Covid and its implications have had a rather mixed effect on diversified businesses. Some, such as farm shops have generally come out as winners, whereas others such as farmhouse B&Bs have seen income disappear, mitigated only, perhaps, by aspects of the support packages.
Furnished holiday lettings (FHLs) have probably come out as overall losers, although some will have experienced a windfall from the business rates grants, other owners may have picked up useful income in the summer from the “staycation boom”, and others may have taken the opportunity to simply write the year off and catch up on maintenance and refurbishment. However, as is often the case, there may be a tax problem in the making.
Qualifying FHLs have a privileged tax position, and despite legally being a “property business” they are treated as a trading business if certain conditions are met. This not only means that the income is pensionable, but also that capital allowances can be claimed, and there is no higher rate restriction on a claim for mortgage interest suffered. Moreover, capital gains on the disposal of a FHL asset can usually be reduced or deferred by rollover relief, holdover relief or Business Asset disposal relief.
The FHL qualification tests are well known, and relate to location, occupancy and availability. The two key tests which usually need to be considered are occupancy of 105 days for short term lets and availability for letting of 210 days. Clearly these are quite likely to be problematic for 2020/21.
Fortunately there are some reliefs within the existing legislation. Unless this is the first or last year of letting, a business can elect for a “period of grace” which will obviate the occupation test where a commercial business satisfied the conditions in the previous one or two years. A further relief is given where “exceptional circumstances” led to periods of occupation exceeding a 31 day period which would have precluded them from being included within the 105 days.
Neither of these reliefs is helpful in achieving the 210 day “availability” requirement. There is perhaps a fine point for debate on whether a property can be available, if a customer is legally forbidden to occupy it. One could perhaps reasonably argue that the prohibition applies to the tenant, not the property owner, or perhaps that the case law on illegal trades might be usefully invoked. What is really needed is clarity from HMRC to redress a situation which is far from that envisaged when the legislation was passed. The HMRC blog on FHLs and Covid simply says “There is no COVID relaxation in relation to the availability condition for furnished holiday lets. So, if the property is not available for the 210 days, then the FHL status is immediately lost”.
If property fails to qualify, consequences will flow in two directions. From an income tax viewpoint, any income will be treated as normal rent, with the higher rate disallowance on mortgage interest and a potentially awkward position regarding losses, since brought forward FHL losses cannot be set against current rental income, and any rental losses arising in 2020/21 will not be able to relieve future FHL income. Potentially there is even the complication of cessation provisions being brought into play although there is some solace within the HMRC business tax manual which, no doubt with Covid in mind, now states that: “Temporary breaks in trading activity do not amount to a permanent cessation of the trade for tax purposes. For example, if a business closed its doors to customers, or otherwise ceased trading during the coronavirus lockdown period, but intended to continue trading after restrictions were lifted, then the trade should not be treated as having ceased. Any income and expenses relating to the gap in trading will be taken account of in calculation of trade profits or losses, subject to the usual tax rules and case law.
This is dependent on the resumption of activities following the break being the same, or similar, to those prior to the break “
A period of lost FHL status may also have longer term implications. Since most of the CGT reliefs must be time apportioned where an asset is only partially entitled to them, there will potentially be a year of ownership where no business reliefs are due. One wonders whether this will be picked up years into the future, when 2020/21 is just an awful memory.
As we come into the start of the 2020/21 tax return season, FHL owners should perhaps be thinking what evidence they can produce to show that their properties were indeed available for let for 210 days – or better still, HMRC could give some thought to what the tests were intended to achieve – but it is definitely not a case of just “ticking the same boxes as last year”.*The views expressed are the author's and not ICAEW's.