If your limited company pays rent to a connected company, you can deduct that rent as an expense. That reduces your taxable profits and your corporation tax bill. But HMRC does not let you set the rent at whatever figure you like. The rules on transfer pricing and market value apply. Get it wrong and you face a tax adjustment, interest, and penalties.

This article explains how a rent charge connected company corporation tax arrangement works, what HMRC looks for, and how to structure it safely. We cover the rules for limited companies, partnerships, and sole traders using a connected property company.

How a Rent Charge Reduces Corporation Tax

The basic principle is straightforward. If your trading company pays rent to a connected company that owns the property, the rent is a deductible expense. It reduces the trading company's profits. The connected company receives the rent as income and pays corporation tax on it.

Here is a worked example. Your trading company makes £200,000 profit before rent. You pay £40,000 rent to a connected property company. The trading company now shows £160,000 profit, saving corporation tax at 25% (or 19% if below the small profits threshold). The property company pays corporation tax on the £40,000 rental income. The overall group tax bill is broadly the same, but you have shifted profit from the trading company to the property company.

The real benefit comes when the property company has tax reliefs the trading company cannot use. For example, the property company may have capital allowances on the building, or it may have brought-forward losses. In those cases, the rent charge genuinely reduces the group's total corporation tax.

But there is a catch. HMRC will not let you set the rent at an artificially high figure to shift more profit than is commercially justified.

The Transfer Pricing Rules

Transfer pricing rules apply when connected companies transact with each other. The rent must be at arm's length. That means the same price two unconnected parties would agree in an open market.

If you charge rent above market value, HMRC can adjust the trading company's profits upwards. The excess rent is disallowed as a deduction. The property company still pays tax on the rent it received, but the trading company loses its relief. You end up paying more tax overall than if you had charged the correct market rent.

If you charge rent below market value, HMRC can treat the difference as a distribution (a dividend) or a capital contribution. This can trigger additional tax charges for the director-shareholders.

The rules apply to all connected companies. Connected includes companies under common control, companies with common directors, and companies where one controls the other. It also includes companies where a shareholder holds more than 50% of the shares in both entities.

For small and medium-sized enterprises (SMEs), the transfer pricing rules are less onerous. SMEs do not need to prepare full transfer pricing documentation unless HMRC specifically asks. But you still must charge a market rent. HMRC can still make an adjustment if they challenge the figure.

Market Value: How to Determine the Right Rent

You need a defensible market rent. The best evidence is a professional valuation from a chartered surveyor. For commercial property, the valuation should reference comparable properties in the same area. For example, a 1,500 sq ft office in the Birmingham Jewellery Quarter has a different market rent than a similar space in the Manchester Northern Quarter.

For residential property used as an office, the market rent is lower. HMRC will look at local rental listings for similar properties. Do not use the residential market rent for a whole house if you only use one room as an office. Apportion the rent on a reasonable basis.

If you own the property personally and rent it to your company, you must also consider the rent-a-room relief and the property income allowance. These are separate rules that affect your personal tax position, not the company's deduction.

Do not set the rent at the same figure every year without reviewing it. Market rents change. If HMRC challenges your rent and it has not moved in five years, they will question whether it remains at arm's length.

Rent Charges and Connected Companies: The Practical Structure

The most common structure is a trading company renting from a connected property company. The property company owns the freehold or leasehold. The trading company occupies the property and pays rent.

Both companies must file separate corporation tax returns. The trading company claims the rent as a deduction. The property company declares the rental income and claims its own deductions: mortgage interest (if any), repairs, insurance, business rates, and capital allowances.

If the property company is loss-making, the rent charge can use up those losses. That reduces the group's overall tax bill. But HMRC will check that the rent is commercially justified, not simply a device to use losses.

You can also structure this through a partnership. A connected partnership owns the property and rents it to the trading company. The partnership's profits are allocated to the partners. The same arm's length principle applies.

What HMRC Looks For

HMRC's approach to a rent charge connected company corporation tax arrangement focuses on three things.

First, the market value of the rent. If the rent is significantly above local market rates, expect a challenge. Second, the commercial rationale. Why does the trading company rent from the connected company rather than owning the property itself? If the answer is purely to reduce tax, HMRC may argue the arrangement has no commercial purpose. Third, the documentation. If you have no written lease, no valuation, and no board minutes approving the rent, HMRC will treat the arrangement with suspicion.

HMRC can open a transfer pricing enquiry under the Corporation Tax (Transfer Pricing) rules. They can also apply the general anti-abuse rule (GAAR) if the arrangement is considered abusive. The GAAR carries a penalty of 60% of the tax advantage.

For most genuine commercial arrangements, the GAAR does not apply. But if the sole purpose is tax avoidance, the risk is real.

Example: A Manchester Software Consultancy

Consider a 4-employee software consultancy in Manchester turning over £420,000. The director owns the freehold of the office building personally through a separate property company. The consultancy pays £36,000 per year rent to the property company.

A local chartered surveyor values the rent at £34,000 to £38,000 based on comparable office space in the Northern Quarter. The consultancy deducts the £36,000. The property company pays corporation tax on the net rental income after deducting repairs, insurance, and capital allowances on the building.

HMRC would accept this arrangement. The rent is within market range, there is a commercial lease, and the property company has a genuine business purpose (holding and managing the property).

If the same consultancy paid £60,000 rent on the same property, HMRC would adjust the consultancy's profits by £22,000 to £24,000 (the excess over market value). The consultancy would lose the deduction for the excess, and the director might face additional tax on the excess treated as a distribution.

Rent Charges and Sole Traders

Sole traders can also pay rent to a connected company. For example, a sole trader running a shop from a property owned by a connected company. The same transfer pricing rules apply. The rent must be at arm's length.

But sole traders have a simpler option. They can claim a deduction for use of home as office without needing a formal rent arrangement. The simplified expenses method allows a flat rate deduction based on hours worked at home. For a sole trader, this is often more straightforward than a rent charge.

If the sole trader's business is run from a property owned by a connected company, the rent charge is the correct approach. But the sole trader must be able to demonstrate the rent is commercial and the property is genuinely used for the business.

Rent Charges and Partnerships

Partnerships face the same rules. A partnership renting from a connected company must charge a market rent. The partnership deducts the rent as an expense. The connected company pays tax on the rental income.

Partnerships also have the added complexity of profit-sharing ratios. If the connected company is also a partner, the rent charge interacts with the profit allocation. HMRC will look at the overall arrangement, not just the rent in isolation.

Documentation You Must Keep

To defend a rent charge connected company corporation tax arrangement, keep these documents:

  • A written lease or tenancy agreement signed by both parties
  • A professional valuation from a chartered surveyor (updated every 2-3 years)
  • Board minutes from both companies approving the rent and the lease terms
  • Rent invoices and payment records
  • Comparable market evidence if HMRC queries the figure

Without this documentation, HMRC can disallow the deduction and charge interest from the date the corporation tax was due. Interest on underpaid corporation tax is currently 7.75% (as of early 2025).

Alternatives to a Rent Charge

You do not have to use a rent charge. Other options include:

  • The company owning the property directly. The company claims capital allowances and deducts mortgage interest directly.
  • The director owning the property personally and claiming the use of home as office allowance. This is capped at £6 per week (£312 per year) for the simplified method, or actual costs if you keep detailed records.
  • The company paying the director a rental income. This is less common and can trigger additional tax charges.

Each option has different tax consequences. The right choice depends on your specific circumstances, the property value, and your long-term plans for the business and the property.

When to Speak to an Accountant

If you are considering a rent charge between connected companies, speak to an accountant before you set it up. The rules are technical. Getting the market rent wrong, failing to document the arrangement, or structuring it without commercial purpose can cost you more in tax than you save.

As ICAEW qualified accountants, we regularly advise clients on these arrangements. We can help you determine the market rent, prepare the documentation, and file the corporation tax returns correctly.

If your trading company already pays rent to a connected company and you have not reviewed the arrangement recently, now is the time. Market rents change. HMRC's focus on transfer pricing is increasing. A review now can save you a tax enquiry later.

Contact us to discuss your specific situation. We work with businesses across the UK, from London to Glasgow, and can help you structure your property and trading companies tax efficiently.