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FURNISHED HOLIDAY LETTING AND BUSINESS STATUS
A guide to the tax rules governing FHL.
There are special tax rules for rental income from properties that qualify as furnished holiday lettings.
The letting of furnished holiday accommodation is treated as a trade for most UK tax purposes.
Commercially available furnished holiday letting properties that meet the specified criteria
are treated as businesses (trades) for Income Tax purposes and also as business property for
certain Capital Taxes purposes, which ensures that they continue to benefit from valuable
tax reliefs not available with other types of property letting.
The property must be situated in the UK or elsewhere in the EEA. The EEA comprises the 27 states in the EU plus Iceland, Liechtenstein and Norway.
Where there are properties in the UK and the EEA, they are to be treated as two separate property businesses with parallel provisions.
Accommodation is 'furnished' if the visitor is entitled to the use of furniture. There should be sufficient furniture provided for normal occupation.
The business must be carried on commercially. 'Commercially' means let on a commercial basis and with a view to making a profit. Close season lettings may produce no profit but normally help towards the cost of maintaining the property. This letting can still be treated as commercial. On the other hand, lettings to friends or relatives at zero or nominal rents are not commercial.
The type of expenditure that can be claimed as a deduction from income is broadly similar for FHL and other types of property letting businesses. There are however, profound differences between the two options in respect of their treatment for tax purposes. These differences mainly stem from the fact that the letting of commercially available furnished holiday accommodation is treated as a business activity for most tax purposes. Because of this, there are considerable tax advantages in letting property as furnished holiday accommodation. To gain these tax advantages, the holiday letting business must first satisfy certain conditions set out in the Income Tax (Trading and Other Income) Act 2005 (Sections 323 to 326). Broadly speaking:-
With regards to meeting these occupancy thresholds there is, if needed, an opportunity to make an election for a “period of grace”. This will allow your property to be treated as qualifying if you genuinely intend to meet the occupancy threshold, so long as it has qualified in a previous year. The
election can run for two years if necessary.
Where there is more than one property contained in the FHL business, the owner can elect for “averaging” to apply if the circumstances are such that one (or more) properties qualify but one (or more) does not, but the overall “average” occupancy would mean that all properties qualify.
Once it is established that the property(ies) qualifies to be treated as commercial letting of furnished holiday accommodation, then the benefits accruing are as set out below.
EFFECT OF MEETING THE CONDITIONS
Holiday lettings that meet the relevant conditions can be treated as a trade for the following purposes:
Expenditure that is “wholly and exclusively” laid out for the purpose of the letting business is allowable as a deduction in computing the annual profit or loss.
Generally speaking then, if you have incurred an expense as a direct result of operating your FHL business, it will be allowable for Income Tax purposes in some form or another. There have however been changes with regards to tax relief for interest paid by landlords but these do not affect FHL property businesses.(see below).
Landlords: Relief for interest
Interest on loans for the purchase of property has always been allowable as a deduction from profits. However, from 2017/18 residential landlords will no longer deduct interest from profits; instead they will claim a tax credit of 20% of the interest (and other finance costs) paid (so their maximum tax relief is restricted to 20%) rather than 40 or 45% where the owner is a higher rate tax payer. This measure is being phased in from 2017/18 through to 2020/21.
HMRC have confirmed that FHL properties will however continue to be treated as if a trade and interest and finance costs will continue to be deducted from profit and thus full tax relief is retained.
Pre trading expenditure
Expenses incurred before you commenced trading (for a maximum period of 7 years) may also be allowable if they pass the wholly and exclusively test. Expenditure that enhances the capital value (e.g. extensions, conversions, etc) would not be admissible, but interest paid on loans and normal repairs would usually be allowable, as would any other expenditure that would have been allowed had the business been trading (for example, insurance of the property and contents).
Depreciation of Furnishings etc (Capital Allowances)
The FHL business owner is able to claim depreciation in the form of capital allowances on the cost of carpets, furnishings, fitted kitchens and bathrooms, integral features etc and this can result in a significant amount of tax relief that is not normally available to residential letting businesses.
Enhanced capital allowances on certain energy saving equipment and accelerated capital allowances in the form of the Annual Investment Allowance are also available for FHL businesses. As regards the Annual Investment allowance, tax relief is available on 100% of expenditure on plant and equipment (which for holiday cottage owners includes all furnishings, appliances and integral features – see below) up to a maximum of £200,000. This will be particularly helpful to owners that are just setting up, or are undertaking major refurbishments.
As stated above, 100% First Year Allowances are also available on certain types of energy saving plant and equipment… HM Government publish an approved expenditure list that can be accessed online. The annual writing down allowance on existing capital allowance pools is 18% for plant and equipment and 8% for Special Rate Pool items (integral features such as water, heating and lighting systems not previously relieved by the Annual Investment Allowance). Both the Annual Investment Allowance and Writing Down Allowances are restricted by the length of the trading period if that is less than one year.
Residential property business owners cannot claim capital allowances at all on initial expenditure on furnishings etc, irrespective of how much is spent, but can claim the cost of replacement furnishings only… so tax relief on the initial cost of furnishing the property and expenditure on integral fixtures is not available where the property is let as ordinary residential accommodation. The benefit of being able to claim capital allowances is crucial and can often turn a taxable profit into a tax loss, especially in the early years of the business.
Sharing of Profits / Losses:
Where properties are owned jointly:-
Qualifying FHL - Profits / Losses can be shared however the partners choose.
Residential Letting - Profits / Losses must be allocated in property owning ratio.
In most married couple partnerships, this will be 50 : 50.
This is another crucial difference between the two types of letting. If the business is operated by married couples, profits can be allocated to the lowest earner, thus minimising tax liabilities. In the residential let situation profits and losses must generally be allocated in property owning ratio, unless the owners actually transfer the beneficial ownership of the property and file the appropriate election… but this course of action is not necessarily beneficial for all taxes. Losses cannot be offset against other taxable income. Any losses suffered are carried forward and offset against profits arising from the FHL business in later periods and with careful management, this can ensure paying tax on future profits is deferred for several years.
The combination of being able to claim capital allowances and scope for sharing losses and profits in accordance with owners’ agreement gives the FHL business owner major tax advantages over letting property as ordinary residential accommodation and careful management of those two factors should ensure owners legitimately keep more of what they earn from their investment.
Treatment of Income as Earnings:
Qualifying FHL - Profits treated as income for the calculation of pensionable earnings.
Residential Letting - Profits treated as investment income only.
Where profits are earned from holiday letting, the recipient of those profits can pay pension premiums based on income that includes the FHL profits. The legislation covering this area is particularly complicated and evolutionary and one should always seek advice from an Independent Financial Advisor.
The FHL provisions apply to both individuals and companies, although clearly many of them apply only to individuals. However, capital gains exemption for disposals by companies with substantial shareholdings may also apply. Changes in provisions for corporation tax normally run with the financial year (starting on 1 April) rather than the tax year (starting on 6 April), and the April dates mentioned in the text should be read accordingly.
Capital Gains Tax
Qualifying FHL accommodation is treated as a business asset for Capital Gains Tax purposes, which means…
Inheritance Tax – Business Property Relief
Qualifying FHL properties that are let for gain on a commercial basis may (if the owner is also providing a certain and significant level of services to their guests) be treated as business assets for IHT purposes so long as the property has been owned for more than 2 years. As a qualifying business asset the property would then be excluded from the taxable estate on death.
Some Non-tax Considerations: