The Office of Tax Simplification (OTS) has published the findings of its review into the taxation of income from residential property. The report primarily focuses on the implications for individual landlords within the scope of income tax on their rental profits. Having received its largest survey response to date in relation to this report, it highlights several areas of potential confusion for smaller landlords and unrepresented taxpayers, along with areas where particular rules create distortions in the tax system.

Making Tax Digital

ICAEW’s Tax Faculty is pleased to see recommendations to tackle some of the more onerous aspects of Making Tax Digital for income tax (MTD ITSA), many of which were included in its response to the call for evidence. Practical considerations, such as how to report properties under joint ownership, the minimum threshold for landlords within the scope of MTD ITSA, and concerns over the timing of its planned 6 April 2024 introduction, are examined in the report.

The report recommends that:

• MTD ITSA should only be introduced for landlords after outstanding points regarding its operation have been addressed, and sufficient wider testing of the system has been undertaken;
• the gross rental income threshold of £10,000 should be increased, as many falling in the lower end of this will have modest rental profits which may be outweighed by the increased administration required under MTD ITSA;
• jointly owned properties should be the filing entity for MTD ITSA, to reduce the administration required by multiple owners reporting income from the same property, and the difficulties of accessing information that may be made available by third parties only at specific points in the year;
• authorisation for multiple agents on the MTD ITSA system is introduced, as letting agents and bookkeepers will likely need access to systems along with tax agents; and
• a roadmap for guidance and communications is published by HMRC up to the planned introduction of MTD ITSA from 6 April 2024.

Furnished holiday lettings

Another area of focus for the OTS is whether the furnished holiday lettings (FHL) regime is sufficiently targeted and continues to meet its objectives. This is in light of a prevailing perception that the FHL market comprises a “relatively small core of people running a substantial short-term letting business, and a long tail of second-home owners renting one property”. Against the UK’s backdrop of a shortfall of housing stock, especially in coastal and tourist hotspots, the OTS questions whether a clearer distinction should be made between those operating a letting business akin to a trade, and second-home owners who are largely interested in investment gain.

The report recommends replacing the FHL regime with a ‘brightline’ test to define holiday lettings that are run as a business. It proposes thresholds on number of properties let, the length of lettings, level of time devoted to the running of the business and disallowing personal use of the property (except for minimal time during maintenance etc). Property lettings that meet the criteria would be treated as a trade for income tax purposes. Other rentals would fall within the general property income treatment, with transitional measures in place for areas such as capital expenditure.

Alternatively, if the FHL regime is retained, the report suggests disallowing personal use of the property in order to target the FHL treatment at commercially run lettings only.

The report also recommends removing the distortion created by allowing homes in the European Economic Area to qualify as FHLs, either by widening the regime to worldwide properties or restricting it to UK properties only.

Revenue and capital expenditure

The difficulty in distinguishing between revenue and capital expenditure for property rental also comes under scrutiny. There are calls for a broader relief giving upfront income tax deductions for capital costs, particularly considering the increasingly pressing need to upgrade rental properties for energy and environmental reasons. Additionally, findings highlight that landlords frequently fail to claim revenue deductions for like-for-like replacements and instead tend to treat such expenses with an abundance of caution.

The OTS recommends provision of greater guidance by HMRC regarding the boundaries, so that landlords can navigate this area with more certainty. In particular, it suggests the provision of enhanced guidance to assist landlords in identifying the boundary between repairs and improvements, including clear examples and flow charts.

The report also suggests expanding the availability of income tax deductions to all property costs (except certain capital costs, such as structural costs or initial fit-out costs of dilapidated buildings) to give immediate relief and certainty over the tax treatment.

Other recommendations

• Removal of the default 50:50 split of rental income for spouses and civil partners, moving to a split of income reflecting beneficial ownership, to reflect that which is already used for other joint owners. This would not be able to be displaced by an election.
• Removal of the ability to elect for a different split of income by other joint owners, to prevent manipulation of income splits.
• Making self assessment online available to non-resident landlords to cut the amount of paper administration required. 
• In respect of the non-resident landlord scheme, removal of the obligation for withholding by tenants, or raising the income threshold from which it applies.
• Working with third parties to raise greater awareness of the UK tax obligations for landlords with overseas rental properties.
• Introduction of a ‘Rural Business Unit’ to simplify the tax treatment and filing requirements for diversified agricultural businesses, who are using rental income to support a main agricultural business.
• The report also makes several suggestions for lesser understood areas where more HMRC guidance would be welcome, including the application of class 2 national insurance contributions to rental income, the interaction between allowances and finance cost restrictions, and the limits on finance cost deductions when mortgaging or remortgaging.

Additionally, the report offers insight into parts of the property rental system that respondents understood well and found valuable, such as rent-a-room relief.

Full details can be found in the report.