Furnished holidayletting — is it a business?
ASK the owner of a holiday cottage whether they were running a business or holding an investment and the answer will come back, “of course it is a business”.
Recently, HMRC has denied inheritance rax (IHT) relief on holiday cottages. What actions can cottage owners take to improve their IHT position?
Property rental has always been treated as an investment activity for tax purposes, whereas the operator of a hotel or guesthouse is clearly running a trading business.
A furnished holiday letting (FHL) business lies somewhere between these two extremes. There are different types of FHL businesses, some offering a range of additional services, while others leave their guests to their own devices.
In 1984 legislation was introduced treating holiday letting as a business for income tax and capital gains tax (CGT) purposes, but no mention was made of IHT. However, for many years HMRC routinely allowed 100 per cent. business property relief (BPR) on holiday cottages. It has recently changed its interpretation, arguing the business is wholly or mainly one of holding investments. We have now had three tax tribunal cases on this and unfortunately HMRC has won all of them.
The Ross case: Mrs. Ross acquired a holiday business in Cornwall known as Green Door Cottages Partnership, which consisted of eight cottages. There was an agreement with the adjacent hotel whereby cottage guests received their cottage keys from hotel reception and could purchase meals at the hotel at a discounted price.
The judge made several comments which make it unlikely that any holiday cottage will qualify in the future:
l That the level and standard of services was irrelevant as what the guests really wanted was “access to a property to call their own in a beautiful part of Cornwall”.
l That a holiday cottage should generally be treated as an investment activity and that additional services were unlikely to be material.
IHT planning points
1) Give away the property — if done more than seven years before death, no IHT will be payable. This can usually be done without paying CGT. This can have an adverse CGT position if the property is sold in the future, though.
2) Restructure the business — a farming business can qualify for 100 per cent. BPR on all its assets, including those used for investment purposes, provided it can be shown that the overall business is predominantly of a trading nature.
The VAT position needs to be considered — see below — as an improved IHT position may come at the cost of having to pay VAT over on the income.
A brief mention of other taxes
Income tax — FHL income is treated as earned income, subject to meeting several occupancy conditions. It is, however, still entered on the property pages of the tax return. An FHL loss can only be offset against future profits from holiday letting.
Capital gains tax — FHL properties can qualify for several CGT reliefs; rollover relief on sale and purchase of other business assets, entrepreneurs’ relief on sale, and holdover relief on a gift.
VAT— FHL income is standard rated and VAT will need to be paid to HMRC if it is part of a VAT-registered business.
The amount of VAT on related expenses is usually limited, which can put the business at a commercial disadvantage if competitors are not charging VAT. It is possible to undertake these diversifications in a separate business so that VAT does not need to be paid over.
However, HMRC will look closely to check that the two businesses are genuinely separate. Thus all record keeping and marketing activities need to be kept totally separate.