With the seemingly punitive changes to the taxation of residential property income introduced in recent years, 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, 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 always 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 with a FHL property, the FHL income would be subject to VAT from the outset, regardless of the levels of income.
As the majority of FHL customers would 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 the output VAT rather than charge 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 this is unlikely to be an issue and realistically it will only be businesses with two or more properties that this applies to.
Tax point of FHL income – Deposits
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 accept deposits in the course of business and, settlement of the balance or the rental would be made before the actual provision of the accommodation.
Therefore, for VAT purposes, the receipt of the deposit and the receipt of the balance of the rental represents two separate supplies and VAT should be declared on each of them, rather than on the total amount when the rental takes place.
Capital Goods Scheme
Rather than switching a property from a residential let to a FHL, you may be considering converting a disused barn or building a property on a disused parcel of land, which would inevitably incur VAT 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 above, is an exempt supply, half of the VAT recovered on the build would be clawed back by HMRC.
Should you require any help or assistance with anything I’ve raised, please don’t hesitate to get in touch.