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This article was first published in the November/December 2011 edition of Accounting and Business magazine.
The furnished holiday lettings (FHL) legislation has been with us for many years but has undergone some changes recently.
FHLs, although income from property, qualify for certain favourable tax treatments, similar to those afforded to trades, provided that certain conditions are met. The tax breaks cover income tax, corporation tax, capital allowances, chargeable gains and inheritance tax. Individuals, partnerships and companies are all covered by the regime.
The rules had ticked along unchanged for many years and had applied to qualifying properties in the UK, until HMRC issued a Technical Note on 22 April 2009, proclaiming:
'Landlords with income from furnished holiday accommodation elsewhere in the European Economic Area (EEA) cannot currently qualify for this treatment. They were treated instead in the same way as landlords of other types of overseas property, under the property income rules.
'This difference may not be compliant with European law. The Government has decided it should repeal the FHL rules from 2010-11. Until the FHL rules are repealed, HMRC will regard the FHL rules as applying to furnished holiday accommodation elsewhere in the EEA.'
The government realised that, firstly, the existing rules were not compatible with EU law and, secondly, to extend the relief to include all such lettings within the EU would prove to be very expensive. So, the government announced its intention to abolish the favourable tax treatment of FHLs with effect from 6 April 2010.
Common sense prevailed and it was decided that the relief would be retained for a further year, to include FHLs located anywhere in the European Economic Area, but would undergo a consultation process to amend the rules with effect from 6 April 2011.
Before we consider what the new rules are, let us first consider the rules that existed prior to the changes.
- Rules prior to 6 April 2011
- Qualification as an FHL
To qualify as an FHL, the property must meet certain criteria. Prior to 6 April 2011, these were as follows:
- It must be available for commercial letting to the public as holiday accommodation for at least 140 days in the tax year; and
- It must be so let for 70 days; and
- For a period of at least 7 months (not necessarily continuous but including any months in which holiday lettings take place) it must not normally be in the same occupation for a continuous period exceeding 31 days.
- The income is regarded as earned income and may therefore be treated as relevant earnings for the purposes of making pension contributions. It should be noted, however, that no Class 4 national insurance contributions are due on FHL profits.
- Capital allowances are available for expenditure on plant and machinery used in the letting activity. In general, capital allowances may not be claimed for plant and machinery used in a dwelling house. However, an FHL business is a qualifying activity for the purposes of capital allowances on plant and machinery.
Loss relief is available in the same way as for trading losses:
- Relief against general income from all sources of the year of assessment or the preceding year under Income Tax Act (ITA) 2007, s64; and the ability to claim the temporary loss relief afforded by Finance Act 2009, Schedule 6 for losses of up to £50,000 per tax year for 2008/09 and 2009/10 against general income of the three preceding tax years.
- The ability to extend loss relief claimed against general income as above, against capital gains under TCGA, s261B;
- ability to extend loss relief claimed against general income as above, against capital gains under TCGA, s261B;
- Relief for losses incurred in the first four tax years of trade against total income in the preceding three tax years, prior to the year of loss on a FIFO basis under ITA 2007, s72;
- Relief for unrelieved terminal losses arising in the final 12 months of trade, against profits of the same trade assessable in the three preceding tax years on a LIFO basis under ITA 2007, s89;
- Relief for pre-trading revenue expenditure under Income and Corporation Taxes Act (ICTA) 1988, s401. Such expenditure is treated as having been incurred on the first day of trading.
- Carry forward of losses against future profits of same trade under ITA 2007, s83.
- Loss relief is available in the same way as for trading
- Relief against total profits of the accounting period, under the Corporation Tax Act (CTA) 2010, s37(1)(2)(3)(a); (formerly ICTA 1988, s393A(1)(a)), or the preceding year under CTA 2010, ss37(3)(b)(4)(6)(8), formerly ICTA 1988, s393(1)(b)); and the ability to claim the temporary loss relief afforded by Finance Act 2009, Schedule 6 for losses of up to £50,000 per year, for accounting periods ending between 24 November 2008 and 23 November 2011, against total profits (including chargeable gains) of the three preceding tax years
- Relief for unrelieved terminal losses arising in the final 12 months of trade, against profits of the same trade assessable in the three preceding tax years on a LIFO basis under CTA 2010, ss39, 40(2);
- Relief for pre-trading revenue expenditure under ICTA 1988, s401. Such expenditure is treated as having been incurred on the first day of trading, under CTA 2009, s61.
Capital Gains Tax
- Relief for losses on a loan to the person carrying out the furnished holiday letting and so used in the FHL business, under TCGA 1992, s253;
- Roll-over relief on replacement business assets, under TCGA ss152-158;
- Relief for gifts of business assets, under TCGA 1992, s165;
- Entrepreneurs relief on the disposal of whole or part of the business, and associated disposal or shares out of a holding of more than 5%, under TCGA 1992, ss169H-169S.
In certain circumstances, an FHL may be eligible for business property relief for inheritance tax purposes.
Some useful comments are made in the HMRC Manuals at SVM 27600, as follows:
'In some instances the distinction between a business of furnished holiday lettings and, say, a business running a hotel or motel may be so minimal that the courts would not regard such a business as one of 'wholly or mainly holding investments' for the purposes of section 105(3), Inheritance Tax Act 1984'.
The manual goes on to say:
You may therefore normally allow (IHT BPR) relief where:
- The lettings are short term (for example weekly or 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 lettings were for part of the year only.'
The government consulted on proposals for revised FHL rules between July 2010 and October 2010. The amendments to the rules are included in Finance (No. 3) Bill 2010-11 and take effect in stages, as follows:
From April 2011
The first major change to take place with effect from 6 April 2011, and for accounting periods ending on or after 1 April 2011 for corporation tax purposes, is that FHLs in both the UK and EEA will be eligible as qualifying FHLs. This reflects the current situation but is now committed to the statute book.
The second major change is the treatment of FHL losses for income tax and corporation tax purposes. The types of loss relief available before April 2011 are outlined above. However, with effect from 2011-12 for income tax and for accounting periods ending on or after 1 April 2011 for corporation tax, income tax relief for losses against general income (and capital gains, if elected) and for terminal losses; and corporation tax relief for losses against total profits will be removed. This means that, going forward, losses made in a qualifying UK or EEA furnished holiday lettings business can only be offset against income from the same UK or EEA furnished holiday lettings business.
These measures are contained in Clause 52 and Schedule 14 of Finance (No. 3) Bill.
From April 2012
Some further changes will take effect from 6 April 2012, and for accounting periods ending on or after 1 April 2012 for corporation tax purposes. These relate to the criteria for a property to be eligible as a qualifying FHL. The new criteria from April 2012 are as follows:
- The minimum period the property must be available for letting will be increased from 140 days to 210 days in the relevant period. (Finance Bill schedule 14 Part 1 (3)), and
- The minimum period over which a property is actually let will be increased from 70 days to 105 days in the relevant period.
- For a period of at least 7 months (not necessarily continuous but including any months in which holiday lettings take place) it must not normally be in the same occupation for a continuous period exceeding 31 days. This provision remains unchanged.
There is an element of transitional relief available on the shift to the new rules from April 2012.
Where a business fails to meet the stricter 'actually let' requirement for a period of one or two years, it will be possible to elect for FHL treatment to continue for 2011/12 and subsequent tax years.
When the draft legislation was first published, there was some confusion as to when the period of grace would first apply. Schedule 14 to the Finance Bill now confirms that for the period of grace to apply, the accommodation must fully qualify as an FHL accommodation for 2010/11 or a subsequent tax year.
If the accommodation is let by the person during the next tax year or during the next two tax years, and in either or both of those tax years the accommodation would have been an FHL but for failing to meet the 'actually let requirement, then an election can be made for the accommodation to be treated as an FHL for the tax year in which the letting condition was not met.
There must have been a genuine intention to meet the letting condition in the tax year to which the election applies.
An election for a tax year must be made on or before the anniversary of the normal self-assessment filing date of the tax year, so for 2011/12, the election would need to be made by 31 January 2014.
Similar provisions apply for corporation tax purposes.
Remaining benefits of FHL treatment
Although the restriction in loss relief removes what was arguably the most favourable tax benefit from the FHL rules, the existing tax benefits that existed prior to April 2011 remain unchanged.
A final word on FHLs and VAT: value added tax will not often be relevant to an FHL, as the income derived therefrom would normally be below the VAT registration threshold. However, if the owner is already personally registered for VAT, then VAT must be charged on rents received from the properties, since the letting of an FHL is regarded as a standard-rated business activity for VAT purposes.
Simon Wood, technical adviser, ACCA UK