The favourable tax treatment available to qualifying furnished holiday lets has come under HM Revenue & Customs' (HMRC) spotlight in recent years. This article looks at the tax benefits potentially still available for owners of furnished holiday lets, how the tests to qualify for some of these valuable tax reliefs have been tightened up by HMRC in recent years, and what (if any) steps owners could take to protect their position.
The introduction of new tax rules, case law and changes in HMRC practice have potentially weakened the favoured status of furnished holiday lets. A 2018 First Tier Tribunal (FTT) decision has, however, provided a welcome ray of sunshine to owners of furnished holiday lets in the form of a win for the taxpayer in an inheritance tax (IHT) business property relief case.
The popularity of holidaying in the UK has been on the rise in recent years and it is predicted that the lower value of sterling in the aftermath of Brexit will only increase the number of ‘staycationers’ and the use of online platforms such as Airbnb. This increase in demand may attract some property investors to consider dipping their toe in the furnished holiday lets market. We will review whether they remain an attractive investment proposition from a tax perspective.
Income tax and capital gains tax
Unlike other rental property, income and capital gains arising from furnished holiday lets may qualify for a number of potentially valuable income tax and capital gains tax reliefs that are normally only available to trading businesses.
In order to benefit from these reliefs, however, there are certain conditions that must be satisfied.
Firstly, the property must be in the UK or the EEC. The business of running it must be carried on commercially, with a view to a profit. It must be available for short-term commercial letting to the public as holiday accommodation, and it must actually be let for a certain number of days each tax year.
If your holiday home or seaside cottage meets all of these conditions, then losses arising from it can be offset against future profits from the letting business. The restrictions to income tax relief for interest paid on borrowings of residential landlords being introduced from 6 April 2017 will not apply to qualifying furnished holiday lets. Finally, the profits from your letting business may also increase the level of tax-efficient pension contributions you can make in the tax year.
If the property is sold in the future at a profit, then the payment of any capital gains tax liability can be postponed by reinvesting the proceeds in other qualifying business assets until these too are sold. Capital gains arising on the gift of a furnished holiday let can also be postponed until its future disposal. Finally, entrepreneur’s relief may be available to reduce the effective rate of any capital gains tax to 10%.
For completeness, it should also be noted that the UK Government launched a consultation in November 2018 into the criteria under which furnished holiday lets become chargeable to business rates (potentially qualifying for small business rates relief) rather than council tax.
While the transfer of assets with a value in excess of your available IHT nil rate band (which for 2019/20 is £325,000), either during your lifetime or on your death, could be subject to a 40% IHT charge, furnished holiday lets that qualify as business assets attract 100% business relief, which could effectively remove their entire value from your estate for IHT – a fact that has not gone unnoticed by HMRC.
It should not be assumed that furnished holiday lets which qualify for the special income tax and capital gains tax treatment will automatically qualify for business relief. The statutory tests for income tax and CGT do not apply for IHT.
The renting-out and management of the property alone will not be treated as a business for IHT relief. HMRC will scrutinise the level and type of services being offered by the owner and they have indicated that additional services being offered to guests would have to be comparable, for example, to those received in hotels or some high-end bed and breakfasts in order for a business relief claim to be successful. This has proved to be a very high bar for owners to cross.
HMRC had won a number of tax cases on the basis that the nature of the services being provided by the taxpayer were insufficient for their furnished holiday lets to qualify as business property for IHT. The investment services (i.e. letting-out and property management) were found to be more significant than the non-investment services being offered by the owners. It is necessary to look at the whole business in the round, taking account of additional services provided to determine whether it would potentially qualify for business relief.
The FTT in the 2018 case of Executors of Graham v HMRC, however, found in favour of the taxpayer. The nature and extent of the additional services being provided were such that the furnished holiday let business was 'mainly' non-investment. The case involved self-catering cottages on the Scilly Isles. The services provided included: swimming pool with sauna, BBQ area, croquet lawn, bicycles for hire, welcome pack and basic supplies provided to holidaymakers and taxi-service provided by owner. It took around 200 hours per week in the high season to run the business and the FTT made reference to the level of personal care provided by the owner when reaching their decision. It should come as no surprise that HMRC have appealed this decision.
Furnished holiday let owners should be reviewing their business to see if there are any simple, practical and financially viable steps that can be taken to increase its commercial standing and to maximise the nature and extent of additional services being provided to holidaymakers.
Additional services that may strengthen a future business relief claim could include: welcome packs and catering, providing telephone and television, housekeeping services, booking and arranging excusions and other activities such as cycling and horseriding.
Land and buildings transaction tax (LBTT)/Stamp duty land tax (SDLT)
Buying a holiday home can involve extra tax charges.
It will be important to take into account the LBTT (Scottish property) or SDLT (property in England and Northern Ireland) implications on purchase. A supplementary LBTT/SDLT additional dwelling supplement (ADS) will now apply on the acquisition of additional residential properties on purchase with a value over £40,000 taking place on or after 1 April 2016. Homeowners looking at buying a furnished holiday let will now potentially be caught by this supplementary charge.
This ADS charge is levied in addition to the normal rates of LBTT/SDLT applied to the purchase price of the property. The LBTT ADS charge was increased from 3% to 4% from 25 January 2019. The SDLT ADS charge remains at 3%. There would, for example, be an additional £8,000 LBTT charge on the purchase of a Scottish buy-to-let property for £200,000 where you already own your family home.
The UK Government has published a consultation on the introdcution of a new SDLT surcharge of 1% on non-UK residents purchasing residential property in England and Northern Ireland.
Many holiday homeowners unfortunately remain blissfully unaware that they may no longer qualify for some of the potentially valuable tax reliefs that they have previously taken for granted. In certain cases, adopting a pro-active approach could preserve the favourable tax status available for furnished holiday lets while at the same time offering a more attractive commercial proposition.
It is always important to consider the tax implications on the acquisition, ownership and disposal of any interest in property. Simple and effective advice given at the earliest opportunity can help ensure you minimise your tax exposure and protect your interests while maximising the benefits of property ownership.