Finance Act 2011 changes the furnished holiday letting rules that have been in place for 27 years. The rules now apply to properties throughout the UK and the EEA but are dealt with as two separate property businesses for income and corporation tax purposes. Sideways loss relief against general income and terminal loss relief for income tax and loss relief against total profits for corporation tax are removed. The length of periods for which the accommodation must be available for letting and for which it must be actually let are both extended. Planning possibilities under the new rules involve deliberately failing the conditions or establishing the business as a trade.
Finance Act 2011 s 52 and Sch 14 change the furnished holiday letting rules that apply for income tax and corporation tax purposes. It restricts loss relief, tightens the qualifying criteria and confirms the extension of the rules to properties in the European Economic Area (EEA). These three specific changes are interconnected and so should be viewed as a ‘package’, specifically:
The previous Labour government announced in the Budget on 22 April 2009 that it would be necessary to extend the furnished holiday letting regime to properties in the EEA.
As a result of a concern of a loss of tax to the Exchequer it was announced that the furnished holiday letting regime would be abolished with effect from 6 April 2010.
It is more important than ever to
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As a result of much lobbying the abolition did not proceed and a compromise approach was put forward by the new coalition government which after considerable consultation has been enacted in this Finance Act.
While HM Treasury does not have very reliable figures as to the cost of the furnished holiday letting regime, it is clear that the main concern was the extension of the regime to the EEA and the likelihood of further loss claims against other income. Hence the decision to restrict loss relief.
It was also felt that the regime should only be available to commercially let properties and that the definition of what constitutes commercial letting has changed since the regime was first introduced in 1984.
David Gauke emphasised this point in the Finance Bill Committee debate when he said that in order to make the extension of the relief to the EEA affordable, ‘changes to the legislation are being made to target the tax allowances at businesses run on a truly commercial basis’.
As a result it will be necessary from next April onwards to have a property available for letting for 210 days a year and actually let for 105 days a year.
The danger in increasing the day count limits is that more remote locations within the UK are disadvantaged.
So new period of grace rules are being introduced to overcome these concerns as acknowledged by David Gauke when he said that ‘it may be more difficult for certain outlying areas to meet the tests every year, but the new period of grace should go a long way to help those businesses meet the tests.’
There will be many existing furnished holiday let properties where the changes to the regime will have no impact. It is also important to appreciate that the deemed trading nature of furnished holiday let properties for capital gains tax purposes continues unaffected as long as the qualifying conditions are met.
Therefore entrepreneurs’ relief, rollover relief and business asset holdover relief will continue to be available.
Qualifying properties also continue to receive the benefit of capital allowances and the income from such properties continues to constitute net relevant earnings. However, for many owners of properties the changes do have significant implications and it is important that their advisers understand the new rules and the planning opportunities available.
The restriction to current year loss relief means that it is more important than ever to consider the nature of the activity being carried on as for a UK property there are three possible alternatives namely:
Furnished holiday lets within the EEA are dealt with as a separate ring-fenced activity and so represent a possible fourth category depending on the nature of the activities being carried on – especially when advising individuals.
For income tax loss relief purposes ITA 2007 s 127 is amended to restrict certain forms of loss relief.
Previously the section deemed a qualifying furnished holiday let to be a trade for income tax loss relief purposes apart from one minor exception.
For a client with a substantial property business planning to incur significant expenditure on a furnished holiday let
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Therefore for all practical purposes a trading loss arising on a furnished holiday let was just the same as a trading loss.
That is no longer the case as ITA 2007 Part 4 Ch 2 (trade losses) now applies as if ss 64–82 and 89–95 are omitted.
Given that chapter 2 starts with s 60 and ends with s 101 this does not leave much. Sections 96–101 deal with post cessation relief and sections 60–63 are introductory.
That leaves ss 83–88 which deal with the carrying forward of losses. All you can now do with a loss on a furnished holiday letting business is carry it forward against future profits of the same business.
There is an easy trap to fall into here in that despite the fact that a furnished holiday letting activity is a property business, a loss cannot be offset against a normal property business profit.
Therefore for a client with a substantial property business planning to incur significant expenditure on a furnished holiday let property it may be better to have that property not qualifying as a furnished holiday let so that the loss arising can be used against the existing property business profit. This is likely to be particularly important to consider when a property is first acquired as it may be better to long-term let the property whilst refurbishment expenditure is incurred.
While the above analysis concentrates on income tax, similar restrictions and considerations apply for corporation tax.
It is also important to consider whether the activities amount to a trade. In the Committee debate David Gauke was asked to comment on this and in particular whether or not it made a difference if the proprietor was in occupation on the basis of existing case law. Further guidance on this distinction was also requested from HMRC. In response all David Gauke said was that ‘if the proprietor provides significant services – for example, meals – the business may be a trade, in which case it would enjoy all the trade tax benefits. The status of the business will depend on the individual facts of the case.’
There is little sign that HMRC intend to provide further guidance on this point, but the change in the rules is an opportune time for advisers to reconsider whether the activities do in fact amount to a trade. Such a distinction would be relevant for various tax purposes but in particular would create the opportunity for current year loss relief.
The ‘period of grace’ provision
The main result of the lobbying and consultation on the changes of the rules has been the introduction of a ‘period of grace’ provision.
This takes the form of an election in ITTOIA 2005 s?326A and CTA 2009 s 268A.
The section title in each case is ‘under-used holiday accommodation: letting condition not met’.
This provides for an election for the furnished holiday letting rules to continue to apply even though the actual letting day count condition is not met. In practice this is likely to be referred to as a period of grace election.
In the Committee debate David Gauke said that ‘the period of grace is designed to help businesses that fail to meet the occupancy threshold for up to two years.
Therefore, the business needs to meet the thresholds for only one year, not three. The introduction of the increased thresholds has been delayed by a year to allow businesses to adapt their letting strategies.
Those should be particularly helpful to regions where the new rules may be more challenging’.
This election can only apply where there is a genuine intention to let the property and the property must certainly be made available for the 210-day period.
The hope is that this provision will deal with situations such as the foot and mouth outbreak, economic downturns and the timing of Easter such that it is possible to have two Easter breaks in one tax year and none the following year.
HMRC are issuing further guidance on their interpretation of this new provision.
For advisers it is now necessary to consider how these changes effect each client on a case-by-case basis.
John Endacott, Tax Partner, Francis Clark
