The UK tax system has historically afforded special tax treatment for UK furnished holiday lettings and in recent years HMRC have had to extend this to FHLs situated anywhere in the European Economic Area (EEA). Some of the tax breaks disappear with effect from April 2011 and the qualification criteria will change, with effect from April 2012.
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;
Income tax
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:
Corporation Tax:
Capital allowances are available for expenditure on plant and machinery used in the letting activity.
Loss relief is available in the same way as for trading losses:
Capital Gains Tax
Inheritance Tax
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:
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.
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:
Transitional Relief:
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” 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 of 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 other tax benefits that existed prior to April 2011 remain unchanged.
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. If he or she is already registered 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.