Other tax changes for furnished holiday lets
In my last article on furnished holiday lets (“FHLs”) and the abolition of their preferential tax status from April 2025, I focused on the capital tax reliefs that will be lost and surmised that ongoing holiday let businesses would just have to deal with the other tax changes. To some extent that is correct, but what are the other changes, and might there be room to improve your situation?
Tax relief for finance costs
The changes will hit some businesses harder than others, and perhaps those with high borrowings will be most affected.
It is not uncommon for those with several holiday lets to have high borrowings, and under the current FHL rules income tax relief is given at your marginal rate of tax, so a higher rate taxpayer will get, say, £8,000 income tax relief on £20,000 of mortgage interest. Loss of FHL status brings with it a restriction to this tax relief, and on the same amount of mortgage interest, tax income relief will amount to no more than £4,000.
This illustration represents a £4,000 increase in the annual income tax liability despite there being no change in the holiday let operation or its profitability. In addition, the mechanics of calculating taxable profits from holiday lets changes and this could cause profits to be pushed into higher rates leading to further income tax costs. In this illustration, if a higher rate taxpayer were pushed into the additional rates, they would suffer a further £2,250 in income tax each year.
In terms of improving your situation, the first thing to do is to understand and quantify what this change will mean to your holiday letting operation. Might you need to review your borrowing, are there better terms available to you, is there an opportunity to share the rental profit with a joint owner in a lower tax bracket, or might there be an opportunity to transfer the business into a company where finance costs wouldn’t be restricted? A thorough review of your business to understand the impact will be invaluable to identify whether any of these options is sensible.
Capital allowances
Income tax relief for the depreciation in value of items within your FHL is given in the form of capital allowances, but from April 2025 allowances on new expenditure will cease.
Beyond April 2025 you will still get income tax relief for the cost of property repairs and for replacing items within your FHL such as furniture, furnishings, white goods and the like, but not for improvements or to expand the business where relief relies on capital allowances being available.
Where an existing FHL business has an ongoing capital allowances ‘pool’ of expenditure they can continue to claim annual income tax relief on that pool beyond April 2025 which begs two questions:
- Do you have any planned expenditure that would qualify for capital allowances but not as a repair or replacement, and could this be accelerated so that the cost is incurred before 6 April 2025; and
- Does your ongoing capital allowances pool include claims for all relevant items within your FHL? Most people will have fully claimed on overtly tangible items such as furniture, furnishings, white goods and the like, but many people do not know claims can be made for other features including, for example, kitchens, bathrooms, central heating systems, certain electrical and lighting installations, and others. Allowances may well have been claimed in obvious situations where, for example, a new kitchen has been installed and the cost is easily identifiable, but qualifying expenditure can be identified in other situations. For example, a proportion of the purchase price of the property will relate to qualifying expenditure, similarly in new build projects, renovations and conversions.
Now is a good time for FHL owners to consider their capital allowances position to ensure past expenditure is recognised in the ongoing capital allowances pool at 5 April 2025, and to consider whether planned expenditure thereafter could be brought forward to get into that pool.
As a bonus, if new qualifying expenditure is identified, for example in the cases in the final sentence under point two above, a capital allowances claim could be included in your tax return for the year ended 5 April 2024 to help reduce that year’s income tax liability. It may also be possible to claim income tax relief against FHL profits in the year ended 5 April 2023 to generate an income tax refund from HMRC for that year. This would need to be done before 31 January 2025 as the window to amend your tax return for the year ended 5 April 2023 closes on that date.
Flexibility for married couples and civil partners
Where FHLs are jointly owned by a married couple or by civil partners, they currently have freedom to allocate profits between them as they see fit and for best tax advantage. For example, by weighting profits to the person in the lowest income tax band.
This flexibility will fall away from 6 April 2025 and FHL profits will automatically be allocated equally between owners who are married or in a civil partnership, which may cause profits currently sheltered in the basic rate income tax band to be exposed to the higher or additional rates of income tax.
Depending on how the FHL is operated, adjusting ownership proportions – holding property as tenants in common – and making the relevant elections to HMRC so that profits can be shared income tax efficiently is an option, but the adjustment and elections must be made before HMRC will recognise their effect. Perhaps operating the FHL business through a partnership might be worth considering as a means of flexibly allocating partnership profits.
VAT reminder
Finally, with the abolition of the FHL rules, some may think that they will no longer be required to add VAT to holiday rental charges. Sadly, this is not the case.
The abolition of FHL status does not change the VAT status of holiday accommodation, the provision of which is a taxable supply, hence if your turnover is above the VAT threshold, or perhaps if your holiday let is part of a larger business that is already VAT registered, VAT will still need to be added to your holiday rental charges as it is now.
Will these changes raise much tax?
The tax information and impact note suggest abolishing the current tax advantages enjoyed by FHL operators will generate an extra £35million in tax for the Treasury next tax year, then in the following three tax years £140million, £180million, and £245million.
It is therefore certainly worthwhile taking time and thought now to determine whether and to what extent your holiday letting business will be impacted, and whether there is any sensible action to be taken, perhaps before 6 April 2025, to improve your situation going forward.
In my last article focusing on the capital tax implications of losing FHL status I suggested “the proposed income tax changes are what they are and will simply have to be dealt with by continuing FHL business”. However, as outlined above, there are actually quite a few points to be aware of, some forward thinking to be done, and perhaps some opportunities to consider to reduce your tax exposure when the FHL rules are no longer there to help.
As ever, if you have any queries, or if you would like advice regarding how you might be impacted by the abolition of the FHL regime and whether any mitigatory action could help, please get in touch.
Tax changes for furnished holiday lets – Part 1
Photo by Yaopey Yong on Unsplash