Panellists

• Stephen Relf, Technical Manager, Tax, ICAEW
• Lindsey Wicks, Senior Technical Manager, Tax Policy, ICAEW
• Katherine Ford, Technical Manager, Tax, ICAEW

Producer

Ed Adams

Transcript

Stephen Relf: Hello and welcome to The Tax Track, the podcast series from ICAEW where we explore the latest developments in the world of tax. In this episode, we’ll be talking about the abolition of the furnished holiday lettings regime for tax, including the transitional rules.

Lindsey Wicks: There’s lots of things around capital gains tax. We have got an anti-forestalling rule that applies from Budget Day on 6th March 2024.

SR: And the potential complexities arising from the abolition.

Katherine Ford: People just want certainty and finality of their tax position. If people need to pay tax. They can pay it, but people just need to know,

Stephen Relf: I’m Stephen Relf, Technical Manager, Tax at ICAEW. I’m joined, as always, by Lindsey Wicks, Senior Technical Manager for Tax Policy, and by Katherine Ford, Technical Manager, Tax. Welcome to you both.

Regular listeners will have noticed that Lindsey and I have swapped chairs as I take on the hosting duties for this episode. So let’s make a start. The former Conservative government announced the abolition of the furnished holiday lettings regime from April 2025 at the Spring Budget in March. It was confirmed by the new government in July, and draft legislation published. Katherine, could you start us off please by explaining the special rules that apply to FHLs for tax, including how we determine what is an FHL?

Katherine Ford: Of course. So the rules were introduced in the 1980s following some uncertainty after some tax cases about where the line was between investment and trading when it came to property income. The current conditions are that it has to be let for at least 105 days on short-term lets, and then has to be available for at least 210 days per tax year to qualify.

SR: That’s great. And what are the current tax benefits of a property qualifying as an FHL for tax purposes?

KF: The benefits arise from the fact that furnished holiday lets are treated as a trade. So, for example, you can currently deduct interest in full – you’re not just subject to the basic rate tax reducer. You can also claim capital allowances. You can claim a lot of the CGT release that depend on it being a trade, such as Business Asset Disposal Relief and Gift Hold-over Relief. And you can also use the profits from your furnished holiday letting as earnings when you’re making pension contributions.

SR: OK, so some quite significant tax benefits there, particularly for individuals.

KF: Absolutely. And there was previously a fifth one, and that was loss relief against other income, but that was withdrawn in 2011 when they had to extend it to European furnished holiday lets.

SR: OK, so a while back – but there has been maybe a tradition of rolling back on the benefits of this?

KF: Correct.

SR: OK, so what’s changing then, from April?

KF: What’s changing is that the furnished holiday letting business will no longer be treated as a trade, so it will merge back in with existing UK property business or foreign property business. One of the big changes is that the interest deduction that’s currently available will be replaced with the basic-rate tax reducer, and capital allowances will also be withdrawn for new expenditure.

SR: OK, so I imagine, in particular, the interest one is going to be quite a change for landlords.

KF: Yes. We’ve put a simple example attached to the show notes. And the example is where the interest deduction currently keeps the taxpayer, the individual, below higher rate, so pushes them back into basic rate, and with the interest deduction, it will potentially almost double the tax bill on their property income.

SR: OK, so I think we probably all expect that moving from deduction to relief at the basic rate would affect higher- and additional-rate taxpayers, but it does also have the potential of affecting people who are already basic-rate taxpayers.

KF: Exactly. According to HMRC’s tax return data for the 2022/23 tax year, there are approximately 130,000 individuals who declare furnished holiday letting income.

SR: And I imagine a big chunk of those will have an increased tax bill as a result?

KF: I should think so, particularly if they have interest borrowings.

SR: Lindsey, could you explain why this policy has been introduced?

Lindsey Wicks: Yes. I’ll quote from the Budget speech back on 6th March 2024, where the former chancellor Jeremy Hunt said: “I’m concerned that this tax regime is creating a distortion, meaning that there are not enough properties available for long-term rental by local people. So to make the tax system work better for local communities, I’m going to abolish the furnished holiday lettings regime.”

SR: OK, so quite a kind of commercial rationale for that. But I suppose, putting it into perspective, there was also a need to balance the books – and I think it’s worth bearing in mind, especially when it comes to thinking about the impact on taxpayers, that this measure is expected to increase tax revenues by some £600m over the period from April 2025 to March 2029. Lindsey, we mentioned earlier that draft legislation had been published. ICAEW has responded to that. Could you talk us through ICAEW’s comments?

LW: Yes. We had three key themes that we talked about. First of all, we are concerned that the uncertainty of tax treatment returns. Katherine’s already referred to the fact that part of the reason why the FHL rules were introduced back in the 1980s was because there was some uncertainty about the borderline between whether some things are a trade or actually a property business. Because if you’re doing something on a quite organised basis – maybe on a larger scale, and you’re offering other services – then potentially it could be treated as a trade. And because of this uncertainty, it’s contrary to the Tax Faculty’s ‘Ten Tenets for a Better Tax System’, we would say. Tenet Two is that things should be certain, and Tenet Three is that things should be simple. And arguably, because we lose this test, we do have this uncertainty returning. There’s also some uncertainty about the operation of the transitional and commencement rules. As we said, there’s 130,000 individuals affected, and we do think there’s a real need for guidance for those who are affected by the rules and what it actually means for them.

SR: You mentioned the Ten Tenets and simplicity. I think on the outside, people may expect that this actually makes tax more simple and that it removes one area of tax and puts everyone on the same footing. But I imagine – at least for the first couple of years of this bedding in – it is going to be quite challenging?

LW: It’s not just about the uncertainty about how the rules apply. It’s do you fall on one side or the other of the trading and property business line?

SR: So let’s have a closer look at the transition from FHL status to a normal property business. Should we start with capital allowances, Lindsey?

LW: Yes. So on Budget Day, we weren’t certain about what would happen with capital allowances. There was no detail around that, so there was some concern about whether the abolition of the rules would create a business cessation, and that would trigger things like balancing allowances and balancing charges if you’d got capital allowance pause there. But when we got the draft legislation at the end of July, it was confirmed that you can continue to claim writing down allowances on existing capital allowance pools. Things to bear in mind as well are that if you do have a capital allowance pool, and especially as that pool gets reduced over time, then there is the small pools allowance. If the amount in the pool is £1,000 or less, you can write off the balance of that expenditure at that point. So in terms of, you know, making things simple going forwards, that’s something to bear in mind.

The other thing that we pulled out in our representation is that it would be helpful to have some confirmation about whether the Section 198 Elections that are available to fix the disposal value of fixtures on the disposal of a property will be possible after April 2025. Normally, if you sell a property with fixtures, then it is possible to set out between the buyer and seller what value you want to assign to those fixtures. But will that be possible going forwards after April and, again, we would like some certainty about that.

SR: Right, thanks, Lindsey. So just to sum up, then we have the capital allowances pool at April 2025. You can then continue to claim writing down allowances on that balance, or if it’s less than £1,000 you have the small pools allowance. But going forward, you can’t then claim capital allowances on new additions. There is a tax relief for replacing domestic items, but I understand that is more restrictive than capital allowances, so some things won’t qualify. Can you also talk us through the transitional rules for losses?

LW: So currently, losses from furnished holiday letting businesses can only be carried forward against profits of that same furnished holiday lettings business, and there was some uncertainty at Budget Day about what would happen to those losses. But it was clarified back in July that it will be possible to carry forward those furnished holiday letting losses, either against a UK or an overseas property business, as appropriate.

SR: I think it’s going to get a little bit more challenging now, but shall we talk about disposals and the transitional rules that apply there?

LW: Yes, there’s lots of things around capital gains tax. So first of all, and this was announced at the Budget, we have got an anti-forestalling rule that applies from Budget Day on 6th March 2024. It will apply to contracts entered into between 6th March 2024 and April 2025 where the conveyance or the transfer happens after April 2025 and the purpose of that transaction is to obtain a tax advantage through the use of unconditional contracts to obtain capital gains tax relief under the current rules. So there’s going to be two exceptions from that anti-forestalling rule. The first is that there was a commercial reason for that transaction, or the transaction is between unconnected parties; and in both cases, no purpose of that transaction was to avoid the capital gains tax changes that have been announced.

One thing that is slightly concerning, that we pushed back on in our representation on the draft legislation, was that it does apply from 6th March, but we didn’t actually get the draft legislation until 27th July. So arguably, should it have applied from 27th July, when we actually saw the legislation and what the capital gains tax changes actually mean?

SR: I suppose, as well, especially given the upheaval that we had in that period with the general election, it was by no means certain this would actually happen?

LW: Exactly. And then the next one is Business Asset Disposal Relief. So as Katherine’s referred to, we currently get Business Asset Disposal Relief on disposals of furnished holiday lets. And normally, if there’s a cessation of a furnished holiday let business, or any business, then you can still get Business Asset Disposal Relief if you make a disposal of that within three years of the cessation. And it’s been confirmed that where the business ceased prior to 6th April 2025, that that three-year rule will carry on. So if you dispose of the business within three years of the cessation, you can still get business asset disposal relief, even if that disposal is after 6th April 2025.

But there’s a couple of questions. What happens if you’ve changed having a long-term tenant in this current tax year, 2024/25? Will you get Business Asset Disposal Relief in that case? And actually, is the removal of the furnished holiday lettings regime itself a deemed cessation on 5th April, 2025 – so could you potentially, if you sold within three years of April 2025, could you still get business asset disposal relief on that form of furnished holiday letting? Absent any clarity on that, I can see that will be something where there’ll be a lot of enquiries and arguments and – potentially – cases going before the courts to argue that point. So it’d be really good to know what the government’s intention is in that respect.

SR: It is quite an important point, isn’t it, because where you have this Business Asset Disposal Relief, you have that tax rate of 10%; and if you’re a higher-rate taxpayer, it’s going to be 24% CGT on residential property. So the amounts involved could be fairly significant.

LW: Another one of the reliefs that is potentially available if you’ve currently got a furnished holiday let business is rollover relief. And actually, I can remember people selling their businesses and potentially investing into furnished holiday lets to roll over the gain on a former trading business in the past. So again, if you sell your furnished holiday let business currently, you can roll that over into another qualifying asset. And the policy paper that came out in July said that that rule won’t be disturbed if the conditions were satisfied before 6th April. So if you sell your furnished holiday let business before 6th April, then you could roll it over into a qualifying asset if you buy another qualifying asset after 6th April. But after 6th April 2025 it will no longer be a qualifying asset on disposal. But there is a strange commencement role in the draft legislation, and we’ve questioned what the purpose of that rule is. So I think there’s still a little bit of uncertainty about how it is intended that the rollover relief rules will apply.

SR: So I think we’ve been through the main areas of the transitional rules, and we’ve already identified a few areas where there are unanswered questions. Are there any other areas where further clarification or perhaps guidance is needed?

LW: There are a few. The first one is the 50/50 rule for spouses and civil partners, where property is owned in unequal shares. Now the Office of Tax Simplification’s (OTS) property income review back in 2022 highlighted a lack of awareness of these rules. Currently, if you’ve got a furnished holiday letting business, and you own a property in unequal shares – maybe 60/40 – then you will be taxed on the income in those unequal shares. But when it’s a property business, then it defaults to this 50/50 rule. So from 6th April 2025 if you own the property in unequal shares, but if you don’t want to be taxed 50/50, then you will need to fill in Form 17. And Form 17 is subject to some quite strict rules. First of all, it applies from the date that you make the declaration, and you have to submit it to HMRC within 60 days of that declaration. If you don’t want the 50/50 rule to apply from the start of the next tax year, you’ve got to act fairly quickly to get your Form 17 in.

KF: I think there’s a bit of an urban myth as well around what Form 17 actually does. Some people think that Form 17 actually changes the capital ownership splits away from 50/50 but it doesn’t – that needs to be done separately. So you may need to talk to a lawyer about that and how you can change the percentages.

SR: So this already sounds like a very complicated area, and given that there’s a fairly tight deadline to get this in place, I guess everyone’s going to have to be more involved in making people aware of this.

LW: Yes, it’s about raising awareness, and also whether or not actually there should be a soft landing from the government on this. There’s also a question over the special commencement rules for new businesses. Katherine spoke about the 210-day and 105-day tests. Now, those normally apply for the tax year, but when there’s a new business you apply it for the first 12 months of the business, rather than the tax year or the accounting period. So the question is, if you have a new furnished holiday let business that starts in the current tax year, 2024/25, then the 12 months runs beyond that abolition date. Do you still look at 12 months or not? And so again, that’s one thing that we’ve asked the government.

Then one final thing is, we’ve asked for confirmation that holiday accommodation remains standard rated for VAT. There was a little bit of uncertainty around this, because the stated objective is to align the rules of furnished holiday let businesses with other property businesses, and so it was uncertain about whether that would also extend to a change in the VAT rules. Now the draft legislation doesn’t mention VAT, so we assume that it remains standard rated for VAT.

SR: OK. Now, we did mention earlier why the FHL rules were introduced way back in the 1980s – and that was to clarify the divide between the property business and the trade. But once the FHL rules have gone, where does that leave us, Katherine?

KF: Well, at the moment, it reverts back to us not having a test of what is property trade versus property rental income; what is an investment? And the Office for Tax Simplification in their 2022 review did suggest what they called a brightline test, which would provide clarity to taxpayers without people having to resort to going to tax tribunal. People just want certainty and finality of their tax position. If people need to pay tax, they can pay it, but people just need to know. So the Office of Tax Simplification proposed several factors that could be looked at – for example, the number of properties, and that letting has to be on a short-term basis. Currently, the maximum it can be let to any one person is 31 days, so that could be replicated in a test. The restriction on the use of the property by the owner to show it is intended as furnished holiday letting, not for their own use; and we could then also potentially look at the level of time devoted to the letting and what services the owner provides. We had a similar case a few years ago involving Mrs Ramsay, who claimed Section 162 CGT incorporation relief on a property business. And in that case, I understand Mrs Ramsay was involved personally with the properties for about 20 hours a week, and that was seen as a business in this case, rather than a trade; that was seen as a business on which she was able to get the Section 162 incorporation relief. So something similar could be looked at, for example, the level of hours of input provided by the owner – for example, the cleaning, the gardening, changing the beds, welcoming the guests, welcome hampers, that kind of thing – and maybe a higher test for the number of hours if provided by an employee or a letting agent. So we want some concrete tests that will give people certainty. And ideally it would be nice if that test extended, for example, across the taxes – so we’re looking at income tax, capital gains tax, potentially inheritance tax. For inheritance tax purposes, furnished holiday lets have generally been seen as an investment. And it would be useful if we could have certainty across all the taxes so people know where they stand.

SR: OK, and have we raised the possibility of a brightline test with HMRC?

KF: I believe that we have corresponded with HMRC both prior to and as part of the budget representations.

SR: So could you tell us a little bit about HMRC’s response to the request, Lindsey?

LW: Well, HMRC said it wasn’t inclined to introduce a brightline test, partly based on the OTS test that were put forward. It was concerned that it would bring more things into trading, but also that it would favour those that had more money to invest. So for those that have got a larger portfolio, they would be favoured. But arguably, if you’ve got a big portfolio, you’re going to be doing it on a more organised basis. It’s less likely to be a second home and things like that. So those are also indications that you’re trading.

SR: So far, we’ve concentrated on the nuts and bolts from a tax perspective. What is the general reaction to this proposal?

LW: Well, I think we need to remember that back in the Budget speech, Jeremy Hunt did reference the fact that he’d had representations made by MPs in certain areas. So things like St Austell and Newquay, north Devon, the cities of London and Westminster, Torbay and Truro, those are either in the capital or in the West Country. We know those are real property hotspots. And so there’s the question about whether or not this is a bit of a blunt tool for the whole country. But then there’s also been some of the details about the fact that there are planning restrictions on some of these properties. So, for example, I think that The Professional Association of Self-Caterers has said that, due to planning restrictions, 39% of holiday let properties can only be used for holiday purposes, and so that means that 76,000 furnished holiday lets couldn’t be used as a residential dwelling. And I know that I’m always a little bit – some people would say nosy, but I would like to say curious – when I go on holiday, and I like to look at what local properties are on the market. And you certainly see that if something has got a restriction so that it can only be used for holiday purposes, actually it’s a cheaper property than the local market. So those planning restrictions actually work conversely to the way that you’d want it to work for locals wanting to buy houses.

KF: And it’s a fine line, isn’t it, between making housing affordable for local people and not being taken up as holiday homes, but also those holiday homes do then provide jobs locally in the sense that, you know, there’s cleaners, there’s gardeners, there’s decorators, there’s the letting agents, but it’s a fine balance between the two.

SR: I think, as well, we mentioned the policy’s intention was to kind of create more housing opportunities for families. But a lot of these properties currently used as FHLs may not be suitable for families, either because they’re not big enough, or just location – they may not be next to amenities. So perhaps, as we say, this is a good fit for some areas, maybe not for others. I think as well, if I remember correctly, it did come as a little bit of a surprise back in March when it was announced and we didn’t have a consultation on the actual policy, did we?

LW: No, we didn’t. And it would have been arguably better to have had a consultation first.

SR: Is it also the case that the kind of consultation we have had on the draft legislation, we had quite a short time frame for that?

LW: We did. I think we had the draft legislation at the end of July, and we had to respond by 15th September, so much shorter than the normal 12-week window that we’d expect.

SR: Hopefully we’ve demonstrated that this change is quite significant from a tax perspective, but also has quite a lot of other implications for the wider economy. So ideally, this would have been one where the policy itself was scrutinised a little bit more closely, and there was more of an opportunity to question some of the detail. OK, then, so what are the key takeaways for our members?

LW: Well, I’d say, watch out for developments. There’s certainly a lot more detail that we’d like to see around the draft legislation. There’s communication to clients. So as Katherine’s mentioned, there’s potentially increased tax bills if they’ve got borrowing – new rules to understand. So the interest restriction renewals basis, compared to capital allowances; as Katherine mentioned earlier, furnished holiday letting income is earnings for pension purposes, but property income isn’t. And I think we also need to think about implications if clients change what they do as a result of these changes. So, for example, if they switch to long-term letting instead of letting a property as an FHL, there are things to think about there. For example, if they’re VAT registered, if you’ve got a lot of furnished holiday letting properties, you might have tripped over the VAT registration threshold. But if you start doing long-term letting, does that take you back down below the VAT registration threshold? Could you deregister? But then you’ve got to think about things like VAT deregistration charges on the things that you’ve purchased for your property.

KF: And I think, as well, you’ve got to be talking to clients about what their intentions are for their property, whether they are going to sell – we’re obviously coming to the end of the main holiday season this year in the UK – and what their intentions would be for next year. Have they already got bookings for next year that they can’t cancel? What’s their CGT position? Have they used up their lifetime allowance of Business Asset Disposal Relief? Do they need to sell? You know, I think you have to have a dialogue with your clients about what their intentions are for the future use or disposal of the properties.

SR: And I guess if we go back to changing models as well, we know we spent quite a bit of time earlier on the interest restriction. And one possible way around that is to incorporate the business and use a company. Companies can still deduct the interest, and they’ll save corporation tax at 25% if they’re a larger company. But incorporating a business isn’t straightforward, is it? There are lots of pitfalls. That’s something that isn’t to be rushed into.

LW: Yes, you covered a case on a previous episode, didn’t you, in terms of, if you get the capital gains tax wrong, what rate are you paying? And also, you’re triggering a charge, potentially without the cash to pay it.

SR: OK, so I think the key takeaways are probably to engage with your client, make sure they understand what’s coming, to understand their needs and what’s planned for them in the next few years. But also, if you are thinking of any sort of change, then to tread carefully. Right, well, we know that the FHL rules will be abolished from April next year. As we’ve heard, there are some loose ends but, with the budget on 30 October, we should have more details soon. Please do keep an eye on our news services for updates.

That’s it for this episode. Many thanks to Lindsey and Katherine for your contributions, and thank you for listening. If you’ve missed anything, we’ve included some links for further reading in the show notes, and if you found it useful, then don’t forget to subscribe so that you never miss an episode. You can rate and share the podcast too. We’ll be back next month with the next Tax Track. In the meantime, why not check out the sister podcast from ICAEW? Accountancy Insights provides business, finance and accountancy analysis, while each episode of Behind the Numbers offers a deep dive into a selected topic. There’s also the Student Insights podcast aimed at young professionals. If you’re not already a member of ICAEW’s Tax Faculty, remember that Institute members can join the faculty for no additional cost. Faculty members receive our monthly TAXline bulletin. In addition, anyone can subscribe to receive our weekly TAXwire bulletin containing the latest news from ICAEW. Thank you for listening.