The article considers the scope for buy-to-let landlords to reduce their taxable profits in the current general financial difficulties.
Arguably, landlords are being expected to shoulder an unfair burden in the context of the current government action against Coronavirus. For example, it has been made much more difficult for tenants to be evicted for non-payment of rent, even if there is no good reason for that nonpayment. Quite apart from this, many landlords are being asked to accept rent payment ‘holidays’ by hard pressed tenants at the moment, and this means that much needed cash can be in short supply. It therefore makes obvious sense for landlords to consider any options they have for reducing their tax liabilities currently. This article considers buy-to-let landlords; that is, landlords of residential properties occupied as dwellings. The considerations are obviously different for commercial landlords; for example, there is generally no scope for re-evaluating the possibility of capital allowance claims for inherent fixtures; although some of the considerations for commercial landlords are the same as what follows.
The starting point is to consider the basis on which the income of a property business has been calculated since the introduction of self-assessment (ITTOIA 2005, s 272). Generally speaking and in overview, since self assessment was introduced (in 1996/97), the rules for calculating the profits of a property business have been much the same as those which apply for calculating trading profits. For example, under ITTOIA 2005, s 25, generally accepted accounting practice needs to be used.
In the context of the government action against Coronavirus, clearly the likelihood of bad debts is significantly increased, with many tenants losing their livelihoods and not necessarily being fully compensated by financial support from the government. So, first of all, landlords should clearly consider all cases where rent has not been paid on time and is still outstanding at the time of preparation of the accounts.
A reasonable assessment (as for trading debtors) needs to be made as to whether the doubtful debt will go bad; and as with trading debts, it is not necessary for absolute certainty to be available that the debt is bad for it to be the subject of a validly deductible provision in the property business accounts. As with trading businesses, a general provision (say, 5% of the total debtor book) will generally not be permissible because it has not been calculated on a sufficiently careful, caseby-case basis. Instead, rental debtors should be examined on a case-by-case basis and provisions made where there is sufficient likelihood that the rent will not be received.
Although the format of the legislation has changed with effect from 6 April 2017 for individuals, the basic rule still applies that remuneration of staff is not claimable in a period in which it is accrued in the accounts, unless it is paid within nine months of the end of the relevant period. However, accruing for the remuneration of staff of a property business is fundamentally just as valid as it would be in the case of a trading business.
Whilst landlords may not, in the past, have accrued for staff payments (including payments to closely related individuals), there seems no reason in principle why they should not do so provided that the ‘wholly and exclusively’ rule has been complied with, i.e. providing the remuneration accrued is fair and reasonable.
If the property concerned is sub-let, landlords should consider whether they have already effectively accrued a liability to make good dilapidations under their own lease with the head landlord. If such a liability is legally a present liability as a result of a past event (being the dilapidations, and the contractual obligation to make good those dilapidations under the lease), the requirements for a provision against profits to be made under generally accepted accounting practice will be met. Once again, this is something that landlords probably fail to take into account in many real life situations; however, the need to calculate profits on a prudent basis in the current financial situation may make this review worth undertaking.
Property income losses
As far as property income losses are concerned, the rules are radically different between limited company landlords and individuals.
In the case of companies, property income losses are offset automatically against other profits in the same accounting period, and if they exceed other profits (e.g. profits from trade or other investment income) they can be carried forward and offset against the other profits of the company in the next accounting period, or surrendered as group relief.
By contrast, individuals are only permitted to carry forward losses against profits from the same property business arising in future periods. HMRC seems inclined to interpret this requirement very strictly, and in the Property Income manual (at PIM4210), they make the statement that losses arising in one property business cannot be carried forward against:
• Profits of another rental business which the taxpayer has in a different capacity; for example, if a taxpayer has let property of his own and is a member of a partnership which has rental income, losses of his personal rental business cannot be set against his share of the partnership’s rental income.
• Profits of a current property business started after the one in which the loss arose has ceased.
• Property businesses which are treated as separate by statute, such as UK property businesses on the one hand and overseas property businesses on the other, or losses arising on a furnished holiday letting business, which can only be used against profits of the same furnished holiday letting business.
Incorporate the rental property business?
These rules relating to relief for property losses lead to a consideration of whether planning can maximise the effective and timely relief for property losses. It is very popular, at the moment, for promoters to recommend buy-to-let landlords transferring their personally-held property portfolios into limited companies, usually utilising the capital gains tax relief against tax on the transfer which is available for incorporation of a ‘business’ under TCGA 1992, s 162.
Very often, a spur for suggesting such an incorporation is the availability of mortgage interest relief in full against the profits, where that mortgage interest is paid by a limited company; contrasting with the disallowance of that interest in the hands of an individual for the purposes of higher rate income tax. But in addition to this potential benefit of incorporation, there is also the potential benefit in the event of property income losses that these losses can be offset against the company’s other income; a form of relief which is not available, as we have seen, in the context of an individual receiving property income and incurring property income losses.
Finally, an individual whose property interests are set out in a number of different holding structures could well find that the ability to ‘pool’ losses without going against HMRC’s views as set out in PIM4210 favours a rationalising of those different property holding interests.