That means it must be the price that would be agreed between two independent parties negotiating in the open market.
For commercial property, the arm's length rent is determined by comparable evidence. What do similar properties in the same location let for? What is the rent per square foot? Are there rent-free periods or tenant incentives that would apply in an open market negotiation? You need to be able to justify the rent with real market data.
If you set the rent too high, HMRC will treat the excess as a distribution (a dividend) or as a capital contribution, depending on the circumstances. The excess is not deductible for the paying company. If you set it too low, HMRC can treat the shortfall as a deemed loan or as a gift, with tax consequences on the receiving side.
The rent charge connected company corporation tax rules mean that you need a formal rental agreement, ideally documented before the rent is paid. The agreement should set out the rent, the payment terms, the property description, and the duration of the lease. HMRC will look at the substance, not just the paperwork. If you have a written agreement but the rent is clearly above market, the paperwork will not save you.
How to Determine Market Rent
For most small businesses, a formal RICS valuation is not necessary unless the rent is significant. You can use comparable evidence from online property portals (Rightmove, Zoopla, Realla) for similar commercial properties in the same area. If the property is a standard office unit on a business park, the market rent is usually easy to find.
For more unusual properties, or where the rent is high (say above £50,000 per year), a professional valuation from a chartered surveyor is sensible. It provides a defendable position if HMRC ever enquires. The cost of the valuation is deductible for the company that pays it.
One common approach is to use a rent that covers the property company's costs (mortgage interest, insurance, repairs, management fees) plus a modest profit margin. That is not automatically arm's length, but if those costs align with market rents, it is usually acceptable. The danger is when the cost-plus approach produces a rent that is significantly above or below market.
Transfer Pricing Documentation Requirements
For small and medium-sized enterprises (SMEs), HMRC does not require formal transfer pricing documentation to be prepared and filed automatically. But you are expected to be able to demonstrate that your pricing is at arm's length if asked. The burden of proof is on you, not HMRC.
If your group is larger (typically more than 250 employees, or turnover above €50m, or balance sheet above €43m), formal transfer pricing documentation is mandatory. Most owner-managed groups will fall below these thresholds, but the documentation requirement still applies in practice if HMRC opens an enquiry.
We recommend keeping a simple file that includes:
- The rental agreement signed by both companies
- Comparable evidence (screenshots or printouts of similar properties for let)
- A brief note explaining how the rent was determined
- Any professional valuation report if obtained
- Evidence that the rent is actually paid (bank statements, invoices)
If you do not have this documentation and HMRC challenges the rent, you are in a weaker position. The enquiry may result in an adjustment, interest, and penalties if HMRC concludes that the pricing was deliberately artificial.
Structures and Buildings Allowance: An Extra Benefit
One of the advantages of holding commercial property in a separate company is that the property company can claim Structures and Buildings Allowance (SBA) at 3% per year on the construction cost. This allowance is available on new commercial buildings constructed after 29 October 2018. It is also available on certain conversions and renovations.
The SBA reduces the property company's taxable rental income. If the rent charge is £40,000 per year and the SBA is £15,000, the property company only pays corporation tax on £25,000. The trading company still deducts the full £40,000. The net tax saving for the group is the difference between the corporation tax saved by the trading company (on £40,000) and the corporation tax paid by the property company (on £25,000).
If the property company also claims Annual Investment Allowance (AIA) on plant and machinery within the building (fittings, air conditioning, lighting), the tax shelter is even greater. But be careful: AIA is only available on qualifying plant and machinery, not on the building structure itself.
Common Traps and Pitfalls
The most common mistake we see is the "round sum" rent. A director decides that the rent will be £1,000 per month because that is a tidy number. If the market rent for the property is actually £750 per month, the excess £250 per month is not deductible. HMRC will disallow it, and the paying company will owe additional corporation tax plus interest.
Another trap is failing to actually pay the rent. If the trading company accrues the rent in its accounts but does not pay it, HMRC may argue that the expense is not allowable because it has not been incurred. For cash basis companies, this is a direct issue. For accruals basis companies, the rent is deductible when the liability arises, but only if there is a realistic expectation of payment. A rolled-up rent that is never paid will be challenged.
A third trap is using a rent charge to extract profit from a company that has no property. If the trading company does not occupy the property, there is no genuine commercial reason for the rent. HMRC will treat the payment as a distribution or a capital payment, not as a deductible expense. The property must genuinely be used by the paying company for its trade.
Finally, watch the connected party loan rules. If the property company is also a close company and the director has a loan account with it, the rent charge could interact with the director's loan account in unexpected ways. This is a specific area where professional advice is needed before you start.
Alternatives to a Rent Charge
A rent charge is not the only way to shift profit between connected companies. Other options include:
- Management charges: The property company charges the trading company a management fee for services provided. This must also be at arm's length.
- Interest on loans: If the property company lends money to the trading company (or vice versa), interest must be at a commercial rate.
- Royalties: If one company owns intellectual property used by the other, a royalty charge can be made. Again, arm's length pricing applies.
Each of these has its own rules and pitfalls. A rent charge is often the simplest because the market rent is usually easy to determine. But if the property is not let to the trading company at market rent, none of these alternatives will work either.
When Does This Become a Tax Avoidance Issue?
HMRC has the power to counteract tax advantages arising from transactions that are not at arm's length under the transfer pricing rules. But there is also a general anti-abuse rule (GAAR) that applies to abusive tax arrangements. If your rent charge is clearly designed to exploit a tax loophole, HMRC may challenge it under the GAAR.
In practice, the GAAR is reserved for aggressive arrangements. A genuine commercial rent charge at market value, properly documented, is not abusive. It is standard tax planning. The risk arises when the rent is artificially inflated, or when the property is not genuinely used for the trade, or when the structure has no commercial purpose beyond tax saving.
If your group's turnover is below £10 million and the rent charge is modest (say under £30,000 per year), HMRC is unlikely to open a full enquiry unless there are other red flags. But that does not mean you should be careless with the pricing.
Practical Steps to Take
If you are considering a rent charge between connected companies, here is what to do:
- Identify the market rent for the property using comparable evidence. If the property is unusual, get a professional valuation.
- Draft a formal rental agreement between the two companies. Include the rent, payment terms, property description, and lease term.
- Ensure the trading company actually uses the property for its trade. If the property is empty or used for non-trade purposes, the rent is not deductible.
- Pay the rent on time. Accruals in the accounts without payment will be challenged.
- Keep documentation of how the rent was determined. Store it with the company records.
- Review the rent annually. Market rents change. If you do not adjust the rent, you may drift away from arm's length pricing.
If your group is more complex, or if the rent is significant (say above £100,000 per year), speak to us before implementing the structure. The cost of getting it wrong is far higher than the cost of professional advice upfront.
The rent charge connected company corporation tax rules are not designed to stop genuine commercial arrangements. They are designed to stop artificial pricing. If you price at market and document properly, the structure works. If you try to push the numbers, HMRC will adjust them.
For more on how corporation tax applies to your specific situation, see our corporation tax guide for limited companies. If you are considering restructuring your group, our incorporation and structure page covers the key considerations. And if you need help with the documentation, get in touch.