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Julie Butler FCA, of Butler & Co, has a timely look at the property lettings market, and highlights potential tax advantages of property lettings.

Introduction 

With the property market facing falling prices and slow sales, it is timely to look at the letting market and the tax advantages of Furnished Holiday Lets (FHLs). With the collapse of the odd airline, the UK-based tourist industry could currently be very attractive.

In the UK, an FHL “business” can have distinct tax advantages - e.g. Business Property Relief (BPR) for Inheritance Tax (IHT). Other advantages are Entrepreneurs’ Relief (ER) and Rollover Relief for Capital Gains Tax (CGT), and the offset of “business” losses sideways against total income.

Inheritance Tax

It is important that clients who own holiday properties should try and ensure, as far as possible, that they qualify for IHT relief. Case law suggests that in order to qualify for BPR, it might be necessary to own a number of properties. It will also be necessary to be involved in running the properties.

IHT relief is normally allowed on FHLs where the following has applied:

• The lettings were short term (for example, weekly, fortnightly); and
• The owner, either himself or through an agent such as a relative or housekeeper, was substantially involved with the holidaymaker(s) in terms of their activities on and from the premises, even if the letting period(s) were for part of the year only.

As usual, whether these IHT tests will be satisfied will depend on the facts.

The HM Revenue and Customs (HMRC) solicitor has advised the Capital Taxes Office (CTO) that many more such businesses would not be excluded by the Inheritance Tax Act 1984 - IHTA 1984 s 105(3) than the CTO had previously thought. The criterion is where the owner (either himself or through agents), ‘was substantially involved with the holidaymaker(s) in terms of their activities on and from the premises’. The key issue in order for landlords to secure maximum tax relief is to be involved in the actual services provided.

Risk areas which might jeopardise the IHT claim are:

• Where no services are provided to holidaymakers;
• Where lettings are to friends and relatives; and
• Longer-term lettings (including assured short holds).

BPR has been achieved on one property but there is greater emphasis on the need to be involved in the running of the property; to really be involved in the “business of furnished holiday lets”.

The guidance is found in Share Valuation Manual SVM 27600. The manual states:

‘In some instances the distinction between a business of furnished holiday lettings and, say, a business running a hotel or a motel may be so minimal that the Courts would not regard such a business as one of “wholly or mainly holding investments”  [if it were, it would be ineligible for the relief], for the purpose of IHTA 1984 s 105(3).

If you encounter any difficulties in this area you should refer to the Appeals Team.’

What Qualifies as a Holiday Let?

The property must meet certain requirements to qualify as an FHL and be eligible for the tax reliefs thereon.

The property does not have to be in a tourist area, but the pattern of lettings must satisfy these three conditions (ITTOIA 2005, pt 3, ch 6):  

1. The property must be available to the public for commercial letting as holiday accommodation for at least 140 days a year.
2. It must actually be let to the public as holiday accommodation for at least 70 days a year.
3. It must not normally be let for a continuous period of more than 31 days to the same tenant in seven months of the year, and those seven months include any months in which it is actually let as holiday accommodation.

Whereas non-‘holiday let’ periods can qualify for the Income Tax, National Insurance (NI) and CGT advantages, in order not to fall foul of IHTA 1984 s 105(3), greater evidence of the provision of practical services to genuine holidaymakers will help.

Other relevant factors might be:

• The cottage is located in a tourist area;
• The property is marketed professionally;
• Small business rates are paid;
• The property is awarded a rating by the English Tourist Board or equivalent;
• Public liability insurances are paid on the property;
• The operation of the business is commercial, and profits are made and tax paid accordingly.

The tax-planning confusion rests with the extent of the involvement with the tourist. The tax relief is helped if there are lots of services provided, e.g. ‘the meet and greet’, organising car hire, cleaning and laundry, supply of basic food for the fridge, etc. The owner can subcontract out these services. The important point is the extent of the involvement with the holidaymakers, even if this is handled by an agent. The key is to ensure there is a contemporaneous record of the services provided. Further examples are visits to the cottage with local maps and guides to historic attractions, and organising the maintenance of the property before, during and after the period let, including gardening.

The VAT Trap

The standard rate of VAT applies to rents for holiday lets as long as they are advertised as such (Value Added Tax Act 1994 - VATA 1994 Sch 9 Group 1 Note 13). If they are offered at lower rates in the off-season, they can be treated as residential accommodation if they are let for that purpose for more than four weeks and the property is situated in a resort where trade is clearly seasonal. Thus a VAT-registered sole trader owning a holiday cottage will have to charge output VAT on their VAT return, but will be able to claim input VAT on repairs and related costs. If high expenditure on the holiday let is planned, then the organisation of the ownership of the property to come within the scope of VAT can be considered as a tax planning exercise.

Clearly, two or three FHL properties could easily cause turnover to rise above the VAT registration limit.

Rollover of Capital Gains

The FHL qualifies as an asset into which capital gains can be 'rolled over'. It might later turn out that the FHL conditions become too difficult to comply with and the property is subsequently used as a residential let instead. If this were the case, then any gain rolled over whilst the property did qualify as an FHL, would not crystallise until the property were sold.

Entrepreneurs’ Relief (ER)

From 6 April 2008 the taxpayer can no longer claim Business Asset Taper Relief (BATR) on capital gains and the 18% flat rate applies to all gains. However, ER is available which allows an effective 10% rate of tax for £1 million of lifetime gains on qualifying business disposals.

Let commercial property - which includes Farm Business Tenancies (FBTs) - does not qualify for ER but with the exception of Furnished Holiday Lets which do qualify as an effective ‘trade’.

Maximising the Income Tax Loss Relief

Another advantage of FHLs is the ability to claim losses against total income in the year of the loss and the preceding year, with all the advantages of opening years' losses.

The 'sideways’ loss relief advantage of the FHL makes interesting Income Tax planning in years of high earnings for the taxpayer and possible high FHL overhead or management expenses.

Summary of the Advantages

Checklist for maximising the FHL benefits:

• Trading status with the provision of services by the landlord;
• Ability to claim ‘sideways’ loss relief;
• Potential protection from IHT where substantial involvement with holidaymakers;
• Rollover of capital gains into the purchase, possible change of use and CGT crystallisation only on the disposal;
• VAT ‘sting’ for registered individuals, but possibly use to advantage when high expenditure;
• Entrepreneurs’ Relief.

The above article was originally produced for the Internet Cottager Newsletter, and is reproduced with the kind permission of the author.