STEP

Title Research

Maximising FHL benefits

  • Author : Julie Butler
  • Date : March 2009
ABOUT THE AUTHORJulie Butler is the author of Tax Planning for Farm and Land Diversification and Equine Tax Planning

W ith 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 industry would currently be very attractive.

In the UK, ‘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 cottages 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.

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

IHT relief is normally allowed on FHLs where the following is in place.

  • 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 were for part of the year only.

As usual, whether this IHT test 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” for the purpose of s.105(3) [IHTA 1984]. …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 a 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 (Income Tax (Trading and Other Income) Act – ITTOIA 2005, pt 3, ch 6):

1
The property must be available for commercial letting as holiday accommodation for at least 140 days a year.
2
It must actually be let 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 as follows.
  • The cottage is located in a tourist area
  • The property is marketed professionally
  • Small business rates are paid
  • The cottage 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, Sch. 9 grp. 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 clearly 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.Two or three FHL properties would clearly cause turnover to rise above the VAT registration limit.

Rollover of capital gainsThe FHL qualifies as an asset that capital gains can be rolled over into. It might be that the FHL conditions are too difficult to comply with and the property is subsequently used as a residential let instead. If this is the case, then rolled over gain will not crystallise until the property is sold.

Entrepreneurs’ relief (ER)

From 6 April 2008, the taxpayer can no longer claim business asset taper relief on capital gains and the flat 18 per cent rate applies to all gains. However, ER is available which allows the effective 10 per cent rate of tax for GBP1 million of lifetime gains on business disposals.

Let commercial property does not qualify for ER, which includes farm business tenancies with the exception of furnished holiday lets which do qualify as an effective ‘trade’.

The important point is the extent of the involvement with the holidaymakers, even if this is handled by an agent
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 following year with all the advantages of opening year’s 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

Below is a 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.

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