Holiday Lets and serviced accommodation – tax and VAT considerations

simon

Simon Misiewicz

22nd March 2016


Are holiday lets a good investment?

Are you fed up with being targeted by HMRC for being a residential property investor? In his budget George Osborne made it clear he won’t be backing down on his war against buy-to-let investors, announcing that the 3% stamp duty surcharge will definitely go ahead and that while the capital gains tax (CGT) rate will be cut, this won’t apply to residential properties.

Did you know that some of the recent negative tax changes do not apply to holiday lets and serviced apartments? In fact, there are a number of tax benefits to investing in this type of business.

Whilst you are reading this article you may wish to read our page on the subject of “buy to let tax for UK landlords” where we discuss all the different types of tax that you need to be aware of. Read Here for more (opens in a new tab)

The problem – residential investments are taxed heavily

I have written before about the 2016 budget announcement for property investors and how it will affect residential investors. But by the looks of things, if you own a holiday let, then you’ll escape the worst of its effects, especially if you have a limited company.

Here are the headline downsides for residential property investors:

  • Tax relief on mortgage interest to be limited to 20%
  • Withdrawal of the 10% wear and tear allowance for furnishing your property

Are holiday lets a good investment? Let’s compare residential to holiday lets:

  • Capital allowances — you can claim capital allowances on the furniture and other items that you buy for the property, which may be higher than the 10% wear and tear allowance. Accommodation is considered to be ‘furnished’ if the tenant is entitled to the use of furniture. In practice, due to the nature of holiday lettings, queries about whether the accommodation is furnished are unlikely to arise.
  • Losses on holiday lets may be property losses offset against your total income (including employment income), provided the loss was due to the above capital allowances. Any claims of this nature must be made within 22 months after the year end when tax relief is given.

Capital allowances —what are they?

Examples of capital allowances for holiday lets:

  • vehicles
  • tools used for maintenance
  • office equipment used in running the rental business
  • fixtures in a let property

Example of how to offset losses on holiday lets

Guy’s rental business makes a loss of £30,000 in 2005-06 after taking into account capital allowances. For that year Guy has net capital allowances (after deducting balancing charges) of £35,000 for his rental business. The entire loss of £30,000 is therefore eligible for what are known as ‘sideways’ loss claims for 2005-06 and 2006-07.

Guy has no rental business losses to be brought forward at 6 April, 2005. But Guy’s total relievable income for the two above years together is only £20,000 and so only relief up to this amount can be given.

The balance of Guy’s 2005-06 loss (£10,000) can be carried forward and set against later rental business profits, but not claimed sideways against general income.

Holiday lets/serviced apartments are still treated as property income for tax purposes under Schedule A of your self assessment, unless you are in a partnership or run the business through a limited company.

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How a property qualifies as a holiday let/serviced apartment 

For your property to qualify as a holiday let a number of qualification tests for holiday lets need to be passed. These include:

  • The property must be let out on a commercial basis to make a profit
  • The accommodation must be available for commercial letting to the public generally as holiday accommodation for not less than 210 days per year
  • The periods for which it is let must amount (in the aggregate) to at least 105 days per year
  • The property must not normally be in the same occupation for more than 31 days (known as ‘longer term occupation’). If it is, these periods do not count towards a year’s qualifying number of days. And if these ‘longer term occupation’ periods add up to more than 155 days in any year. Your property will lose its holiday let status for that year.

For a property that has been used as a holiday let for many years, the year will be defined as the dates the tax year runs for each period. If, however, the property is acquired, sold or has a change of use during a tax year. The year will be calculated differently according to the dates of these changes. There are also some options to average across units for those that own more than one holiday let.

CGT relief benefits

Roll-over relief

In addition to the other tax benefits, there are also capital gains tax (CGT) benefits if you have a holiday let/serviced apartment. If you sell your property, you can claim roll-over relief for commercial buildings, meaning if you buy another commercial property (such as another holiday let) intended to be used for business purposes then the CGT may be mitigated, provided that the entire capital gain is reinvested. There are a few caveats, however:

  • The roll-over relief is only available to items affixed to the building rather than the furniture within
  • To claim roll-over relief the property must have been used on a commercial basis (holiday let/serviced apartment) basis during the entirety of its ownership
  • The roll-over relief must be claimed within four years of disposal of the asset. For example, if a disposal is made by a sole trader in 2006-07. And the consideration received is reinvested in replacement business assets in 2008-09. The time limit for a claim to roll-over relief is 5 April 2013
  • To claim roll-over relief you have to use the appropriate form

Examples of roll-over relief:

An individual disposes of an asset in June 2004 for £250,000, making a gain of £100,000. In his tax return for 2004-05 he makes a declaration that he intends to reinvest the whole of the consideration in new assets for the purpose of a claim to roll-over relief.

No tax is paid on 31 January 2006 on the gain of £100,000. The relevant date by which the proceeds must be reinvested is 31 January 2009. If no valid claim to roll-over relief has been made by that date. Then the individual will have to pay tax on the gain, together with interest from 31 January, 2006.

Entrepreneurs’ relief

You can also claim entrepreneurs’ relief for a business that owned holiday lets/serviced apartments, whether you owned the asset in your own name or you sold/closed a limited company that owned the business.

Gift relief

If you gave away a residential property to your children you would have to pay CGT based on the market value, at the date of transfer, less the cost of purchase and capital items of expenditure.

However, hold-over relief may be claimed if you gift a commercial building (including a holiday let business) to someone such as a friend or family member. There is no CGT immediately payable, however the recipient will pay a higher rate upon the sale.

HMRC gives us a handy example to explain exactly how this works:

“You give an asset worth £50,000 to your brother. It cost you £17,000. The chargeable gain is therefore £33,000. If a claim is made by you and your brother. You do not have to pay tax on your chargeable gain. Which is known as the ‘held-over gain’. Instead, your brother’s cost for the purposes of calculating his CGT liability on any future disposal of the asset. Which would normally be its value of £50,000. Is reduced by the amount of the held-over gain, £33,000. Leaving a base cost of £17,000.”

Are holiday lets a good investment? Want to understand how to implement this strategy or to discuss other finance/tax questions? Please book some time with us. Use the consultation button at the top / bottom of this article.

Are you aware of the VAT implications for holiday lets or serviced accommodation? 

Is your holiday let / serviced accomodation rental income over £85,000

Once you reach an income level of £85,000 on holiday let/serviced accommodation then you need to register for VAT. This brings about your very first issue.

Who pays your VAT bill?

It is a good question because you could start to lose the competitive edge if you need to charge an extra 20%. This is a problem if your clients are unable to claim back VAT themselves.  The alternative is that you absorb the 20% VAT charge and keep the prices to your clients the same.

This means that you will not lose clients but you will lose profit margin.

What are you to do?

You will need to work out what you can afford to absorb of the VAT bill. For example, you may charge £100 per night. If you absorb the full rate of 20% VAT to keep the price at £100 (including VAT) then the money in your pocket will be reduced to £83.33 after VAT.

This may now give you a nightly profit of £13.33 rather than the previously assumed £30. This may not be sufficient so you may decide to increase the price to the client to £110 including VAT. This means the money in your pocket of £91.67 is reduced from the original £100. However, this provides you with an improved profit compared to absorbing the VAT payment.

There will always be a compromise as to what VAT you absorb and what VAT you pass onto your clients.

10.5% VAT flat rate

The government introduced a flat rate of VAT for use by UK businesses where they meet specific conditions.

For hoteliers and holiday let operators the flat rate is 10.5%.

This simply means that you pay 10.5% of the price of the room (inclusive of VAT) to HMRC and you retain the rest. In the above example, a night charge of £110 including VAT would require you to pay HMRC £11.55, leaving you with £98.45. This is better than the above example where you would normally pay VAT to HMRC at the full rate of 20%.

If you use the flat rate you need to know that you will not be able to claim back VAT on everyday expenses of your holiday let business. However, you are still allowed to claim back the VAT you paid when buying them:

  • All VAT paid on VATable services invoiced in the 6 months prior to your date of VAT registration.
  • All VAT paid on VATable goods invoiced in the 4 years prior to your date of VAT registration that is still owned and used within the business at the date of reclaim.

Flat rate VAT administration

Do keep in mind this may cause you an administration nightmare as you would reduce the costs from the profit and loss account and may affect your tax position if you have already submitted your accounts. It may be better from an administration and stress point not to go back to accounting years.

  • All VAT paid on capital goods on or after your date of VAT registration e.g. goods which you buy to use within your business, like furniture or laptops – if the invoice total is more than £2,000.

The VAT flat rate also provides an advantage in that there is little administration. Whatever you charge your clients (inclusive of VAT) you will need to pay HMRC 10.5%. This is much better than those that wish to go on standard VAT accounting, where all invoices need to be lodged in their book keeping system and pay over to HMRC the net VAT position.

Please note that you can only join the VAT flat rate scheme when your income is less than £150,000, as per HMRCs website. You must leave the VAT flat rate scheme when your income exceeds £230,000, as per HMRCs website.

Reduction of 1% for the first year – also for VAT flat rate users

Do not forget that you also get a reduction of 1% for the first year of using the flat rate scheme. Instead of paying 10.5% VAT flat rate in the first year you would pay out just 9.5% over to HMRC.

VAT Flat rate applies to all income streams

Flat rate VAT is applied to all turnover within the business – even VAT exempt and VAT zero rated turnover. This is a good reason to have a separate company for holiday lets. If you have both residential and holiday let rental income then the VAT flat rate scheme would be less attractive.

As an example if you have £5,000 non holiday let rental income and £1,000 holiday let income in the same limited company then you would need to apply the 10.5% VAT rate to all income. Both holiday lets and residential rental income. This creating a £630 VAT bill which is actually higher than the £200 that would be paid on normal rates!

Limited cost businesses for VAT flat rate users

These changes took effect on 1 April 2017. You shouldn’t use the limited cost business rate before this date.  This is also a type of flat rate scheme and the rate is 16.5%.

You’re a limited cost business if the amount you spend on relevant goods including VAT is either:

  • less than 2% of your VAT flat rate turnover
  • greater than 2% of your VAT flat rate turnover but less than £1000 per year

If your return is less than one year the figure is the relevant proportion of £1000. For a quarterly return, this is £250.

For some businesses, this will be clear but for other businesses – particularly those whose goods are close to 2% – they may need to complete this test each time they complete their VAT return. This is because it is possible to move from a limited cost rate of 16.5% in one period to the relevant sector rate in another. This would happen if your costs fluctuate above and below 2% from one quarter to the next.

If you’re a limited cost business this means that you may pay more VAT than you do on standard accounting – you may want to check to make sure the Flat Rate Scheme is still right for you.

Example 1

A business has a flat rate turnover of £10,000 a quarter. It spends £260 on relevant goods.

This is more than 2% of the flat rate turnover and more than £250 so the rate they need to use is the VAT flat rate used for their sector their business.

Example 2

A business has a flat rate turnover of £20,000 a quarter. It spends £325 on relevant goods.

This is more than £250 but less than 2% of the flat rate turnover so the rate they need to use is VAT flat rate of 16.5%.

Example 3

A business has a flat rate turnover of £10,000 a quarter. It spends £225 on relevant goods.

This is more than 2% of the VAT flat rate turnover but less than £250 so the rate they need to use is 16.5%.

Reclaiming VAT on buy-to-let property expenses

Buy-to-let property owners are being targeted by the taxman. However, we are always on the lookout for ways to redress the balance! One of them being the VAT flat rate.

Renting out residential property (other than furnished holiday lets & serviced accommodation) is always VAT exempt. It would not usually be possible to recover VAT on costs relating to the rental activity, since it is an exempt supply.

However, if the property is owned by a VAT registered entity (individual or limited company), then partial exemption de-minimus rules should usually allow recovery of VAT on the rental expenses, in most cases.

Where a VAT registered entity makes both taxable supplies (i.e., its normal business activity) and exempt supplies (i.e., renting out residential property) then it will be partially exempt. It is possible to reclaim up to £625 per month of exempt input VAT. This being VAT on costs relating to the rental activity, plus a proportion of VAT on mixed costs and general overheads. This is provided that this exempt VAT is not more than 50% of the total input VAT being reclaimed.

This allows up to £7,500 per annum of the extra VAT to be recovered.

So, can property investors reclaim VAT?

A VAT reclaim is only possible where the property is owned by a VAT registered entity. This could be where the property used in the business as an office or shop.

You cannot recover the VAT on your running costs if you use the flat rate scheme. You will also be liable to pay flat rate VAT on the rent from residential properties. This is because the flat rate scheme also captures zero rated and exempt income.

Reclaim VAT on purchased before registration

You can claim VAT made on certain purchases that were incurred before registration per the HMRC website. This is irrespective if you use the VAT flat rate or not.

  • 4 years for goods you still have, or that were used to make other goods you still have
  • 6 months for services. This may include cleaning, solicitors, accountancy fees.

You can only reclaim VAT on purchases for the business now registered for VAT. They must relate to your ‘business purpose’.

You should reclaim them on your first VAT Return (add them to your Box 4 figure) and keep records including:

  • invoices and receipts
  • a description and purchase dates
  • information about how they relate to your business now

If you claim back the VAT you will need to put in the credit against your profit and loss account.

For example, the full invoice cost of £100 if you purchased cleaning services against your income. Once you are registered you could claim back the VAT paid of £16,67 (£100 charges less £83.33 cost before VAT). You would claim back the £16.67 from HMRC.

You will pay 19% corporation tax on this credit as it will be seen as additional profit. This can be a tricky transaction, so a book keeper will be required going forward to get this right.

Pensionable earnings 

The one thing I haven’t written about before is the fact that with holiday lets the profits count as earnings for pension purposes, whereas rental income from standard lettings does not. You can invest up to £40,000 into a pension each year (recent developments may decrease this annual allowance but we will ignore this for now) and you can get tax relief on the money you invest into a pension.

If you invest in a pension as a basic rate taxpayer then you will receive a tax credit of 20%. If you are a higher rate taxpayer then you will receive 40% tax relief.

Let’s look at an example:

Mr A has taxable earnings from his property investments of £20,000, after his personal allowances have been taken into account. He would pay 20% tax on this amount, so £4,000. Mr A would not get any tax relief if he invested £10,000 into a pension. Because he only has income from residential property investments.

However, if Mr A had income from commercial properties/furnished holiday let investments, had a profit of £20,000 and invested £10,000 into a pension. Then he would only pay tax on £10,000. So he’d save £2,000 in tax by putting his money into a pension scheme.

As you can see. This is yet another tax break available to those owning holiday lets/commercial properties rather than normal residential property investments.

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