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Commonhold vs. leasehold for flats
In this fact sheet, we’ll explore the benefits and drawbacks of both leasehold and commonhold flats so that you can make an informed decision for your property.
What’s the difference?
Leasehold is the most common type of property ownership, especially for flats. Under a leasehold arrangement, the property owner (known as the leaseholder) pays an annual sum to the freeholder (the owner of the land on which the property is built) for the right to occupy the property for a set period of time. This is typically 99 to 120 years, but can be as high as 999 years.
Commonhold is a newer type of ownership, established in England and Wales from 27 September 2004 by the Commonhold and Leasehold Reform Act 2002, Commonhold Regulations 2004 and Commonhold (Land Registration) Rules 2004. Under a commonhold arrangement, each flat owner becomes a member of a company that owns the entire building and its associated land for an indefinite period of time. This gives each owner a share in the management and upkeep of the property, and there is no need to pay an annual lease fee.
There are different Capital Gains Tax implications for leaseholds and commonholds. Long Leaseholds with over 50 years left can create tax issues, including SDLT, Capital Gains, Income Tax and Corporation Tax. You can read more about CGT issues in HMRC’s Capital Gains Manual. Essentially, if you dispose of a leasehold, interest and Capital Gains Tax will be payable on any profit you make.
Fortunately, ESC/D39 can be applied to lease extensions. These rules state that “the surrender of an existing lease and the grant of a new lease should not be treated as a disposal for the purposes of capital gains if the taxpayer so wishes and all of the following conditions are satisfied:
- The transaction, whether made between connected or unconnected parties, is made on terms equivalent to those that would have been made between unconnected parties bargaining at arm’s length;
- The transaction is not part of or connected with a larger scheme or series of transactions;
- A capital sum is not received by the tenant;
- The extent of the property under the new lease is the same as that under the old lease;
- The terms of the new lease (other than its duration and the amount of rent payable) do not differ from those of the old lease. Trivial differences should be ignored.”
Capital Gains Tax will not be payable on the disposal of a commonhold interest, as long as it is your main residence. These are the rules of the Principle Private Residence Relief Scheme.
However, it’s important to remember that the flats will still need some form of management, and with community ownership this can cause tensions within the building. To reduce any potential issues, members should sign a Commonhold Community Statement, which outlines the rules and regulations, for example, rules about subletting, pets, noise and use of gardens.
Flat management companies & tax
If you own or manage a flat management company, it’s important to be aware of the various tax implications. This fact sheet will highlight some of the key taxes that you need to be aware of, as well as some helpful tips on how to minimize your tax liability. By understanding the basics of taxation for flat management companies, you can ensure that you are in compliance with the law and avoid any penalties.
Most flat management companies are subject to Corporation Tax at a rate of 19%.
Many of these companies are set up under The Right to Manage (RTM), which is a process that lets qualifying leasehold tenants take over the management of their building, even without the agreement of the landlord. The tenant(s) must have been a property resident for at least 12 months, and the property must be their only or main home. To set up a flat management company, you must follow the normal process for setting up a private limited company.
If the following conditions apply, you may not need to complete Corporation Tax Returns or pay Corporation Tax:
- The only income received by the company is the service charges paid by the property owners.
- The income is spent on the day-to-day maintenance and management of the complex.
- Surplus income is transferred to deferred income for future maintenance expenses.
- No deposit interest is earned in the year.
Company Tax Return
Flat management companies must send a Company Tax Return to HM Revenue & Customs (HMRC) no later than 12 months after the end of their first financial year. This is because HMRC might decide that the company is dormant, which means that you wouldn’t need to submit returns from this company in future years.
HMRC may consider your company as dormant if the company does not:
- Allow directors who aren’t residents or leaseholders to be appointed in its articles of association.
- Do more than manage the property in the interests of shareholders.
- Make a profit.
- Need to pay more than £100 in Corporation Tax in a year.
- Get any income from land.
- Pay dividends or other payments from profits to shareholders.
- Own any assets it is likely to dispose of which would give rise to a chargeable gain.
- Make payments that need to be taxed.
HMRC will send you a letter if they consider your company dormant.
If any of the above criteria apply to your business or if HMRC does not confirm that they think the company is dormant, then you will need to complete yearly Company Tax Returns.
If HMRC has previously confirmed that the company is dormant and then the company starts doing any of the things listed above, they will need to submit a new Company Tax Return.
How to create a group using share exchange
Share for share exchange is a type of share transaction that allows two companies to reorganise their shareholdings without triggering Capital Gains Tax (CGT) or Stamp Duty. Under this arrangement, one company transfers its shares to another company in exchange for an equal number of shares in the second company. This type of share swap is often used when two companies are merging or joining forces in some way.
To do a share for share exchange, you must have genuine commercial reasons for doing it – it cannot just be to avoid tax. For example, you might want to create a group in order to separate trading and investment activities and enable an investment company to obtain mortgage finance.
The share exchange process
The process to create a group for share for share exchange involves 4 steps:
- Form the new companies
- Apply for HMRC clearance
- Create the contract
- Check Stamp Duty Relief conditions
Form the new companies
Holding companies are created to own a controlling interest in subsidiary companies. These are the most common ways of forming a group structure.
Assuming you are creating a new holding company with a new investment company, these need to be formed first. The process of registering a holding company is similar to registering other private limited companies. You can register online through HMRC online services or by post.
Apply for HMRC clearance
Although this step is not mandatory, it is best practice to apply for clearance of a transaction from HMRC. To do so, you need to submit a letter explaining the facts of the transaction, the group structure and the commercial reasons. Such a letter is typically 6 to 10 pages long.
You can also request advance clearance by emailing firstname.lastname@example.org with a note stating that you accept the risks associated with email and that you confirm that HMRC can email you.
Create the contract
Typically carried out by a solicitor, the share contract is a legal agreement between the acquiring company and the shareholders of the target company. It deals with how the shares are to be acquired and usually includes details such as pricing and payment dates.
Check Stamp Duty Relief
Because the acquiring company is paying consideration for the shares, in the form of its own shares, the transaction is subject to Stamp Duty.
However, relief can be claimed if certain conditions are met. Specific HMRC guidance on relief can be found on STSM042370. You will also need to ensure that the anti-avoidance rule of S77A FA 1986 does not apply.
Once the conditions have been checked and a claim has been prepared, you can claim relief by emailing email@example.com, explaining why you want to claim it. Put the type of relief in the subject line and attach a signed and dated scan of your stock transfer form. The claim needs to be made within 30 days of the contract date.
What is the Construction Industry Scheme (CIS)?
The Construction Industry Scheme (CIS) is a set of rules that apply to contractors and subcontractors who carry out construction work in the UK. The scheme is designed to ensure that HMRC receives the correct amount of tax from these businesses.
How does CIS work?
Under the CIS, contractors must deduct money from payments they make to subcontractors and pay this money to HMRC to cover the subcontractor’s taxes. They will also need to submit monthly CIS Returns to HMRC and verify each subcontractor’s employment and CIS status.
Who needs to register?
All contractors must register for CIS. It is not mandatory for subcontractors to register, however, most do because of a lower deduction from their pay.
Subcontractors who are registered for CIS get 20% deducted from their pay to be sent to HMRC to cover their tax. For subcontractors that are not registered for CIS, 30% is deducted.
Contractors register for CIS at the same time as registering as an employer. Subcontractors can register by phoning the HMRC Helpline at 0300 200 3210, or online through HMRC online services.
Which work is covered?
CIS covers construction works to a permanent or temporary building or structure, and any civil engineering work like roads and bridges.
Construction work includes preparing the site, demolition, building work, alterations, repairs, decorating, installing systems and cleaning up after the construction work. There are some exclusions, such as architecture, surveying, carpet fitting, scaffolding hire and delivery of materials.
A complete list of included and excluded work can be found in the CIS guide for contractors and subcontractors.
Monthly CIS returns
Contractors need to complete monthly CIS returns. The monthly returns inform HMRC about the payments and deductions made throughout the period.
The return must include all payments to all subcontractors in the month, regardless of the subcontractors’ CIS status or deduction rate. It is also necessary to declare that the subcontractors are not considered employees of the business.
To complete the return, you will need each subcontractor’s name, UTR and verification number, as well as the gross amount of payments made to each subcontractor, the total cost of any materials paid for by the subcontractor and the amount of tax deducted.
If you have months in which no payments were made to subcontractors, you must file a nil return to HMRC.
CIS subcontractor invoices must include the CIS deduction to show how much is being deducted and transferred to HMRC. This is usually included in the cost breakdown, above the total due.
In addition to the CIS deduction, the domestic reverse charge may apply to the sale if your business is registered for VAT. This means that you will have to apply the reverse charge to your invoices which means that the buyer will account for VAT rather than the supplier. To apply the reverse charge, you can zero out the VAT and add a disclaimer on the invoice “Domestic reverse charge: Customer to pay the VAT to HMRC”.
Do you need a 5% VAT certificate for construction work?
In the UK, the standard rate of VAT for most building services is 20%. However, a reduced 5% VAT rate can be charged for certain types of construction work, including:
- renovating a residential property that has been empty for more than 2 years.
- increasing the number of dwellings, such as converting a house into flats.
- converting a commercial building into a residential property.
- converting a house into an HMO (house in multiple occupation).
How to apply 5% VAT
It is up to the builder/contractor to determine whether (and on what services) the 5% VAT rate can be applied. To apply the reduced 5% VAT rate to construction services, the supplier must first get proof that they have applied the rate correctly, based on the criteria listed above.
For example, council tax records can be used as proof that a residential property has been empty for more than 2 years. For conversions to residential property or increasing the number of dwellings, a copy of the planning permission or architect’s plans can be used as proof.
Do I need a 5% VAT certificate?
In the majority of cases, you do not need to obtain a certificate. As long as you have the required proof to support your claim, HMRC will be satisfied.
However, a 5% rate certificate is required when renovating or converting a “relevant residential building”. This includes:
- an institution or home that provides residential accommodation for children.
- an institution or home that provides accommodation with personal care for persons in need of personal care.
- a hospice.
- residential accommodation for students.
- residential accommodation for members of any of the armed forces.
- a monastery, nunnery or similar establishment.
- an institution which is the sole or main residence of at least 90 per cent of its residents and will not be used as a hospital, prison or similar institution or a hotel, inn or similar establishment.
- a building that will be used solely for a relevant charitable purpose.
If your construction business undertakes works on one of these types of properties, you must obtain a certificate to apply the 5% rate.
How to obtain a 5% VAT rate certificate
For zero-rated supplies, the property owner can issue a certificate. However, for the 5% rate certificate, the supplier completes the certificate once they have determined that the supply is eligible (and has proof of eligibility).
The supplier will need to download and complete the “Zero-rated and reduced-rated building work certificate” from the “VAT Notice 708” page on gov.uk.
What are allowable property expenses?
Allowable expenses are business costs that can be deducted from trading income when calculating the business’ profits for tax purposes.
It’s important to note that some expenditure never qualifies for relief and some can only be claimed against the gain when you sell the property.
Below, we’ll outline the main allowable expenses for property landlords.
- Advertising expenses: Expenditure related to advertising the property for new tenants. This includes placing an advert in the newspaper or on a rental website.
- Bad and doubtful debts: A rental debt that is clearly irrecoverable or the amount estimated to be irrecoverable. This can only be claimed if you’ve taken all steps necessary to recover the debt.
- Cashback on loans: Depending on the terms of the cash-back scheme. For instance, if the scheme provides for a discount on the interest, the relief is limited to the net amount paid.
- Cost of providing services: In addition to renting a property, landlords may provide additional services. The costs related to providing these services can be deducted as long as the receipts they earn from them are included as part of their business income.
- Costs due to common ownership: If there are separate parts of a building that are not let out but are used by multiple commercial tenants, the landlord can deduct expenses related to the upkeep of those spaces.
- Expenses before renting: Some expenses can be claimed before the letting commences as “pre-trading expenditure” if the expenditure is solely related to the business and would have been allowed if it were incurred on the (letting) start date.
- Expenses for own home: Expenditure on a landlord’s own home cannot normally be deducted. However, if a landlord genuinely runs their property business from their home, they can claim extra costs such as lighting, heating and rent based on the portion used for the business.
- Fees for loan finance and similar: Costs incurred from obtaining a loan can be deducted as long as they relate exclusively to the property being rented on a commercial basis.
- Insurance premiums and recoveries: Insurance premiums may be deductible if they relate to your property business and are for either damage to the fabric of the property, damage to the contents of the property or loss of rent.
- Legal and professional costs: Legal fees are deductible if they are incurred for the purpose of the business. However, the fees cannot be claimed if they are considered capital expenditure or related to the purchase of a property.
- Rates and council tax: If the rental agreement states that the landlord is responsible for rates, the expenditure can normally be deducted. This includes business rates and water rates.
- Rent collection: Rent collection costs can be deducted provided it relates exclusively to commercial property rented out.
- Rent paid out: If rent is paid out wholly and exclusively for the purpose of the business, it may be deducted. For example, if the landlord occupies one part of the property and lets out the rest, the portion of rent related to the let out part can be claimed.
- Salaries and wages for employees: Wages and salaries for employees that help manage the property or land can be deducted, including normal pension contributions.
- Travelling expenses: Unincorporated landlords can choose to use a fixed rate mileage deduction, which is currently 45p/mile for the first 10,000 miles. There are several other ways to claim for travel expenditure, that you can find on gov.uk in the property income manual under section 2220.
What landlords should know about clause 24
Clause 24, also known as Section 24, is an amendment to the UK’s tax laws that restrict landlords from deducting finance costs from their rental income.
The legislation that was gradually phased in from 2017 to 2020 means that landlords cannot claim tax relief on mortgage interest, admin fees, loans for furnishings or other costs incurred from borrowing funds.
It was introduced to stop the highest-earning landlords from claiming back large amounts of tax relief and to help first-time buyers get on the property ladder.
Landlords now need to pay tax on the full amount of their rental income. Then, they can claim back finance costs up to the basic rate of income tax, which is currently 20%. If you’d like to learn more about how to claim, please view our fact sheet on the finance cost allowance.
Who does it apply to?
Clause 24 only applies to the following:
- Buy-to-let (BTL) properties
- Houses in Multiple Occupation (HMO)
- Partnerships and LLP’s
- Individual landlords
The rules do not apply to Furnished Holiday Lettings (including serviced accommodation if they meet the FHL rules), limited companies, commercial properties in mixed-use buildings and property development and trading.
What loans does it apply to?
Clause 24 applies to any loans that are related to an applicable property, including:
- Loans taken out to purchase residential property for the purpose of letting
- Loans taken out to buy an interest in a property letting partnership
- Existing mortgages and loans of a residential landlord
What costs does it apply to?
Section 24 applies to any finance cost related to the property. This includes mortgage interest and any incidental costs and fees related to the loan.
What if I remortgage?
Remortgaging and withdrawing capital has been a common practice for those that own buy-to-let properties.
However, under section 24, the mortgage is limited to the original property value (including Stamp Duty Land Tax and related costs) plus any improvement costs. In other words, you cannot deduct loan interest above the original purchase price.
Let’s say your rental income is £15,000 and your mortgage interest is £5,000.
Under clause 24, you’ll need to pay tax on the full amount of your rental income – this amounts to £3,000 if you’re a basic rate (20%) taxpayer.
You are then able to reclaim 20% of your mortgage interest under the finance cost allowance, which amounts to £1,000.
It’s important to note that you can deduct 20% of the lower of:
- Finance costs not deducted from income, or
- The profits of the property business, or
- The adjusted total income.
Therefore, you’ll pay a total of £2,000 of tax on your rental income (£3k – £1k).
How to account for construction retentions
This is common in construction projects where the customer will require you to fully complete the job and fix any defects before they release the funds.
Typical retention is 5-10% of the contract amount and the standard wait period is 6 – 12 months from the end of the contract.
If your business deals with projects that have retention, it’s important to ensure that the details of the retention are clearly stated in the contract.
How to record retentions
Accounting for retention can be confusing, especially when the waiting period spans financial years and VAT periods. However, they must be recorded correctly to avoid unnecessarily paying tax on income that is not guaranteed.
Retentions should be held in the balance sheet accounts because they shouldn’t be invoiced to the client or paid out to subcontractors.
On the balance sheet, they should be recorded under the ‘sales and sub-contract costs’ section. This can be recorded in one of the following ways:
- Include the retention in the turnover amount and estimate how much it will cost to do remedial works. Make sure to consider any possible debt impairment.
- Defer recording the retention until the retention payment has been received.
Recently, construction industry customers have been less willing to pay out retentions. This means that even if there are defects that need to be fixed, they are less likely to pay for them. In these cases, there will be no change in the net profit figure on your balance sheet.
VAT on retentions
In regards to VAT reporting, the tax point for retentions is when the VAT invoice is issued or when the payment has been received, whichever happens first.
It’s important to note that this tax point rule only applies to the retention portion of the contract. The standard project costs are subject to the standard tax point rules.
Your construction company has completed some work for a customer in which the total cost of the work amounts to £20,000. You have agreed with the customer that they will pay you 90% (£18,000) now and retain 10% (£2,000) for 6 months.
In your invoicing software, you will have to raise 2 invoices – one for the initial amount, and another for the retention. On the balance sheet, you can either:
- Add the £2,000 within turnover, include the estimated cost of remedial work and make provision for debt impairment (in case the customer doesn’t pay the retention).
- Delay recording the £2,000 until the receipt becomes virtually certain (i.e., it has been paid).
How to get a post-transaction valuation check (CG34)
Post-transaction valuation checks (PTVC) are offered for free by HMRC. They review your valuations and work out your Capital Gains Tax liability, which will help you complete your Self Assessment tax return. It is available to all taxpayers, individuals, trustees and companies.
The CG34 is not a required document, but if you do get one, it will protect you against HMRC questioning your valuation.
Who should get one?
Post-transaction valuation checks are beneficial in transactions between parties that are ‘connected’, such as developers and buyers of properties they develop or sell together.
The CG34 can be used for land, shares, goodwill and other assets that are subject to Capital Gains.
How do you request one?
You can only request a post-transaction valuation check after you have disposed of an asset that is subject to Capital Gains Tax, but before the date you need to submit your Self Assessment.
The CG34 form can be downloaded from the HMRC website. Once completed, you need to mail it to the relevant address on the last page of the form.
HMRC will need the details of the taxpayer, the valuation date and the proposed value on that date.
You may also need to submit supporting documentation, such as an independent valuation report. For land valuations, you will also need to provide:
- A copy of the current lease if it is a leasehold property
- Current tenancy agreements if the property is let at the time of valuation
- Plans showing the land location if it is undeveloped land
How long does it take?
It can take at least 3 months for HMRC to check your valuation. Therefore, it’s extremely important to send the CG34 form and all supporting documents a minimum of 3 months prior to your Self Assessment filing date. We recommended that you submit the documents as soon as possible after the disposal of the asset(s).
After the check
If HMRC agrees with your valuations they will not question your use of those valuations in your tax return, unless there are any important facts that you did not disclose to them. If HMRC does not agree, they will suggest alternatives and allow you to discuss your valuations with specialist valuers. You will still need to file your return by the due date.
Business expenses if you don't charge a market rent
There are several reasons why property owners might decide to charge a rent below market value or even rent for free. It has been common throughout the pandemic that landlords reduce the rent charged.
However, this means that the owner will have more limitations on what expenses they can claim.
What is a ‘market rent’?
HMRC do not have the power to tell a landlord how much to charge for rent. However, HMRC may ask for written confirmation if they believe you are claiming for expenses that you are not eligible to claim.
Although there are no set amounts, a standard rent amount can easily be found on rental websites such as Zoopla and Rightmove.
If HMRC request confirmation of market rent, it will need to be signed by a local letting agency.
Wholly and exclusively rule
When determining which expenses you can deduct, it is important to first check if the expense is used wholly and exclusively for business purposes. If so, then it can likely be deducted from the rent you charge the tenant.
If you rent a property for less than the market rate, you can only deduct expenses up to the value of the rent received.
In most cases, expenses that are not wholly and exclusively for business use cannot be deducted. However, there are a few exceptions such as electricity, in which you can claim the business proportion of the expense.
It is very common, especially during Covid, for property owners to rent a room or property to relatives or tenants rent free. However, this comes with risks. Since there is no rent to offset the expenses, all expenses will be fully incurred by the landlord.
Relatives & friends
When you rent to relatives, it is unlikely that the expenses of your property are incurred wholly and exclusively for business purposes. In this case, you will not be able to claim the expenses against the rent received.
A relative or friend can ‘house sit’ your property between lettings as long as your property is available to let and you are actively seeking tenants. If you meet these conditions, you can deduct expenditure in the normal way.
Timing of expenses
When a property is likely to be occupied rent free or at below-market rates, the landlord should seek to incur expenses related to their property while it is being let at a market rate. This will protect them from losing out on any potential deductions.
What is Multiple Dwellings Relief (MDR)?
Stamp Duty Land Tax (SDLT) is a tax on the purchase of property in England. Multiple Dwellings Relief (MDR) allows homebuyers to pay less SDLT if they are purchasing more than one dwelling in a single transaction. The relief is available to companies as well as individuals.
The rules surrounding the taxation of multiple dwelling purchases and what constitutes a “single” home are complex and best handled by a tax expert.
What is a “Dwelling” for MDR?
The Finance Act 2003 states that “a building or part of a building counts as a dwelling if—
(a) it is used or suitable for use as a single dwelling, or
(b) it is in the process of being constructed or adapted for such use.”
The dwelling must be self-contained and have its own entrance, kitchen, sleeping area and bathroom. For example, an annexe can be considered its own dwelling if it meets the above conditions, and any connected entrances are locked at the time of purchase.
When does MDR apply?
Multiple Dwellings Relief can be applied to purchases of more than 1 property in a single transaction or in “linked transactions”. Linked transactions occur when a buyer purchases several properties from the same seller, or from someone connected to the seller. Linked transactions do not need to be a single purchase, but can be a series of purchases over a period of time.
How to claim MDR
It is up to the buyer whether they wish to claim the relief or not. Both companies and individuals are eligible to claim.
When you purchase a property, the conveyancing solicitor or property accountant will calculate SDLT and MDR and claim it in the land transaction return.
However, if you are thinking about claiming MDR after the purchase of a property, then you can submit a refund paper claim directly to HMRC within 12 months of the SDLT return filing date for the purchase.
3% surcharge for existing homeowners
If you already own a home, there is a 3% surcharge on each additional residential home that you purchase, unless you are purchasing the property to replace your current home or the new property has a commercial portion, such as flats above a store.
The SDLT calculation
To calculate the SDLT due, you will first need to divide the total cost of the properties by the number purchased. For example, if you purchased 5 properties for £1m, this would equal £200,000. Then, you calculate the tax per property, which in this case would be £1,500 SDLT on £200,000. Lastly, multiply this amount by the number of properties – this would equal £6,000 (£1,500 x 4). This is less than the SDLT you would pay on the total purchase price because £200,000 is in a lower tax band.
Letting conditions for Furnished Holiday Lets
Many property owners opt to rent their property as a Furnished Holiday Letting (FHL). There are several benefits to FHLs including Capital Gains Tax relief and capital allowances for furniture and fixtures.
To access these benefits, there are several conditions that must be met for a property to qualify as a Furnished Holiday Let.
To qualify as a Furnished Holiday Let, the property must be in the UK or EEA, fully furnished and commercially let.
The 3 occupancy conditions
In addition to the qualification criteria, the property must pass all 3 occupancy conditions.
These conditions apply to the first 12 months of letting for new lets, or to the tax year (6 April – 5 April) for continuing lets.
1. The pattern of occupation condition
If the total of long-term lets (31+ days) exceeds 155 days in the year, then this condition is not met and the property will not qualify as an FHL.
The reasoning for the limit is to reduce the possibility of property owners accepting long-term lets and passing them off as holiday lets to access the tax benefits.
2. The availability condition
The property must be available for at least 210 days in the year to qualify as an FHL. This excludes any days that you or your family stayed at the property.
This rule was introduced to ensure that the property is genuinely available as a commercial let with the goal of earning a profit.
3. The letting condition
The final condition is that the property must be let as furnished holiday accommodation to the public for at least 105 days in the year. This does not include long-term lets of 31 days or more or days that you stayed at the property.
However, if your holiday let failed to attract 105 days of paying guests, there are 2 options to help you reach the threshold:
- The averaging election: if you have more than one property.
- Period of grace election: if your property reaches the threshold in some years but not in others.
The averaging election
If you have more than one holiday let, and one or more of these properties is not meeting the letting condition, you can use the average occupancy of all FHLs you let.
This is particularly useful if you have a high level of occupancy in one property but are struggling to achieve the occupancy level in a new property.
Period of grace election
If you genuinely intended to meet the letting condition but were unable to, you may be able to make a period of grace election that allows the property to qualify as an FHL as long as the other 2 conditions were met.
To make an election, you must have met the letting condition in the previous year or provide proof that you genuinely attempted to reach the threshold.
Rules for CIS contractors
The Construction Industry Scheme (CIS) is an HMRC scheme for workers in the construction sector. Businesses that employ subcontractors are required to register for CIS.
The CIS establishes rules for the payment of subcontractors. A portion of the subcontractor’s pay is deducted and transferred to HMRC as tax deductions.
The contractor is responsible for deducting the sum from the subcontractor’s wage and submitting it to HMRC.
As a contractor, you must register with the CIS if you hire subcontractors to carry out construction work, or you have spent more than £3 million on construction in the 12 months since you made your first payment.
You will need to register as a subcontractor if you do construction work for a contractor.
Here are some rules that CIS contractors must follow:
- Before you begin working with subcontractors, you must first register for CIS. This can be done online on gov.uk by registering as an employer.
- Check the HMRC employment status rules to see if you should employ the individual rather than subcontracting the work. If they should be a worker rather than a subcontractor, you might incur a fine.
- Check with HMRC to ensure that your subcontractors are correctly registered with the CIS. You can verify a worker’s status using the HMRC CIS online service.
- When you pay subcontractors, it’s usually necessary to make deductions from their payments and remit the funds to HMRC. Deductions are considered advance payments towards the subcontractor’s Income Tax and National Insurance obligations. The amount deducted for registered subcontractors is 20%, however, if the subcontractor has ‘gross payment status’, no deductions are made.
- You’ll need to submit monthly returns to HMRC and maintain complete CIS records – you could face a fine if you don’t. You can file returns by using the HMRC CIS online service. If you did not make any payments in a month, you do not need to file a return, but you will still need to tell HMRC that no return is due.
- Any changes to your business must be reported to HMRC. This includes changes to your address, business structure or trading status. You can contact HMRC via webchat or phone.
How does the finance cost allowance work?
Finance costs are any costs involved in borrowing money to purchase or build assets. Finance costs for residential landlords include mortgage interest, loan interest to furnish the property and any fees incurred when taking out or repaying a mortgage or loan.
From 2021 onwards, individuals can claim a 20% deduction from their Income Tax liability for the sum of finance costs that were not deducted when calculating the profit. Any unused costs can then be carried forward to the next tax year.
How does it work in practice?
For example, Tom is a residential landlord with the following income and finance costs in the tax year:
Property losses carried forward
Finance costs carried forward
Here’s how Tom would calculate his Income Tax liability using the numbers above:
He would be taxed at the following rates:
- Personal Allowance £12,500 at 0% = 0
- Basic Rate £37,000 at 20% = 7,400
- Higher Rate £0 at 40% = 0
Therefore, Tom’s Income Tax liability before the Residential allowance would be £7,400.
The tax reduction is the basic rate value (20%) of the lower of:
1. Unused finance costs
Any finance costs not deducted in this tax year. In Tom’s case, this would include £10,000 of mortgage interest and £2,000 of costs carried forward from the previous tax year. This comes to a total of £12,000.
2. Property business profits
Any profits of the property business in the tax year after deducting any losses carried forward. In Tom’s case, this would total £4,500.
3. Adjusted total income
Total income (after losses and reliefs) that exceeds your personal allowance. In Tom’s case, this would be £37,000.
The lowest value is the property business profits which are £4,500. Therefore, the basic rate (20%) tax reduction is £900.
Tom then deducts that from his pre-reduction tax liability: 7,400 – 900 = 6,500.
£6,500 is Tom’s final tax liability after the tax reduction. The remaining unused residential finance costs can be carried over to the following tax year.
If you need help calculating your finance costs or income tax liability, please give us a call and we’d be happy to help.
How to register for CIS
The Construction Industry Scheme (CIS) is an HMRC initiative that outlines how subcontractors should be paid. Most businesses and workers in the construction industry must register for the scheme.
Registering as a contractor
There are 2 types of contractors: mainstream contractors and deemed contractors. Both must register for CIS.
If your business is in construction and you pay other construction workers, you are considered a mainstream contractor.
If you do not do construction work but you have spent more than £3 million on construction in the 12 months since you made your first payment, then you are considered to be a deemed contractor.
You must register in the 2 months prior to making your first payment.
To register for the Construction Industry Scheme, you must register as an employer on the HMRC website. During registration, make sure to choose the PAYE option and tick the box “will you be engaging any subcontractors in the Construction Industry?”
You will also need to enter your:
- Business UTR
- Business contact details
- Your National Insurance Number
- Start date
Once you’ve completed the online form, you’ll receive a letter from HMRC within 5 working days with your PAYE reference number and the information you need to start working as a CIS contractor.
Registering as a subcontractor
A subcontractor is a self-employed worker who is hired by a contractor. To register for CIS as a subcontractor, you’ll need your:
- Legal business name
- Trading name (if applicable)
- National Insurance Number
- Business UTR
- VAT number (if applicable)
If you do not have a UTR, you can register as a new business for Self Assessment and choose the option “working as a subcontractor” when prompted. You’ll then be registered for Self Assessment and the CIS at the same time.
If you’re both a subcontractor and a contractor, you will need to register for CIS twice.
You can register by phoning the HMRC Helpline at 0300 200 3210, or online through the Government Gateway service. If you register online, you’ll need your Government Gateway ID and password you received when you registered for Self Assessment.
It’s beneficial to check if you would like to apply for gross payment status prior to registering. This means contractors will pay you in full, without deductions. You will then be responsible for paying all your tax and National Insurance at the end of the tax year.
You can register for gross payment status when you register for CIS. You will need to demonstrate that you have paid your taxes on time in the past, that your business does construction work and that your business is run through a bank account. Your turnover from the previous 12 months must also exceed £30,000 if you’re a sole trader.
What's the difference between cash accounting and traditional accounting?
When you start a new business, you need to make several decisions. One of the most important decisions you’ll make is whether to use the cash basis accounting method or the traditional accounting method.
Cash basis accounting
Cash accounting, also referred to as cash basis accounting, records financial events when payment is made or received, rather than when an invoice was sent.
Cash accounting is best suited for small businesses because you only need to declare money when it comes in and out of your business.
You can only use the cash accounting method if you run a small self-employed business with a turnover of less than £150,000 a year. Limited companies and limited liability partnerships cannot use cash accounting.
Cash accounting is the default basis for landlords. If a landlord wishes to use traditional accounting on their Self Assessment, they will need to select that option on their tax return.
VAT cash accounting
The VAT Cash Accounting Scheme follows the principles of cash accounting. This means that you pay VAT on your sales when your customers pay you, and you reclaim VAT on purchases when you have paid suppliers.
For many businesses, the scheme improves cash flow as you do not pay VAT until you receive payment from your customer. To join the scheme your VAT taxable turnover must be £1.35 million or less.
Traditional accounting, also known as accrual accounting, records financial events right when they happen, rather than when payment is made or received.
In other words, an income or expense is recorded for tax purposes when the job is ordered, even if you have not received or sent the money.
Limited companies and limited liability partnerships must use the traditional accounting method.
This is because directors of companies must prepare a balance sheet and a profit and loss account that give a true overview of the state of the company at the end of the financial year. To have a complete overview, they must enter all sales and purchases in the accounts, not just the ones that have been paid.
Traditional accounting portrays a more accurate statement of the company’s health and makes it easier for senior management to create budgets and plan for the future.
As an example, a construction business provides a £5,000 service to a client on 30 October. The client receives the bill for the services rendered and makes a cash payment on 20 November.
Under the cash accounting method, the transaction will be recorded in their books on 20 November. Under the traditional accounting method, the transaction would be recorded on 30 October.
How to claim your £1,000 property allowance
Landlords can get up to £1,000 in rental income tax-free every year under the Property Income Allowance. If you own a property with others, you can each claim the allowance against your share of the gross rental income.
The property allowance applies to:
- Domestic and overseas property businesses
- Commercial & residential lettings
There are some important exclusions, with the most notable being any rent-a-room receipts and partnership properties.
If you earn less than £1,000 from rental income in the tax year, you don’t need to do anything because it’s tax-free.
However, if you earn more than £1,000 from UK and overseas property income, then you will need to decide if it’s worthwhile to use the property allowance, or if it would be more cost-effective to claim your expenses. It is not possible to claim both.
You can decide each year which is better – £1,000 or the actual costs. Elections must be made by the 31st of January following the tax year.
Is it worth claiming the property allowance?
If you’re renting out a buy-to-let or a second property, usually your expenses are higher than £1,000 a year, so only use this allowance if you misplace your receipts or if you only incurred a few expenses.
However, you can review your expenditure each year and make a choice. You can also give us a call if you would like further advice.
Adam rents out his second home in which he has £1,200 of relievable receipts in the year. He also has legal fees of £150 from drawing up a rental agreement between him and the tenants.
Adam elects to use the property allowance for partial relief. Here’s how he would calculate it:
1. Calculate the total receipts of the relevant property business:
Calculate the total income related to the property business. For Adam, this amounts to £1,200.
2. Subtract the deductible amount from receipts:
The £1,000 allowance is subtracted from the total receipts for Adam’s property business. £1,200 – £1,000 = £200.
Therefore, Adam’s taxable profit from his property is £200.
The £150 legal fees are not brought into account because you cannot claim both the property allowance and expenses.
VAT on early termination fees, compensation, and dilapidation payments
From April 2022, HMRC’s guidance was changed to reflect their new stance on the VAT treatment of early termination fees, compensation, and dilapidation payments. This means that payments that were previously considered to be outside the scope of VAT are now considered to be subject to VAT.
This factsheet covers the issue of whether supplies are within the scope of VAT, not whether VAT should be charged. Property supplies are generally VAT-exempt, although it is possible to opt to tax a property, in which case supplies of that property are standard-rated.
The general rule
The key test to consider is whether goods or services are being provided in return for a consideration (usually a payment). This is known a “reciprocity” between the supplier and the customer. If the reciprocity exists, the transaction is subject to VAT.
Previously, HMRC considered payments described as “compensation” or “damages” to be outside the scope of VAT on the basis that there was no reciprocity. However, because of numerous court rulings, such payments are deemed to be subject to VAT, particularly if they are provided for in a contract.
Early termination of a contract
A contract may provide for the tenant to pay fees in the event of terminating a contract early, as in the case of lease surrenders. Such fees may be described as “early termination fees”, “compensation” or “liquidated damages”.
If the tenant of a vatable commercial property wishes to vacate the property before the end of the lease and is obligated to pay an early termination fee, the payment will be subject to VAT. This is because it is a payment being made in return for a service provided by the landlord. The service, in this case, is the right to use the property, even if the tenant does not wish to do so.
When the contract does not provide for early termination
When early termination fees are paid and the initial contract did not provide for those fees, the fees are still subject to VAT. This was shown in a VAT tribunal involving Lloyds Bank, which found that the landlord had made a supply by granting and exercising an option to terminate the lease in return for Lloyds making a payment and vacating the premises.
It’s worth noting HMRC’s position regarding reverse surrenders. Reverse surrenders are when the landlord pays the tenant in order to terminate a lease early. In this case a supply is being made by the tenant and it will be either VAT-exempt or standard-rated depending on whether the tenant has opted to tax their interest in the property.
Dilapidation payments, which exist to ensure the landlord is not out of pocket if the premises are not returned in the agreed condition at the end of the lease, are considered by HMRC to be outside the scope of VAT.
Generally, this is because dilapidation payments not inevitable at the beginning of the lease and are made so the landlord can return the property to its original condition. There is no reciprocity in this situation because the landlord has not received anything. HMRC say however, that they may depart from this view if in individual cases they find evidence of value shifting from rent to dilapidation payment to avoid accounting for VAT.
HMRC’s VAT Supply and Consideration manual gives further examples – see VATSC05910, VATSC05920 and VATSC05930.
Making Tax Digital for Property Landlords
In this fact sheet, we’ll outline how Making Tax Digital (MTD) for income tax self assessment (ITSA) affects landlords. We’ll also consider the recent government communication in which a delay to MTD was announced.
What is MTD?
Under MTD for ITSA, businesses, self-employed individuals, and landlords will keep digital records and send a quarterly summary of their business income and expenses to HMRC using MTD-compatible software. In response, they will receive an estimated tax calculation based on the information provided to help them budget for their tax. At the end of the year, they can add any non-business information and finalise their tax affairs.
Implementation and thresholds
In December 2023, the government announced that the implementation of MTD for ITSA would be phased in from April 2026. Previously, MTD had been due to start from April 2024. The phased implementation will work as follows:
From April 2026: self-employed individuals and landlords with an income of more than £50,000 will be required to keep digital records and provide quarterly updates of their income and expenditure to HMRC through MTD-compatible software.
From April 2027: self-employed individuals and landlords with an income of between £30,000 and £50,000 will need to comply with the MTD rules.
These thresholds are new; prior to the December 2023 announcement the threshold for MTD was set to be £10,000.
At this point, it is unclear if those with income below £30,000 will be mandated to comply with the MTD rules.
Keeping digital records
Under the MTD rules, business records must be kept in software that meets HMRC’s specifications.
If you have more than one business (for example, if you are a landlord and a builder), you must meet the requirements for each business.
This means you must keep separate records and make separate submissions for each business.
All properties that are:
- in the UK are treated as one ‘UK property business’.
- outside of the UK are treated as one ‘overseas property business’.
In the software, you’ll need to create records of each of your business transactions, as close to the transaction date as possible. Each quarter, the software will add together the totals for each income and expense category and send this information to HMRC. If you wish to make accounting or tax adjustments to the quarterly information, you can, but it won’t be mandatory. Instead, any adjustments and claims for tax reliefs can be made at the end of the year when you finalise the data.
Benefits of digitalisation
The delay to MTD’s implementation was welcomed by many, but it is worth considering moving to digital record keeping before 2026. Digital record keeping means that you don’t need to keep as much paperwork, and you’ll be able to access real-time information about your business. If these benefits interest you, please speak to us about the software options available.
Why you should not buy a holiday let if you intend to stay in it
Holiday lets are a great investment and offer several benefits including Capital Gains Tax relief and capital allowances for furniture and fixtures. However, there are strict letting conditions, and if you intend to stay in the property for part of the year, this could mean that the property no longer qualifies as a holiday let.
Let’s take a look at some taxes that might become payable by staying in your holiday let. These do not apply if you do not stay in the property.
Annual Tax on Enveloped Dwellings (ATED) is a tax that companies must pay if their UK residential property value exceeds £500,000. The tax is payable by companies that own such a dwelling and the amount of tax payable depends on the property’s value.
You will need to complete an annual ATED return if the property is located in the UK, is considered a ‘dwelling’ (a sufficiently self-contained unit), is valued at more than £500,000 and is owned completely or partly by a company, partnership or collective investment scheme.
The chargeable amounts for the 2022/23 tax year are as follows:
£500,000 – £1 million
£1 million – £2 million
£2 million – £5 million
£5 million – £10 million
£10 million – £20 million
More than £20 million
Benefit in Kind
Benefits in kind (BIK) are benefits that directors or employees receive from their company that are not included in their salary. This may include property and living accommodation benefits.
If a company purchased a holiday let for its director(s), you should check how much tax you will need to pay and for how much of the year it applies. You can find a detailed example below.
An HMRC example of a BIK case can be found in EIM11421. To sum up, a UK company purchases a flat in France for £200,000. The market rental price for the property would be £500 per week during the 6-month skiing season and £100 per week during the rest of the year. A husband and wife who are both directors of the company use the flat for holidays 4 weeks per year (3 weeks during ski season and 1 week during the slow season). The sole reason the property was bought was as a holiday home for the couple and it has only been used as such.
Because the flat was habitable for the entire year, HMRC would seek a benefit measured on availability for the whole year (even though they only use it for 4 weeks).
Therefore, a cash equivalent for the tax year, under Section 106 ITEPA 2003, would be £15,600. This is calculated as 6 months of ski season at £500/week (£13,000) and 6 months off-season at £100/week (£2,600).
If the property was personally owned, different tax rules would apply and the bill would be significantly lower.
Please contact us if you would like to know more about ATED and any exemptions that may apply. We can advise you on the best (and most tax-effective) way to proceed.
Should HMO or buy-to-let landlords set up a limited company?
There are several considerations to take into account when deciding whether or not to set up a limited company for your HMO or buy-to-let business. Some key factors to consider are the level of personal liability you’re willing to accept, the tax implications, compliance requirements and mortgage relief.
The benefits of setting up a limited company
If you’re operating as an Unincorporated property investor, you’ll be personally liable for any debts or losses incurred by the business. This means that your personal assets, such as your home, could be at risk if the business fails. A limited company offers limited liability protection, which means that you’re only liable for the debts of the company up to the amount you have invested.
The introduction of Clause 24 is another motivator to set up a limited company. This restriction was implemented in 2017 to reduce the amount of mortgage interest that can be claimed as a cost against residential property letting. It was introduced gradually, and as of 2021, the interest costs are now disallowed and replaced with the Finance Cost Allowance. For higher rate taxpayers this has a major impact. However, this does not apply to limited companies. Companies will continue to claim 100% of interest.
If you do set up a company for the reason of Clause 24, it’s important to recognise that it would be beneficial to set up a separate company for each property investment. This will simplify your taxes, allow you to sell shares at 0.5% Stamp Duty (instead of selling the property), and make Inheritance Tax Planning simpler. In addition, Capital Gains Tax will be 8% lower on selling shares and based on the net asset value of the company (allowing the offset of borrowing).
Another tax advantage of setting up a company is that you’ll no longer have to pay income tax on your profits. However, you will have to pay corporation tax which is currently at 19% but is set to increase to 25% from 2023. Therefore, if you’re in the 40% tax band, a company could significantly reduce your bill.
Single property companies are better if you want to shop around for borrowing, as the lender can take a charge over the property and debenture over the company.
The drawbacks of setting up a limited company
Some drawbacks of setting up a limited company as an HMO or buy-to-let landlord include:
- Limited mortgage deals: There are not many mortgage providers that lend to companies, so your choice will be restricted.
- Disclosure: Companies have to publicly disclose details about their business, including the registered address, date of incorporation and current officers. This may deter some landlords.
- Transferring properties into the company: If you already own a property and wish to transfer it to a limited company, you need to go through the standard sale and purchase procedures. All standard taxes will be payable.
If you have one property, then it may be better for you to continue as an Unincorporated property investor. However, if you’re near the tax threshold of £50,000 or plan to expand your portfolio, then it’s worth considering setting up a limited company.
How to set up a company
HMRC offers a step-by-step guide to walk you through the process. You can register online or via post and you’ll be registered for Corporation Tax simultaneously. Alternatively, if you would like us to set up a company on your behalf please get in touch.
How to account for a property management company
Property management companies let properties they do not own and are responsible for their day-to-day operations and repairs. It is an industry that has grown exponentially in the past decade due to low startup costs, huge housing demand and the potential for large profits.
All property management services are VATable if the company reaches the VAT threshold or voluntarily registers.
Property management companies receive the majority of their income from the fees they charge to the property owners. They can then offset their business expenses from their income, for instance, office costs and insurance.
Since property management companies do not own the properties they manage, they will need to keep their client accounts in separate ‘control accounts’ on the balance sheet.
A control account is a summary account that shows the overall balance of a specific category. For property management companies, this may include:
Rent from tenants
Once the fees and management costs have been deducted from the rent received, the net amount is then passed along to the property owner.
It is essential to maintain your control accounts and to reconcile them on a monthly basis (if applicable). This will help to ensure that the company’s financial position is accurate and up to date.
In addition, the control account can be used to track the performance of the company’s properties. For example, if a property is not generating enough income to cover its expenses, this will be reflected in the control account. As a result, control accounts are essential tools in this type of business.
Property management companies should also consider separating their own bank accounts and ledgers from their client accounts.
This way, you’ll keep your business administration costs separate from the income and expenses relating to your managed properties.
Keeping these accounts separate will give a clear picture of where the company’s money is coming from and going to. It will also make it easier to track expenses and budget for future needs. Therefore, it is advantageous to have separate accounts for service and administrative operations.
There is different software available that can help property management companies manage their business and accounting. Feel free to reach out to us for recommendations.
When to recognise revenue on services provided
Revenue recognition often causes confusion among contractors and subcontractors, but it is essential to get it right to avoid HMRC investigations. Construction contracts can often span several months and reporting periods. Let’s take a look at how construction workers should recognise revenue.
Work in progress
Work in progress (WIP) is a way of recording income before a job has been invoiced. Since income and corresponding expenses often don’t occur in the same period, it’s important to recognise the progress of contracts within a reporting period or tax year, if applicable.
When you can reliably estimate how much money you will earn from a contract, you should recognize that income as it becomes available. This means that if you have completed most of the work but have not yet been paid, you should still count that income in your financial reports.
In other words, it should be recognised gradually, based on the stage of completion of the transaction at the end of the reporting period.
According to The International Accounting Standard IAS 18, the transaction can be estimated reliably when all the following conditions are met:
- The amount of revenue can be measured reliably.
- It is probable that the economic benefits associated with the transaction will flow to the seller.
- The stage of completion of the transaction at the end of the reporting period can be measured reliably.
- The costs incurred to date for the transaction and the costs to complete the transaction can be measured reliably.
If it’s not possible to reliably measure the outcome of a job, then you can only recognise revenue up to the amount of money that was spent to provide the service.
Determining the stage of completion
Although there are no set rules for calculating the stage of completion of a project, some common methods include:
- Comparing the costs incurred to date to the total contract cost.
- Comparing the services performed to date to the total services to be performed.
- Surveys of work performed.
It would be beneficial to prepare a Cost Value Reconciliation (CVR) or Cost Value Comparison (CVC) report to show the value of the work completed to date as well as the profit.
For example, a contractor has a job worth £200,000. The estimated total budget is £150,000. If the costs incurred to date are £30,000, the contractor will divide the costs incurred by the estimated budget (£30,000/£150,000 = 0.2). Therefore, the percentage of the job completed is 20%.
By multiplying the percentage of the job completed by the contract amount (0.2 x £200,000), the amount that should have been billed to date is £40,000.
This is one way to calculate the stage of completion. If you would like to learn more about this, please contact us.
How to check if your supplier invoice is correct for input tax
Many business owners have made the mistake of purchasing business supplies in their own name rather than the business’s name. Or if you have multiple companies, the purchase invoice may be directed at the incorrect company.
However, in the eyes of HMRC, invoices that are not directed to the correct company may be invalid for reclaiming VAT.
As a general rule, you should always ensure that if you are purchasing business supplies, the invoice states the correct business name.
Supplies to employees
Business owners can reclaim input tax on supplies to employees in certain circumstances. Supplies to employees include expenses such as fuel, accommodation and meals.
To reclaim input tax on supplies to employees, the supply must be paid for by the employer for the purpose of the business.
For instance, you can reclaim input tax on fuel expenses to a work site. However, you should not claim fuel expenses that are not work-related.
Simplified VAT invoices
When the total amount due on a business’s invoice is under £250, they can issue a simplified invoice. Simplified invoices do not need to include the customer’s name and address.
You can reclaim input tax with a simplified invoice as long as it includes all of the mandatory information:
- The supplier details
- An invoice number
- The tax point (the transaction date)
- A description of the products/ services sold
- The VAT rate(s)
- The total (gross) amount due
If the simplified invoice is above £250 or does not include the mandatory information, you must contact the supplier as soon as possible. Make sure you document your attempts of getting a valid invoice in case HMRC ask for it.
Reclaiming VAT without a valid invoice
If you do not have any luck obtaining a valid invoice, there are other ways that you can prove the sale to HMRC.
You will need to prove to HMRC that:
- There has been an actual supply of goods and/or services to your business.
- Your business received the goods and/or services.
- You have some form of documentary evidence to support the claim.
Any additional documentation would be helpful to your claim – including contracts, purchase orders, email correspondence, bank statements, etc.
The information you provide will be reviewed by HMRC staff who will have the final decision on whether or not your deduction request is approved.
CIS - Are you a property investor or developer?
Most Construction Industry Scheme (CIS) documentation only refers to contractors and subcontractors. However, there are other classifications in the case that your job doesn’t entirely fit into one of those categories.
This fact sheet explains the differences between property developers and property investors and how they are categorised for CIS tax purposes.
What is a property developer?
A property developer is described as an individual or entity that constructs new buildings, renovates existing buildings or takes part in other civil engineering works.
Property developers are considered ‘mainstream contractors’ for CIS purposes.
Mainstream contractors must register with the CIS if they hire subcontractors to carry out construction work, or if they have spent more than £3 million on construction in the 12 months since their first payment.
Mainstream contractors are also responsible for deducting a portion of each subcontractor’s pay and transferring the amount to HMRC, as well as submitting monthly CIS returns.
What is a property investor?
A property investment business isn’t the same as a property developer. A property investor buys or sells buildings for capital gain or rental purposes.
A property investment business has a number of properties it needs to prepare before letting. Minor refurbishments are generally required in order for those buildings to be suitable enough to let.
Property investors are considered ‘deemed contractors’ for CIS purposes if they spend over £3 million on construction in a 12 month period.
Deemed contractors include property investors, local authorities and housing associations. They generally do not carry out construction work but have exceeded the £3 million threshold on construction work in the 12 months since their first payment.
It’s important to monitor your construction expenses if you think you’re likely to become a deemed contractor.
The scheme must be applied for any work done on property that is:
- not used by the business for business purposes
- for sale or to let
- is held as an investment
Property investors do not need to apply for the CIS if the construction expenditure is solely for their business property, for instance, an office.
Deemed contractors follow similar rules as mainstream contractors. They must register for the CIS, verify each subcontractor, make deductions from subcontractors’ paychecks and submit monthly returns to HMRC.
How does the Rent a Room Scheme work?
With the Rent a Room Scheme, you can earn up to £7,500 per year tax-free from letting out furnished accommodation in your home.
Although the name suggests renting a single room, you can actually rent out as much of your home as you’d like.
If you share the income with your partner or anyone else, then the threshold is halved. In other words, each person would get a £3,750 tax exemption.
Who can use the scheme?
You are able to opt-in to the scheme if:
- you rent a furnished room to a lodger
- you run a guest house, B&B or other letting activity that amounts to a trade
You do not need to own the property, however, if you’re renting, you will need to get permission from your landlord to sublet.
Who can’t use the scheme?
As with most HMRC schemes, there are strict eligibility rules. You cannot use the Rent a Room Scheme if the accommodation is:
- not part of your main home when you rent it
- used as an office or for business purposes
- in your UK home and is rented while you live abroad
- converted into separate flats
How do I claim the £7,500 tax exemption?
If you earn less than £7,500 per year from letting the room(s), then the tax exemption is automatic and you don’t pay any tax on your profit.
If the gross profits are above £7,500 per year, you must complete a Self Assessment tax return. In this case, you can choose to either:
1. Pay tax on your actual profit:
Your actual profit is your total receipts minus any expenses and capital allowances.
2. Pay tax on the amount exceeding the £7,500 limit:
Your taxable profit would be your gross profit minus £7,500. If you choose this method, you cannot subtract expenses or capital allowances.
It would be beneficial to calculate your profits using both methods and choose whichever method produces the lowest amount.
HMRC will automatically use your actual profit to calculate how much you owe. If you would prefer to pay tax on the amount exceeding the £7,500 limit, then you will need to contact HMRC.
Can I transfer my investment income to my spouse?
The rules for income from assets jointly owned by married couples can be tricky. There are a few things to take into consideration in order to make the transfer as tax-efficient and compliant as possible.
HMRC have outlined specific anti-avoidance rules to tackle situations where they consider you may be shifting income purely for the sake of saving tax. It’s important to ensure that you’re following the rules.
If only an income stream (for instance, rental income) is transferred to your spouse, and you continue to retain an interest in the capital value of the property, then you (the transferor) will continue to be taxed on the income.
If you would like to transfer the income and the tax obligation to your spouse, then you will also need to transfer an equal proportion of capital interest.
For example, if you would like to transfer 75% of the rental income to your spouse, a 75% interest in the capital value of the property must be transferred as well.
HMRC automatically taxes rental income at an equal fifty-fifty basis for married couples. If you wish to be taxed at a different (unequal) split, you must complete Form 17 on the HMRC website. Form 17 is used to declare an unequal interest for jointly owned property. It must be completed within 60 days of making the transfer and you need to resubmit the form any time there is a change in the allocation of interest. If this is not done, then your interest will automatically revert back to a 50/50 split.
Transfers and taxes
Luckily, you do not pay Capital Gains Tax (CGT) on transfers of capital assets between spouses, as long as you were not separated at the time of the transfer and it was not a business-related transaction.
However, Stamp Duty Land Tax (SDLT) is still payable on transfers of property between spouses if the amount transferred is over the SDLT threshold, which is currently £125,000.
For example, let’s say you own a property and have an outstanding mortgage of £300,000. If you were to transfer 50% of the property to your spouse, your spouse also takes on 50% of the mortgage (£150,000).
SDLT is charged on the amount of “consideration” given. In this case, £150,000 of “consideration” has been transferred, which is above the SDLT threshold.
Based on the current SDLT rates, your spouse would pay 0% on the first £125,000 and 2% on the remaining £25,000. This comes to an SDLT payable of £500.
If the investment property was previously your main residence, please be advised that you may lose private residence relief.
A transfer of ownership doesn’t mean you need to transfer the legal title. However, it would be beneficial to write an agreement about how the property is transferred to satisfy HMRC.
Can I submit micro-entity accounts?
More than half of all limited companies registered in the UK are considered micro-entities.
Micro-entity accounts are becoming increasingly popular among property investors as they save both time and money compared to full annual accounts.
What is a micro-entity?
A business is considered a micro-entity if it meets at least 2 of the following conditions:
- a turnover less than £632,000
- less than £316,000 of assets on its balance sheet
- less than 10 employees
There are certain companies that cannot qualify as micro-entities, including charities, credit institutions, and investment undertakings.
The majority of property investment companies are not investment undertakings. Investment undertakings have shareholders with no involvement in the operation of the business or have multiple properties in the same company. Please contact us if you would like to learn more about this.
The benefits of micro-entity accounts
If your company is a micro-entity, you can prepare simpler accounts, benefit from exemptions and you will only be required to send a simplified balance sheet to Companies House.
The main advantages of micro-entity accounts for property investors include:
- Preparing a simplified balance sheet and profit and loss account.
- Accounting notes aren’t required.
- Only the balance sheet needs to be submitted to Companies House.
- You must use historical cost rather than fair value.
- Directors’ reports aren’t required.
Fair value vs. historical cost
If you’re a property investor filing full accounts, you must report property values at their fair value. This means that you must accurately report how much you think the property is worth. You may not want to do this if you’re planning to sell the property, as this might hinder negotiations.
On the other hand, with micro-entity accounts, you cannot use fair value and instead have to use the historical cost which most property investors will prefer.
Historical cost is the original value of the property at the time it was purchased.
How to file micro-entity accounts
You can file your accounts with HMRC and Companies House at the same time from the HMRC website.
Even if you’re familiar with preparing a balance sheet or P&L, micro-entity accounts can be complex as the abridged version requires different information than the full version. Please contact us if you would like our help preparing your accounts.
VAT rules for serviced accommodation
Residential rent is a VAT exempt supply, however, serviced accommodation is treated as holiday accommodation and is subject to VAT.
This fact sheet explores the VAT obligations of serviced accommodation businesses.
As a holiday accommodation business, you cannot charge VAT unless you are registered for VAT. You are only required to register for VAT if your VAT taxable turnover exceeds £85,000 in any 12 month period.
Your VAT taxable turnover is the total value of your taxable sales. In other words, your total sales minus any VAT-exempt items.
If your accommodation business reaches the £85,000 threshold, you can register for VAT on the HMRC website. The process is fairly straightforward, just make sure you have details like your turnover, business activity and bank information at hand.
After registering, you will receive your VAT registration certificate within 30 working days. It would also be beneficial to update your booking and invoice systems to
ensure that you’re charging the correct amount of VAT on your sales. Please contact us if you would like further information about this.
VAT Flat Rate Scheme
If your serviced accommodation business is required to register for VAT, it would be beneficial to check whether your business can make use of the Flat Rate Scheme (FRS).
The FRS is designed to simplify VAT reporting for small businesses with a turnover of less than £150,000, saving you time completing tax returns.
Rather than calculating the exact amount of VAT from the quarter, you’ll instead pay a fixed percentage of your annual turnover.
The current flat rate for serviced accommodation is 5.5% but is expected to rise to 10.5% from April 2022.
VAT on deposits
Most deposits are considered advanced payments. Therefore, whenever you receive a deposit, you must account for the VAT in your next VAT Return.
If you need to refund a deposit, you can reclaim the VAT on your next return.
VAT on cancellation charges
If your business charges cancellation fees, these are considered compensation and VAT is not due.
If the cancellation fee is in the form of a retained deposit, then you can reclaim any VAT already collected on your next return.
How to register and set up your Government Gateway account
The Government Gateway is a system in which you can access the majority of government online services, including your tax account.
Let’s explore how to set up your account, add your taxes and invite your accountant.
Register for a Gateway
A Gateway account is created the first time you enrol for a government online service. If you previously accessed online government services, you may already have an account. If this is the case, you will be prompted to log in instead of register.
To register for an account, go to the HMRC services website and follow these steps:
- Enter your email address. You will then receive a verification code that you will need to enter.
- Enter your full name.
- Create a unique password.
- Set up a recovery word in case you lose your password.
- Choose the type of account you wish to set up. Select “Organisation” if you’re registering as a business.
- Set up 2-Step Verification for security protection. You can either enter a phone number or use an authentication application.
- Answer the additional security questions when prompted.
Once registered, you will receive your Government Gateway User ID via email. Make sure to save this for your records.
Add your taxes
You will be able to add any relevant business taxes to your account from the Business Tax Account Home Page. The most common tax services are VAT, Self Assessment, Corporation Tax, PAYE and CIS (which is included in the PAYE option).
Each time you add a service, you will receive an activation PIN within 10 days. Once you have entered the pin, you can start using the service.
To add a service, follow these steps:
- On the Home Page, click “add a tax, duty or scheme”.
- Select which tax or service you wish to add.
- Follow the steps when prompted.
For Corporation Tax, you will need your Unique Taxpayer Reference (UTR) and your Company Registration Number.
For Self Assessment, you will need your UTR and National Insurance Number (NIN). If you do not have this, you will be prompted to register for Self Assessment and will receive your UTR within 10 days.
For PAYE or the Construction Industry Scheme, you will need your Employer PAYE Reference and the HMRC office number found on the letter HMRC sent you when you registered as an employer.
For VAT, you will need your VAT number, date of registration, the month your last VAT Return ended and the amount in box 5 of your last VAT Return.
Add your accountant
You can authorise an agent to have access to your Business Tax Account and handle your tax affairs.
To invite your accountant, follow these steps:
- Click “Manage Account” in the navigation bar at the top.
- Choose “Accountants” from the list in the middle of the screen.
- Select the service(s) you would like to add them to.
- Click “Authorise an Agent”.
Is it a repair or improvement (revenue or capital expenditure)?
It can often be difficult to distinguish between repairs and improvements, however, it’s extremely important to report them correctly for tax purposes.
Property investors generally want to report costs as repairs because it would result in an immediate tax break. HMRC, on the other hand, generally prefer investors to report costs as improvements because the tax relief would only apply once the asset is sold.
Repairs are often referred to as revenue expenditure and improvements are referred to as capital expenditure. Let’s take a look at the differences between these cost types with specific examples for property investors.
A repair or revenue expenditure refers to the money spent on maintaining and keeping an asset in a good working condition.
This includes repairs to a newly acquired property that requires work to be done, as long as the property was lettable at the time of purchase.
This also includes replacing outdated items with the nearest modern equivalent. For instance, replacing single glazed windows with double glazed windows or replacing lead pipes with copper or plastic pipes.
In regards to kitchen repairs, the costs involved in the refurbishment would also be considered revenue expenditure. This may include stripping out the old items, replacing worktops and wall units, retiling, plastering and wiring. Only similar replacements to the original kitchen can be claimed as repairs. Any new additions (e.g. storage or additional appliances) would be considered an improvement.
An improvement or capital expenditure refers to money spent on an alteration that increases the value of the property, changes its main function or extends the life of the building.
This includes newly purchased properties that were not in a lettable state at the time of purchase and require renovations to be in a condition to let. If significant work is required, you should speak with an accountant to determine the status.
Upgrading any materials or appliances to a superior quality item would also be considered an improvement.
There are special rules surrounding ‘integral features’ such as electrical, cold water, water heating and air cooling or purification systems.
If you replace more than 50% of an integral feature within 12 months, this is considered an improvement (capital expenditure) for capital allowances purposes. If you replace less than 50% within the year, this will be treated as a repair (revenue expenditure).
For example, let’s say you have a 6 room property and will be replacing the electrical system in 2 rooms within 12 months. Because you are replacing less than 50% of the property’s electrical system, this will be treated as revenue expenditure.
When considering the cost type of an expense, it’s best to consider whether the work done will significantly increase the market value of the property.
For instance, replacing the roof would be a repair, however, upgrading the kitchen with superior materials and appliances would be an improvement. If in doubt, feel free to contact us for advice.
Replacement of domestic items relief
Replacement of domestic items (RDI) relief, previously known as The Wear and Tear Allowance, allows residential landlords to claim tax relief for replacements of certain items in the property, known as domestic items.
What are domestic items?
Domestic items include:
- Moveable furniture, such as beds and wardrobes
- Furnishings, such as curtains, carpets and linen
- Appliances, such as fridges, freezers and TVs
- Kitchenware, such as cutlery and crockery
Domestic items do not include any items that become part of the house, for instance, fitted appliances and bathroom fixtures.
Conditions for relief
A deduction cannot be claimed if the property is considered a Furnished Holiday Let (FHL) or if Rent a Room relief has been claimed.
In order for a cost to be considered a replacement, the following 4 conditions must be met:
- The individual or company must run a property-letting business.
- An old domestic item in the house-let is removed and replaced with a new domestic item, for sole use by the tenant.
- The domestic item being replaced must be required for the property business to function. If it is not a necessity, the relief cannot be claimed.
- You have not claimed capital allowances on the cost of the new item.
If all 4 conditions have been met, then you can claim a deduction for the cost of the new domestic item.
New domestic items
The cost of replacing an item is only deductible when it’s replaced with one that is of similar quality.
If the replacement was bought new, this doesn’t automatically make it a higher quality or standard.
For instance, a brand new fridge that cost £400 is not an improvement over a 10-year-old fridge that cost £400 at the time of purchase. In this case, the cost of the new fridge can be deducted.
If the new fridge is of far superior quality and is much more expensive than the original item, RDI relief cannot be claimed as the cost is considered an improvement (capital expenditure) rather than a replacement.
How to complete a monthly CIS return
The Construction Industry Scheme (CIS) is an HMRC scheme for workers in the construction sector. Contractors and businesses that employ subcontractors are required to register for the CIS, deduct money from each subcontractor’s pay, and complete monthly CIS returns.
The monthly returns inform HMRC about the payments and deductions made throughout the period.
Monthly CIS returns must be submitted by the 19th of the following tax month. Tax months run from the 6th to the 5th. For example, if you are submitting a return for the period ending on March 5th, this covers all subcontractor payments made between February 6th and March 5th. The CIS return would be due on March 19th.
You can file your monthly return from the HMRC CIS online service or through compliant commercial CIS software.
The return must include all payments to all subcontractors in that month, regardless of the subcontractors CIS status or deduction rate. You must also declare that the subcontractors listed are not considered employees of the business. If you incorrectly declare the employment status of a subcontractor, you could receive a fine of up to £3,000.
You will need to submit the following information for each subcontractor paid in the period:
- The subcontractor’s name or business name
- The subcontractor’s unique tax reference (UTR)
- The subcontractor’s verification number – this is provided when you verify the worker on your CIS account
- The gross amount of payments made to the subcontractor that month
- The total cost of any materials paid for by the subcontractor that month
- The total amount of tax deducted from the subcontractors pay that month
If you have tax months in which no payments were made to subcontractors, you must file a nil return. If you do not file a monthly return, HMRC will assume that the return is late and you may incur a penalty.
To file a nil return, simply tick box 5 next to “Nil return” and submit it as normal.
Correcting submitted returns
If you realise that you have made a mistake or forgotten an entry, you should amend the return or contact HMRC as soon as possible to avoid fines.
You can file an amended CIS return through your online CIS account or contact the CIS Helpline on 0845 366 7899.
Let’s say you paid a standard-rated (20%) subcontractor £500 this month and they did not purchase any materials. On the return, you would enter the total payment as £500, the cost of materials as £0 and the amount deducted as £100.
How to pay interest to a director or individual lender (CT61)
Most property businesses will require investment from their directors or from individual lenders, whether for startup costs, renovations or expansion.
In this case, the lender can charge interest on any money that the company has borrowed but not yet repaid. For the business, the interest can be deducted as a business expense for Corporation Tax. For the lender, any interest earned will be subject to income tax.
What is a CT61 form?
If a business pays interest on a loan from a director or individual lender, it must submit quarterly CT61 returns. The CT61 should not be used for business-to-business interest payments.
The CT61 form is used to report interest, royalties, alternative finance payments and other similar recurring payments to HMRC.
How to request form CT61
It’s not possible to simply download the CT61 form. Rather, it needs to be requested via an online form on the HMRC website.
Please note that if you’re an LLP, you must send a letter to HMRC with your unique taxpayer reference (UTR) and details of the payment(s) made.
Unlike most taxes, it is not required to submit a nil return if no payments were made. You only need to submit a CT61 if you made interest payments within the calendar quarter.
Deadlines and penalties
If interest payments are made, the CT61 must be submitted on a quarterly basis. Normally, this aligns with the calendar year and the periods ending on the last day of March, June, September and December.
The form and any related payments must be submitted within 14 days from the end of the reporting period. If it is submitted 1 day – 3 months late, HMRC may charge you £100. If it is 3 – 6 months late, they may charge an extra £100. From 6 – 12 months, HMRC will charge an additional 10% of any unpaid tax.
If a director lends their company £25,000, they can charge the standard commercial interest rate based on the size of the loan. In this scenario, the standard interest rate is 2%.
The business would record £500 of interest in the annual accounts (25,000 x 0.02) and the director would record £500 of interest on their Self Assessment return.
The director would not pay interest on this amount if they are a basic rate taxpayer and did not receive any other interest payments in the tax year.
This example is a tax-efficient way of extracting the interest amount from the business. However, each situation will differ. Don’t hesitate to contact us if you would like some advice.
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