The Definitive Guide to
Furnished Holiday Lettings Tax

Benefits of Furnished Holiday Lettings

PRIOR to the General Election in May 2010, the old Labour Government had been planning to abolish the beneficial tax regime for furnished holiday lettings. Thankfully, the then opposition managed to secure a last minute reprieve and the new Coalition Government has confirmed that the regime will be retained for the foreseeable future.

The new Government has, however, made some amendments to the regime which have restricted its benefits and which also now make it more difficult for properties to qualify.

Benefits of Furnished Holiday Lettings
For many years, furnished holiday lettings have enjoyed the best of all worlds. They continue to be treated as investment properties whenever that is more beneficial but get treated like a trade whenever many trading reliefs are up for grabs.

They can sometimes qualify as private residential accommodation and yet still get so many of the advantages generally reserved for commercial property.

Even despite the recent changes made by the new Government, getting one of your properties to qualify as furnished holiday accommodation is the property tax equivalent of winning the lottery! (Albeit with the proviso that the winnings are not quite as great as they used to be and the chances of winning have been reduced!)

In essence, properties qualifying as ‘furnished holiday lettings’ enjoy a special tax regime, which includes many of the tax advantages usually only accorded to trading properties. At the same time, however, the profits derived from furnished holiday lettings are still treated as rental income.

The current taxation benefits include:

• Entrepreneurs’ relief on capital gains
• Rollover relief on replacement of business assets
• Holdover relief for gifts
• Capital allowances for furniture, fixtures, fittings and integral features
• National Insurance should not usually be payable on income

The letting of holiday accommodation is, however, standard-rated for VAT purposes (whether or not the qualifying conditions set out below are met). The landlord must therefore register for VAT if gross annual income from UK holiday lets exceeds £77,000. Foreign VAT registration will also often be required in respect of holiday lettings elsewhere within the European Union.

A furnished holiday letting business might also be exempt from Inheritance Tax where the lettings are generally short-term and the owner (or their employees) was substantially involved with the holidaymakers’ activities. The available reliefs extend to any property used in a furnished holiday letting business. This will include not only the holiday accommodation itself but also any office premises from which the business is run.

Loss Relief
From 2011/12 onwards, losses arising in a furnished holiday letting business may only be carried forward for set off against future profits from the same furnished holiday letting business.

For this purpose, all of a landlord’s UK furnished holiday lettings are regarded as one business but any furnished holiday lettings elsewhere in the European Economic Area (EEA) must be regarded as a different business. (All furnished holiday lettings within the EEA but outside the UK are regarded as the same business.)

Qualification
The current qualification requirements for a property to be regarded as a furnished holiday letting are as follows:

• The property must be situated in the European Economic Area
• The property must be furnished
• It must be let out on a commercial basis with a view to making profits
• It must be available for commercial letting to the public generally for at least 210 days in a 12-month period
• It must be so let for at least 105 such days
• The property must not normally be in the same occupation for more than 31 consecutive days at any time during a period of at least seven months out of the same 12-month period as that referred to in (iv) above

The 12-month period referred to in (iv) and (vi) above is normally the tax year.

From 2011/12 onwards, landlords can elect for properties which qualified for the furnished holiday letting regime under the above criteria in the previous year to stay within the regime for up to two further tax years despite failing to meet the test under (v) above. In effect, this means that properties will generally only need to meet this test once every three years. The property will still need to meet all of the other tests, however, and the landlord must make genuine efforts to meet the test under (v) every year.

A taxpayer with more than one furnished holiday letting property may also use a system of averaging to determine whether they meet test (v). This extension cannot, however, be used in conjunction with the two year extension described above: properties must qualify in their own right before the two year extension can be claimed.

Other Qualification Issues
Whilst the property need not be in a recognised holiday area, the lettings should strictly be to holidaymakers and tourists in order to qualify.

Where a property qualifies, as set out above, then it generally qualifies for the whole of each qualifying tax year, subject to special rules for the years in which holiday letting commences or ceases.

Where, however, there is some other use of the property during the year, the Capital Gains Tax reliefs described above will be restricted accordingly.

Nevertheless, it remains possible for the taxpayer and their family to use the property privately as a second home during the ‘off season’ and still fit within the rules described above.

However, the overall position must still fit in with rule (iii) above and hence, in practice, the property must be made available for letting to third parties for a sufficiently large proportion of the year to give its owners a realistic expectation of profits.

The result of failing to meet this test would be the loss of furnished holiday letting status and hence the consequent loss of all the additional reliefs which that status provides.

Tax Tip
Preparing a credible business plan when you first acquire the property would provide valuable supporting evidence that you had a reasonable expectation of profit. A documented annual review of the plan will also be useful, as the ‘profit expectation’ test must be met every year. A business plan will not help you, however, if it clearly bears no resemblance to your actual behaviour in respect of the property.

Interaction with Other Reliefs
A property which qualifies as furnished holiday accommodation and which has qualified as the owner’s main residence at some time during their ownership, will also be eligible for private letting relief.

Entrepreneurs’ Relief on Furnished Holiday Accommodation
Entrepreneurs’ relief is available when a qualifying business or part of a qualifying business is sold or when assets used in a qualifying business are sold within three years of that business’s cessation.

A ‘part’ of a qualifying business must be capable of being run as a going concern in its own right in order to qualify for these purposes.

In my view, most properties which qualify as furnished holiday accommodation must be a ‘part’ of a business capable of being run independently of any other part of the business. Hence, my interpretation of the entrepreneurs’ relief legislation is that a capital gain on the sale of qualifying furnished holiday accommodation should generally qualify for entrepreneurs’ relief as long as:

• The property is still being used as qualifying furnished holiday accommodation at the time of sale, or
• The property was being used in a qualifying furnished holiday accommodation business at the time of the cessation of that business and is sold within three years thereafter.

However, I have now become aware that HM Revenue and Customs is applying the entrepreneurs’ relief legislation in a more restrictive manner and is arguing that the sale of a single furnished holiday letting property does not constitute the sale of a qualifying ‘part’ of a business when the owner also continues to operate other furnished holiday letting properties.

HM Revenue and Customs’ view seems to be that advertising the properties together (e.g. through the same website) makes them a single indistinguishable business.

This is a new and developing area of tax law, so it is difficult to provide any definitive guidance until we see a suitable case in court.

In the meantime, each case will have to be argued on its own merits. The more steps which the owner takes to separate the way in which the different properties are run, the better their chances are likely to be. Useful steps may include:

• Advertising each property separately
• Ensuring that each property has its own website
• Keeping separate sets of books and records for each property
• Using different cleaners, gardeners, etc.
• Using significantly different names for each property

Naturally, the commercial impact of these steps needs to be weighed against the potential Capital Gains Tax savings: which may be remote and uncertain when no sales are anticipated in the foreseeable future.

Tax Tip
A more certain approach might be to separate out the property which is intended for sale by initially transferring it into different ownership, such as the owner’s spouse or adult child, or a trust. As long as the property is a qualifying furnished holiday let at the time of the transfer, it should be possible to carry this out free from Capital Gains Tax. The new owner would then need to operate the property as a furnished holiday let for at least a year, but could then sell it with the certainty of obtaining entrepreneurs’ relief (provided that they did not have any other furnished holiday lets themselves!)

Subject to the uncertainty created by this issue, a property investor might be able to realise total capital gains of up to £10m on qualifying furnished holiday accommodation at a maximum effective Capital Gains Tax rate of just 10%. Furthermore, a couple investing in property jointly may be able to benefit from this rate on total gains of up to £20m.

European Economic Area
Prior to April 2009, the special tax regime for qualifying furnished holiday accommodation applied only to property situated in the UK. At that time, however, the regime was extended to property located anywhere within the European Economic Area with retrospective effect.

Property may be treated as if it qualified since it was first let as qualifying furnished holiday accommodation (or since the relevant country joined the European Economic Area, if later).

There are some potential drawbacks to claiming furnished holiday letting treatment: neither the 10% wear and tear allowance nor the landlords’ energy saving allowance is available on qualifying furnished holiday accommodation.

You do not have to claim furnished holiday letting treatment on a qualifying property outside the UK for tax years prior to 2011/12: if you do, you will have to make all of the appropriate adjustments, so look before you leap!