January 04, 2024


With the seemingly punitive taxation treatment currently applied to residential property income you may have questioned whether letting out your farm or estate cottages on a residential basis remains worthwhile. Instead you may have considered letting these properties on a short term basis as a furnished holiday let (FHL).

From an income tax perspective the main difference is that residential lets are viewed as an investment, whilst running a holiday let business is considered akin to a trade. This results in favourable income tax treatment of the holiday let income. For example, the deduction of mortgage interest, which is restricted for residential letting income but is fully allowable against FHL income. Capital allowances are also available.

However, one important consideration is the VAT treatment of such income. Whilst residential letting income is exempt from VAT, the FHL income follows the same VAT treatment as hotel accommodation, B&Bs etc. and is subject to VAT at the standard rate (currently 20%). Therefore, a FHL business with turnover above £85,000 would need to be registered for VAT and all FHL income would then be subject to VAT at 20%.

Where the owners of the FHL business are already registered for VAT in connection with another business activity, for example, a farm business, the FHL income would be subject to VAT from the outset, regardless of the levels of income.

As the majority of FHL customers are likely to be non-business, those customers would be unable to reclaim any VAT charged to them. Given the price sensitive nature of the industry, a VAT registered FHL business might be forced to swallow some if not all of the VAT rather than pass it on to customers. In the worst case, this would effectively result in a 1/6 drop in turnover and potentially reduce profit by an equal amount.

Generally, however, small FHL businesses would not be required to register for VAT from the outset. To put it into context, the current VAT registration threshold is £85,000 of turnover. With 100% occupancy, you would need income of £1,635 per week to exceed the threshold. If you only have one property exceeding the VAT registration threshold may not be an issue but it is more likely to affect businesses with two or more properties. Turnover is based on the value of bookings before any commissions or other charges are deducted for example by a booking agent.

When VAT on FHL income has to be paid - The tax point date of FHL income follows the normal VAT rules. Generally, for VAT purposes the tax point is the earlier of the date of receipt of payment or the time of supply.

A FHL owner would ordinarily take a deposit and the balance would have to be paid before the actual provision of the accommodation. For VAT purposes, the receipt of the deposit and the receipt of the balancing payment represent two separate supplies. VAT should be declared on each of them when received rather than on the total amount when the rental takes place. Similarly when looking at whether the VAT registration threshold has been reached it is the date and value of payment that are relevant if paid before the accommodation is provided, not the date visitors stay.

Bookings are often handled by agents. The receipt of payment by a booking agent would normally be treated as receipt of payment by the property owner. When paying VAT to HMRC or when checking if turnover has exceeded the VAT registration threshold receipt the dates payments are received by the agent will be relevant not when the agent passes income to the FHL owner.

Capital Goods Scheme Rather than switching a property from a residential let to an FHL, you may be considering converting a disused barn or building an entirely new property on a disused parcel of land which are likely to incur a VAT charge on the build or conversion costs.

It is not essential to claim this VAT as input VAT; however, doing so could drastically reduce the build budget. If the build costs exceed £250,000, excluding VAT, and you were to reclaim the input VAT in connection with this, the property in question would be subject to what is known as the Capital Goods Scheme (CGS).

The CGS requires the taxable use of the property to be monitored for a period of 10 years. Provided the property is used solely as an FHL during this time, there is no issue. However, if, after say 5 years you decide to let out the property on a residential basis, which, as noted above, is an exempt supply, half of the VAT recovered on the build would be clawed back by HMRC


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