Mark McLaughlin reports on a recent tax case regarding Inheritance Tax and holiday lettings.
Business Property Relief
Business Property Relief (BPR) is a valuable relief for Inheritance Tax (IHT) purposes. BPR offers relief of up to 100% of the value of relevant business property. The difference between a business and a mere investment is an important one, as the latter does not qualify for BPR; but it can be a fine distinction between the two. Even if the 'business' test is satisfied, a business which is carried on otherwise than for gain is not to be regarded as a ‘business’ for BPR purposes (IHTA 1984 s 103(1)).
Difficulties can arise with regard to holiday lettings, in terms of whether the letting is a genuine business activity or a passive investment. The IHT legislation (IHTA 1984 s 105(1)(a)) provides that “property consisting of a business or interest in a business” constitutes relevant business property, if carried on for gain. However, there is exclusion from BPR if the business consists wholly or mainly of “holding investments” (IHTA 1984 s 105(3)). A ‘hybrid’ (trading and investment) business can therefore qualify for BPR in full, but only if the investment business does not predominate.
HMRC’s guidance in the IHT manual originally indicated that BPR would normally be allowed if the lettings were short-term (e.g., weekly or fortnightly) and there were substantial involvement with the holidaymakers’ activities on and off the premises. However, HMRC’s guidance was amended in late 2008, and at the time of writing states the following (IHTM25278):
"Recent advice from Solicitor’s Office has caused us to reconsider our approach and it may well be that some cases that might have previously qualified should not have done so. In particular we will be looking more closely at the level and type of services, rather than who provided them.
Until further notice any case involving a claim for Business Property Relief on a holiday let should be referred to the Technical Team (Litigation) for consideration at an early stage."
The Pawson Case
In Pawson (deceased) v Revenue & Customs  UKFTT 51 (TC), the deceased had owned a 25% share in a property. Her personal representatives appealed against a determination by HMRC that the property was subject to IHT. Their appeal was on the basis that the property was let as a holiday cottage, and was therefore eligible for BPR as relevant business property. The property lettings were typically for two week periods at most. HMRC contended that the use of the property did not constitute a business or interest in a business, and that it was not carried on for gain (s 103(3)). HMRC further argued that even if the property had been so used, it was excluded from BPR on the basis that the business consisted wholly or mainly of holding investments (within s 105(3)).
Was the Holiday Cottage a Business?
The tribunal considered previous case law on the question whether there was a business. It cited the 'six indicia of business' in its judgment, which are derived from the case of Lord Fisher ( STC 238), and were summarised in McCall v CRC  STC 990:
(a) whether the activity is a serious undertaking earnestly pursued, or a serious occupation, not necessarily confined to commercial or profit making undertakings;
(b) whether the activity is an occupation or function actively pursued with reasonable or recognisable continuity;
(c) whether the activity has a measure of substance, as measured by the quarterly or annual value of its outputs (the original words are "taxable supplies" but they derived from a VAT case);
(d) whether the activity is conducted in a regular manner and on sound and recognised business principles;
(e) whether the activity is predominantly concerned with making supplies (the original words were "taxable supplies" but that was in a VAT context) to consumers for consideration; and
(f) whether the supplies are of a kind which are commonly made by those who seek to profit from them.
In the three financial years before Mrs Pawson's death, the holiday cottage had generated a profit of £680, followed by a profit of £802 and a loss of £2,071 respectively. The profit in the year of Mrs Pawson's death was £4,449. The earlier loss had been caused by expenditure on re-decorating and improving the property.
The tribunal found that the exploitation of the cottage amounted to the operation of a business during the period in question. It was held to be "a serious undertaking earnestly pursued". The effort made to advertise for lettings was considered to be an important factor. There had been reasonable continuity in the operation, and the "annual outputs" were not de minimis but had a measure of substance. The tribunal noted that the cottage had been used by family members for three weeks a year, which reduced the level of activity and profit, but that was not considered enough to prevent the property being run as a business.
Was the Holiday Cottage an Investment Business?
The tribunal also considered whether or not any business being operated consisted wholly or mainly of making or holding investments. Three types of activities were identified as potentially needing to be analysed:
(1) Those which a landlord is required to carry out under a lease;
(2) Those carried out for gain; and
(3) Those which, although not required by the lease are connected with, and incidental to, the holding of property as an investment.
Holidaymakers at the cottage were provided with clean bedclothes (albeit that a laundry service only started after Mrs Pawson's death), a television and telephone. The property was cleaned between each letting, and the garden was maintained. The property was inspected regularly. It was fully furnished, heated by night storage heaters, and the hot water was turned on before visitors arrived. The kitchen was fully equipped. The tribunal considered that the services provided to the occupiers of the property were "clearly significant".
With regard to activity (1) above, the tribunal held that it was unrealistic to equate the right of a holidaymaker to occupy property under the same contract as the provision of services with a formal lease typically of much longer duration and under which the services were secondary to the right of occupation.
The tribunal said that the category (2) activity (the separate provision of services carried out for gain) was clearly not part of holding an investment on any view. The tribunal held that category (3) services would only fall within the holding of investments heading if connected with, and incidental to, the holding of the property as an investment. Whilst some services in this case were perhaps not specifically required to be performed under the holiday lettings contract, the tribunal considered that such services could hardly be incidental to the holding of the property as an investment.
The tribunal concluded that an "intelligent businessman" would not regard the ownership of a holiday letting as an investment, since it would involve far too active an operation to be regarded as such. The intelligent businessman would consider it to be a business asset to be exploited as part of the provision of services going well beyond an investment.
The personal representatives' appeal was therefore allowed.
The HMRC guidance on holiday lettings at IHTM25278 predates the tribunal's decision in Pawson. It must be remembered that decisions of the First-Tier Tribunal, although persuasive, do not create a binding precedent. It is not known at the time of writing whether HMRC intends to appeal, although this seems unlikely as HMRC would no doubt suggest that the case was decided on its specific facts. Nevertheless, it would appear from Pawson that the availability of BPR on holiday lettings may be more readily available than HMRC has previously been willing to concede, although it will be interesting to see whether HMRC's guidance is updated in due course, or whether a statutory test or restriction is introduced.