Residential Letting – What is the Finance Cost Allowance and how are Unused Finance Costs used up?

This is often referred to clause 24 or section 24 relating to Finance Act 2015 (No 2) [Section 26 Finance Act 2016] that introduced the change which started from 6th April 2017. It took full force for the tax year 2020/21. The rules restrict interest relief to the basic rate of tax (20%).

The legislation was inserted into Income Tax (Trading and Other Income) Act 2005: Sections 272A, 272B and 274A-274C and Income Tax Act 2007: Sections 399A and 399B.

The legislation does not apply to Furnished Holiday Lets or Limited Companies.

Finance Costs include all finance costs, even those to buy furnishings and the incidental cost of arranging the finance.

The Relief

Its calculated as 20% of the lower of

  1. Finance costs not deducted from income, or
  2. The profits of the property business, or
  3. The adjusted total income

What is adjusted Total Income?

Net income is defined in the Income Tax Act 2007 Section 23

23 The calculation of income tax liability

To find the liability of a person (“the taxpayer”) to income tax for a tax year, take the following steps. Step 1

Identify the amounts of income on which the taxpayer is charged to income tax for the tax year.

The sum of those amounts is “total income”.

Each of those amounts is a “component” of total income.

Step 2

Deduct from the components the amount of any relief under a provision listed in relation to the taxpayer in section 24 to which the taxpayer is entitled for the tax year.

See [F1sections 24A and 25] for further provision about the deduction of those reliefs.

The sum of the amounts of the components left after this step is “net income”.

It excludes Saving and Dividend Income (ITA07/S18 (3) & (4)).

It excludes the personal allowance and blind persons allowance (ITA07/S23).

The end results is adjusted total income (ATI) – S274AA.

A tax reduction can not be used to create a tax refund but it can be carried forward.

Example 2020-21 onwards

Fred has

  • Employment Income £45,000
  • Residential Property Income £25,000
  • Mortgage Interest £10,000
  • Allowable expenses £5,000
  • Property Losses Carried Forward £15,500
  • Unused Finance Costs carried forward from 2019-20 £2,000

Calculation as follows

Employment Income£45,000
Property Income Calculation
Rental Income£25,000
Finance Costs – you can’t deduct Mortgage Interest£0
Allowable Expenses-£5,000
Property Business Profits£20,000
Less Property Losses Carried Forward-£15,500
Taxable Property Business Profits£4,500
Net Income – Employment and Property£49,500
Income Tax Calculation
Personal Allowance £12,500 at 0%
Basic Rate £37,000 at 20%£7,400
Higher Rate £0 at 40%
Income Tax Liability before Residential allowance£7,400

The Basic Rate Tax 20% reduction for Residential Property is the lower of

  1. Finance Costs not deducted in this case that’s £10,000 Mortgage and £2,000 Unused Finance Costs carried forward from 2019-20 which totals £12,000
  2. Property business profits which are £4,500
  3. Adjusted total income (exceeding personal allowance) £37,000 (£49,500 – £12,500)

The lowest amount is the

  • Property business profits which are £4,500
  • So the basic rate tax reduction is 20% x £4,500 = £900

    We can now deduct that from the £7,400, leaving £6,500 as the final income tax liability.

    Unused Finance Costs
    Residential Finance Costs£12,000
    Used in the Basic Rate Reduction-£4,500
    Unused Residential Finance Costs£7,500

    The Unused Residential Finance Cost is carried forward to the next tax year, in this example 2021-22.

    We repeat the calculations above in 2021-22, following all the same steps.

    Let’s assume in 2021-22 his net income from Employment and Property is £60,000

    The tax would be 0% x £12,570 plus 20% x £37,700 plus 40% x £9,730 = £11,432

    The Basic Rate Tax 20% reduction for Residential Property is the lower of

  • Finance Costs not deducted £10,000 Mortgage as in the previous year and £7,500
  • Unused Finance Costs = £17,500

  • Property business profits which are £20,000 (assuming its the same as the previous year – losses having been used up in the previous year)
  • Adjusted total income (exceeding personal allowance) £47,430 (£60,000 – £12,570)
  • The lowest is £17,500.

    So the basic rate deduction is £17,500 x 20% = £3,500

    £11,432 less £3,500 gives a final income tax liability of £7,932

    Unused Finance Costs
    Residential Finance Costs and carried forward amount£17,500
    Used in Basic Rate Reduction-£17,500
    Unused Residential Finance Costs to be Carried Forward£0

    steve@bicknells.net

    A Summary of Tax, Savings and Benefits of Electric Cars

    What is the plug-in grant?

    The plug-in grant has been around for several years as an incentive to purchase electric vehicles to curb climate change. The grant has been modified many times, but it currently offers £2,500 off of eligible low-emission cars and up to £16,000 for larger vehicles.

    You do not need to apply for the grant. The car dealer will include the grant in the vehicle’s price if it is eligible.

    • Cars: CO2 emissions of less than 50g/km and can travel at least 112km with zero emissions. The car must cost less than £35,000 and be on the list of government approved vehicles. The grant will pay for 35% of the car price up to £2,500.

    Grants for vehicle charging points

    In addition to the plug-in grant, you can also receive up to £350 towards the cost of a vehicle charging point. The Electric Vehicle Homecharge Scheme (EVHS) provides up to 75% of the installation cost on domestic properties in the UK.

    There is also the Workplace Charging Scheme (WCS) which is a voucher based scheme that provides support to businesses who install vehicle charging points.

    Both grants need to be applied for from the government’s website.

    HMRC Advisory Fuel Rate

    The advisory electricity rate for fully electric cars is 4p per mile.

    So you can claim 4p per mile for business miles in an electric car.

    Advisory fuel rates – GOV.UK (www.gov.uk)

    100% Capital Allowances

    Businesses of all sizes can claim 100% FYAs on capital expenditure on a car (CA23153) provided that:

    • the car is ‘unused and not second hand’, and is first registered on or after 17 April 2002;
    • it is an electric car or a car with qualifying CO2 emissions of not more than a specified amount;
    • the expenditure is incurred between 17 April 2002 and 31 March 2025; and
    • the expenditure is not excluded by the general FYA exclusions, see CA23110.

    Second Hand zero emission cars are added to the main rate pool and written down at 18%

    Benefit in Kind

    Cars first registered from 6 April 2020 (WLTP)

    CO2 emissions figureElectric range figure2020–212021-22
    0N/A0%1%
    1–50130 or more0%1%
    1–5070–1293%4%
    1–5040–696%7%
    1–5030–3910%11%
    1–50Less than 3012%13%

    steve@bicknells.net

    How do you register for CIS?

    You may need to register as a contractor or a subcontractor or both, let’s look at what you need to do.

    Registering as a Contractor

    If you are within the Construction Industry and you pay Subcontractors, you will be a Contractor.

    What are Mainstream contractors

    If your business is construction and you pay subcontractors for construction work, you’re a ‘mainstream’ contractor. This applies if you’re a:

    • builder
    • labour agency
    • gangmaster (or gang leader)
    • property developer

    What are Deemed contractors

    You count as a ‘deemed’ contractor if your business does not do construction work but you have spent more than £3 million on construction in the 12 months since you made your first payment. This could apply to:

    • housing association or arm’s length management organisations (ALMOs)
    • local authorities
    • government departments

    How do you Register

    You register as an employer but tick the box to say you will be paying subcontractors (you can also register by phoning the HMRC Helpline 0300 200 3210), I generally use the gateway.

    It can take 5 working days to register (longer at the moment), you can’t register more than 2 months in advance and you need to register before you make payments.

    You register on Government Gateway, its registering for taxes, you need to choose PAYE.

    You then need to know:

    • Business UTR
    • Business Contact Details
    • Your NI Number
    • Start date
    • Tick the Subcontractor Box

    When done, you’ll get a letter from HM Revenue and Customs (HMRC) with the information you need to start working as a Construction Industry Scheme (CIS) contractor.

    Contractors need to:

    • Verify Subcontractors – checking deduction status
    • Deduct tax from payment at the rate stated by HMRC
    • Pay tax to HMRC
    • Complete a Monthly CIS return
    • Provide Subcontractors with a Deduction Statement

    Registering as a Subcontractor

    To register for the Construction Industry Scheme (CIS) as a subcontractor you’ll need:

    • your legal business name – you can also give a trading name if it’s different to your business name
    • your National Insurance Number
    • the unique taxpayer reference number (UTR) for your business
    • your VAT registration number (if you’re VAT registered)

    If you’re a subcontractor and a CIS contractor (you pay subcontractors to do construction work), you’ll need to register for CIS as both.

    You can register by phoning the HMRC Helpline

    Telephone:
    0300 200 3210

    Monday to Friday: 8am to 6pm

    Closed on weekends and bank holidays.

    You can also register using the goevrnment gateway – register for CIS online. You’ll need the Government Gateway user ID and password you used when you registered for Self Assessment (or another government service).

    You can apply for gross payment status at the same time.

    If you do not have a UTR, register as a new business for Self Assessment and choose ‘working as a subcontractor’ when prompted. You’ll be registered for Self Assessment and CIS at the same time.

    Companies can use form CIS305 to apply.

    How do you qualify for Gross Status

    You must show HM Revenue and Customs (HMRC) that your business passes some tests. You’ll need to show that:

    • you’ve paid your tax and National Insurance on time in the past
    • your business does construction work (or provides labour for it) in the UK
    • your business is run through a bank account

    HMRC will look at your turnover for the last 12 months. Ignoring VAT and the cost of materials, your turnover must be at least:

    • £30,000 if you’re a sole trader
    • £30,000 for each partner in a partnership, or at least £100,000 for the whole partnership
    • £30,000 for each director of a company, or at least £100,000 for the whole company

    If your company’s controlled by 5 people or fewer, you must have an annual turnover of £30,000 for each of them.

    Gross Status means you can be paid without any tax being deducted.

    steve@bicknells.net

    How do you tell HMRC your business is active? or dormant?

    When you form a new limited company HMRC will send you a letter, the letter will tell you the company UTR and it also says ‘you must tell HMRC within 3 months of starting or restarting any business activity’.

    Personally I think it would much better if this was covered within the formation process, most people form a companies because they want to start business activity immediately so it would make sense that business are automatically registered or at least able to choose a date on which they will start activity, for example the start of a month, this would avoid HMRC creating multiple returns for the same year, as Corporation Tax returns can only be for 12 month period and companies are rarely formed on the 1st day of a month.

    I have seen may situations where businesses forget to tell HMRC that they have started, but do submit accounts and the corporation tax return and HMRC so far HMRC have been ok with this, but that’s no guarantee that they will always be sympathetic.

    What does ‘Active’ mean

    Generally your company or organisation is considered to be active for Corporation Tax purposes when it is, for example:

    • carrying on a business activity such as a trade or professional activity
    • buying and selling goods with a view to making a profit or surplus
    • providing services
    • earning interest
    • managing investments
    • receiving any other income

    What’s interesting is that the definition is slightly different for

    • Other Taxes
    • Company Law
    • Accounting Standards

    What does ‘Dormant’ mean

    Your company is called dormant by Companies House if it’s had no ‘significant’ transactions in the financial year.

    Significant transactions don’t include:

    • filing fees paid to Companies House
    • penalties for late filing of accounts
    • money paid for shares when the company was incorporated

    You do not need to tell Companies House if you restart trading. The next set of non-dormant accounts that you file will show that your company is no longer dormant.

    Your company will be considered dormant for corporation tax purposes in any of the following circumstances:

    • It is not trading and does not receive any other income. This includes investment income.
    • It is a new limited company that hasn’t started trading yet.
    • It is a flat management company.
    • It is an unincorporated association or charity that owes less than £100 corporation tax.

    A dormant company can be, for example:

    • a new company that’s not yet trading
    • an ‘off-the-shelf’ or ‘shell’ company held by a company formation agent intending to sell it on
    • a company that will never be trading because it has been formed to own an asset such as land or intellectual property
    • an existing company that has been – but is not currently – trading
    • a company that’s no longer trading and destined to be removed from the Companies Register

    To remain dormant – don’t make payments

    1. If the company pays an invoice for example from the accountant that would make the business active
    2. If the company pays its formation cost then it won’t be dormant
    3. If you have employees you will be active
    4. If you pay dividends you will be active

    To stay dormant pay any costs personally and not via the company.

    What are the Rules for Clubs

    HMRC may treat your club or unincorporated organisation as dormant for Corporation Tax purposes if it’s active but both the following conditions apply:

    • your organisation’s annual Corporation Tax liability must not be expected to exceed £100
    • you run your club or organisation exclusively for the benefit of its members

    For each year of dormancy your organisation must not have any:

    • allowable trading losses for which it may want to claim relief
    • assets it’s likely to dispose of, which would give rise to a chargeable gain
    • interest or annual payments to pay out from which tax is deductible and payable to HMRC

    When you think your company is dormant

    If your company has stopped trading and has no other income, you can tell HMRC that it’s dormant for Corporation Tax.

    If you’ve never had a ‘notice to deliver a Company Tax Return’

    You can tell HMRC your company’s dormant over the phone or by post.

    If you’ve filed a Company Tax Return or had a ‘notice to deliver a Company Tax Return’

    You’ll still need to file a Company Tax Return online – this will show HMRC that your company is dormant for this period.

    Confirmation Statements

    Dormant companies still need to file the annual confirmation statement and the dormant accounts.

    How do tell HMRC you are active?

    Within 3 months of becoming active you need to tell HMRC, you can do this via the Government Gateway but I think its easier to write to HMRC.

    Your letter must include:

    • the company’s name and registration number
    • the date the company’s accounting period started
    • the date to which the company intends to prepare accounts
    • the company’s principal place of business
    • the nature of the business being carried out by the company
    • the name and home address of each director of the company
    • if the company has taken over another business, the name and address of the former business and also the name and address of the person from whom the business was acquired
    • if the company is a member of a group of companies, the name and registered office address of the parent company
    • if the company has been obliged to comply with the Income Tax (Pay as You Earn) Regulations 2003, the date on which that obligation first arose

    The letter must be:

    • signed by a company director or company secretary
    • include a declaration that the information is correct and complete to the best of their knowledge

    Send your letter to:

    Corporation Tax Services
    HM Revenue and Customs
    BX9 1AX
    United Kingdom

    What about the self employed and Landlords?

    If you earn over £1,000, then you will need to register.

    For the self employed use form LC Forms (hmrc.gov.uk)

    For Landlords use this form LC Forms (hmrc.gov.uk)

    There are other forms for Partnerships

    From April 2023 the Self Employed and Landlords earning over £10,000 a year will need file quarterly under Making Tax Digital rules.

    steve@bicknells.net

    How to reduce IHT with a Deed of Variation?

    Predicting the value of your Estate isn’t easy, not least because you don’t when you will die.

    After someone dies it is possible for the beneficiaries to change the Will using a Deed of Variation, there are free examples on the internet for example Deed of Variation UK Template – Make Your Free Deed of Variation (rocketlawyer.com)

    Note that Beneficiaries under 18 can’t enter into Deeds of Variation.

    HMRC also provide a Checklist IOV2 Instrument of Variation checklist (publishing.service.gov.uk)

    You can’t re-write a Will but a Deed of Variation will change the content of it and the Inheritance Tax (IHT) payable.

    For example by making a donation to charity.

    Where a gift is made to a Charity its taken off the value of the estate and as such will reduce IHT, it could even reduce the rate of IHT on the whole estate currently by 4% (40% to 36%), click here for HMRC reduced rate calculator.

    In summary, your donation will either:

    • be taken off the value of your estate before Inheritance Tax is calculated
    • reduce your Inheritance Tax rate, if 10% or more of your estate is left to charity

    You can donate:

    • a fixed amount
    • an item
    • what’s left after other gifts have been given out

    The Deed of Variation can be prepared before or after the Grant of Probate but generally in must be made within 2 years of the date of death.

    FA 2010 definition of charity

    Under Sch 6 Para 1 FA 2010 a charity is a body of persons or trust that:

    • is established for ‘charitable purposes’ only
    • meets the jurisdiction condition (i.e. is subject to the jurisdiction of a relevant UK court or the courts of a relevant territory)
    • meets the registration condition (i.e. has complied with any requirement under the applicable law to be registered), and
    • meets the management condition (i.e. the managers are fit and proper persons).

    This definition of charity allows charities of relevant territories to qualify as charities for the purposes of UK legislation (provided the conditions above are met). Relevant territories are those in EU Member States, Iceland and Norway

    Other reasons why you might need a Deed of Variation

    1. Equalising distributions between the Beneficiaries
    2. Including beneficiaries such as a grandchild born after the Will was created
    3. Including someone who the Rules of Intestacy do not apply to, such as a partner or step-child
    4. Resolving uncertainty in the Will

    steve@simple-probate.co.uk

    How much VAT can you claim back for expenses before you became VAT Registered?

    You don’t have to wait till you hit the £85,000 threshold to register for VAT, you can voluntarily register even before you make your first taxable supply (sale). You can even back date the registration!

    VATREG21550 – Voluntary registration: intending traders: what is an intending trader?

    An intending trader is a person who, on the date of the registration request:

    • is carrying on a business
    • has not started making taxable supplies
    • has an intention to make taxable supplies in the future.

    Intending traders normally seek registration from a current date in order to reclaim input tax incurred in the setting up and development of their business. In some cases, the amounts involved may be substantial and cover a long period of time.

    VATREG21650 – Voluntary registration: intending traders: requests from an intending trader for retrospective registration

    Requests for backdating an EDR in cases of voluntary registration can only be considered at the time of initial application: see VATREG21150.

    When you are considering such requests, traders must be able to provide evidence that they would have satisfied us at the time (that is, the earlier date requested) that they had a firm intention to make taxable supplies.

    What Evidence is needed?

    Examples would include

    • potential contracts
    • planning permission
    • items purchased for the business
    • patents applied for
    • application for option to tax land or buildings

    What about new companies?

    Companies don’t exist until they are formed (incorporated), so they can’t be registered until they exist, but you can still claim for pre-trading expenses, subject to the rules in the next few paragraphs. The VAT is reclaimed by submitting an expense claim to the company on the day the company was created (incorporated).

    Purchases made before registration

    There’s a time limit for backdating claims for VAT paid before registration. From your date of registration the time limit is:

    • 4 years for goods you still have, or that were used to make other goods you still have
    • 6 months for services

    You can only reclaim VAT on purchases for the business now registered for VAT. They must relate to your ‘business purpose’. This means they must relate to VAT taxable goods or services that you supply.

    You should reclaim them on your first VAT Return (add them to your Box 4 figure) and keep records including:

    • invoices and receipts
    • a description and purchase dates
    • information about how they relate to your business now

    Personal Use

    If the purchases have a element of personal use that must be excluded.

    For example a mobile phone acquired before the business started or not on a business contract used for personal and business, only the business proportion can be claimed on your VAT return.

    If the phone subsequently is replaced with a business contract then the whole cost can be claimed.

    What Goods can the 4 year rule be applied to?

    A good example would be Stock or Work in Progress and to support your claim you would need

    • Quantities and Descriptions
    • Invoices
    • Details of how they relate to your business now

    Fixed Assets would also qualify, for example

    • Computers
    • Desks
    • Office Equipment

    However, VIT32000 states a business may not use regulation 111 to recover VAT on supplies that were purchased for non-business or private purposes. The expense is not a business cost and no VAT can ever be recovered, regardless of any subsequent business use. This principle was confirmed in the case of Waterschap Zeeuws Vlaanderen (see VIT62520). For example:

    • an individual buys a van to use for wholly private purposes. Three years later the individual registers for VAT and uses the van exclusively within their business. The VAT paid on the van is permanently outside of the VAT system because there were no business activities at the time the van was bought. The VAT paid on the van can never be brought back in under the terms of regulation 111

    What about the 10 year Capital Goods rule?

    For capital items within the Capital Goods Scheme and acquired after 1 January 2011 there are different rules.

    Capital items are defined as:

    • Land, buildings and civil engineering work or capital expenditure in relation to the same including construction, refurbishment, fitting out, alteration and extension, where the value is more than £250,000 (Land); or
    • Ships, boats or other vessels and aircraft including capital expenditure in relation to the same of construction, refurbishment, fitting out, alteration and extension, where the value is more than £50,000 (Ships and Aircraft); or
    • Single items of computer hardware where the value is over £50,000 (Computers).

    Where the goods or services acquired prior to registration are capital items and when the business registers on or after 1 January 2011, even in cases where the registration is backdated to an earlier date, the normal regulation 111 time limits of six months for services and four years for goods on hand may not apply. Instead a business may be able to recover VAT incurred up to ten years prior to registration in respect of land and up to five years prior to registration for other capital items.

    What counts as Services?

    Examples could include

    • Subcontractors
    • Professional Services from Accountants and Lawyers
    • Software
    • Rent of Premises
    • Telephone and Internet
    • Equipment leasing

    The main problem is deciding whether the services have been consumed/used up before registration for example Rent – the rental period could be expired before registration in which case it can’t be claimed (however that might not apply to warehouse holding stock or rent paid in advance). The same issues apply to Telephone and Internet – was the cost to generate future work or past work. In fact most types of service need to be carefully examined as they could be past or future, only those relating to period after registration can be claimed as these costs haven’t been ‘Consumed’.

    In order to qualify

    1. The services must be for the business now registered for VAT
    2. Supplied for the purpose of the business and relate to taxable/Vatable activities (ie not exempt activities)
    3. Not related to goods consumed/disposed of before registration, for example if the subcontractor worked on a project sold before the Effective Date of Registration then you can’t claim it

    steve@bicknells.net

    If you were not adversely affected what happens to your SEISS?

    You will have noticed on your self assessment return and partnership returns for 2021 extra boxes for showing grants.

    You must tell HMRC if, when you made the claim, you were not eligible for the grant. For example:

    • for the first or second grant, your business was not adversely affected
    • for the third or fourth grant, your business had not been impacted by reduced activity, capacity or demand or inability to trade in the relevant periods
    • you did not intend to continue to trade
    • you’ve incorporated your business

    You must also tell HMRC if you:

    • received more than we said you were entitled to
    • amended any of your tax returns on or after 3 March 2021 in a way which means you’re no longer eligible or are entitled to a lower fourth grant than you received

    You must reasonably believe that you’ll suffer a significant reduction in trading profits due to reduced business activity, capacity, demand or inability to trade due to COVID-19- between 1 May 2021 and 30 September 2021. You must keep evidence that shows how your business has been impacted by COVID-19 resulting in less business activity than otherwise expected.

    HMRC expects you to make an honest assessment about whether you reasonably believe your business will have a significant reduction in profits.

    What HMRC mean by impacted by reduced activity, capacity and demand

    This applies to your business if it has been impacted by reduced activity, capacity or demand due to COVID-19. For example, you:

    • have fewer customers or clients than you’d normally expect, resulting in reduced activity due to social distancing or government restrictions
    • have one or more contracts that have been cancelled and not replaced
    • carried out less work due to supply chain disruptions

    You must not claim if the only impact on your business is increased costs. For example, if you’ve had to purchase face masks and cleaning supplies. This would not be considered as reduced activity, capacity or demand.

    When you must tell HMRC

    In most cases, if you’re not eligible and have to pay the grant back, you must tell us within 90 days of receiving the grant.

    The 5th SEISS Grant

    Full details of the fifth Self-Employed Income Support Scheme (SEISS) grant, including a new turnover test which determines the level of the grant, were published by HMRC on 6th July.

    Although the eligibility for the fifth grant is the same as the fourth grant, the amount of the fifth grant will be determined by how much the turnover of the business(es) have reduced compared to the turnover in the reference year.

    See: Check if you can claim a grant through the Self-Employment Income Support Scheme – GOV.UK (www.gov.uk)

    The fifth grant is 80% of three months’ average trading profits capped at £7,500 for those whose turnover has reduced by 30% or more. Those with a turnover reduction of less than 30% will receive a grant based on 30% of three months’ average trading profits, capped at £2,850.

    We have been waiting for the precise rules for determining turnover, but HMRC guidance provides more questions than answers and further clarification is still required.

    See:  Work out your turnover so you can claim the fifth SEISS grant – GOV.UK (www.gov.uk)

    The turnover figure required is for a 12-month period starting on any date between 1 and 6 April 2020. Those who prepare accounts on a tax year basis will be able to use the same figure that will appear on the 2020/21 tax return.

    That turnover figure is then compared to the turnover in the “reference period” which for most individuals will be the turnover figure from their 2019/20 tax return and there is an option to use 2018/19 if 2019/20 was not a normal year for the business.

    The turnover figure will be the sum of all of the taxpayer’s businesses but should exclude coronavirus support payments (for example previous SEISS grants, eat out to help out payments and local authority grants). The rules for partners seem particularly illogical, especially where they are also involved in another business.

    steve@bicknells.net

    Is it a Repair, Replacement (RDI) or Improvement?

    This is probably one of the most difficult cost types to define and is extremely confusing for property investors.

    The guidance never seems to quite fit with the work undertaken.

    Its an issue for accountants too, often the investor lists all the costs rather than the projects so you end up with lots of entries like B&Q and have to try to reshuffle them into projects like a new kitchen.

    HMRC has a tool kit Capital v Revenue which gives some guidance.

    In general investors want costs to be repairs (which can be deducted from profit and save tax now) where as HMRC would probably prefer improvements (which are held back and used the Capital Gains Computation when the property is sold).

    In this blog I will try to give some further help aimed at owners of Buy to Let properties, the rules apply both to individual investors and those who invest via a company.

    Pre-Letting Costs

    The general rule is that if you buy a run down property that needs work doing on it before it can be let then that work is an improvement (capital cost).

    However, if you had a letter from an letting agent saying it was lettable in its purchase condition then the works could be a repair (revenue).

    If substantial work is needed, its best to discuss this with your accountant before the work is done to determine its status as an Improvement or Repair.

    The important point is the property needs to in fit state to let before the alterations, refurbishment, repairs are carried out if you want the costs to be repairs.

    Here is HMRC’s Guidance from PIM2030

    Repairs after a property is acquired

    Repairs to reinstate a worn or dilapidated asset are usually deductible as revenue expenditure. The mere fact that the customer bought the asset not long before the repairs are made does not in itself make the repair a capital expense. But a change of ownership combined with one or more additional factors may mean the expenditure is capital. Examples of such factors are:

    • A property acquired that wasn’t in a fit state for use in the business until the repairs had been carried out or that couldn’t continue to be let without repairs being made shortly after acquisition.
    • The price paid for the property was substantially reduced because of its dilapidated state. A deduction isn’t denied where the purchase price merely reflects the reduced value of the asset due to normal wear and tear (for example, between normal exterior painting cycles). This is so even if the customer makes the repairs just after they acquire the asset.
    • The customer makes an agreement that commits them to reinstate the property to a good state of repair.

    Repairs

    HMRC have agreed “A replacement of a part of the “entirety” with the nearest modern equivalent is allowable as a repair for tax purposes.” (Tax Bulletin 59)

    Examples

    • Replacing single glazed windows with double glazed windows
    • Replacing guttering with a new modern guttering
    • Replacing lead pipes with copper or plastic pipes
    • Replacing wooden beams with steel girders

    What about Kitchens?

    The following refurbishment works would be repairs

    • Stripping out
    • Replacing Base Units
    • Replacing Wall Units
    • Replacing Work Tops
    • Re-tiling
    • Floor repairs
    • Plastering
    • Wiring

    Provided you are replacing with a similar standard kitchen

    But if you add storage or equipment these items would be capital improvements.

    There are also special rules relating to expenditure on specified parts of buildings called
    ‘integral features’. The following are integral features:


    • an electrical system (including a lighting system)
    • a cold water system
    • a space or water heating system, a powered system of ventilation, air cooling or air
    purification, and any floor or ceiling comprised in such a system
    • a lift, an escalator or a moving walkway
    • external solar shading.


    Under these rules if expenditure on an integral feature represents the whole, or more than 50%,
    of the cost of replacing the integral feature, then the whole of the expenditure is to be treated as
    capital expenditure

    Replacement of Domestic Items (RDI)

    Since 2016 Replacement of Domestic Items Relief has replaced the Wear and Tear Allowance. The rules are in PIM3210.

    Note – RDI is not given for the purchase of new items that are not replacements

    In order for relief to be given, 4 conditions must be met:

    Condition A – the individual or company looking to claim the relief must carry on a property business that includes the letting of a dwelling-house(s).

    Condition B – an old domestic item that has been provided for use in the dwelling-house is replaced with the purchase of a new domestic item. The new item must be provided for the exclusive use of the lessee in that dwelling-house and the old item must no longer be available for use by the lessee.

    Condition C – The expenditure on the new item must not prohibited by the wholly and exclusive rule (see BIM37000) but would otherwise be prohibited by the capital expenditure rule (see BIM35000).

    Condition D – Capital Allowances must not have been claimed in respect of the expenditure on the new domestic item.

    If the 4 conditions are met, then a deduction for the expenditure on the new item can be claimed.

    However, a deduction is not allowed if:

    • The dwelling-house in question is, in full or part, a furnished holiday letting (special rules apply to FHL’s)
    • Rent-a-Room receipts have been received in respect of the dwelling-house in question and Rent-a-Room relief has been claimed in relation to those receipts.

    If the new item is of broadly the same quality/standard as the old item and doesn’t represent an improvement then the deduction is the cost of the new item. Note that for these purposes, just because an item is brand new does not make it an improvement over an item which has been in use for several years and suffered general wear and tear. For example, a brand new budget washing machine costing circa £200 is not an improvement over a 5 year old washing machine that cost around £200 at the time of purchase (or slightly less, taking into account inflation).

    RDI will be given for ‘domestic items’ such as:

    • Moveable furniture such as beds and free-standing wardrobes.
    • Furnishings such as carpets, curtains and linen.
    • Household appliances such as televisions, fridges and freezers.
    • Kitchenware such as crockery and cutlery

    Improvements

    If an alteration increases the market value of the building, changes its function, or extends the life of the whole building then its an improvement.

    We also noted under pre-letting that work to make a property lettable could be an improvement.

    PIM2030 states

    But there is usually no improvement if trivial increases in performance or capacity arise solely from the replacement of old materials with newer but broadly equivalent materials. For example, the replacement of pipes or storage tanks of imperial measure with the closest metric equivalent may result in slightly increased diameter or capacity but the cost is still revenue expenditure.

    Where a significant improvement arises from the change of materials, the whole of the cost is capital expenditure. This includes things like redecoration after the main work has been done (redecoration would ordinarily be a revenue expense). The entire cost is capital expenditure, including the expense of making good any damage to decorations.

    Alterations to a building may be so extensive as to amount to the reconstruction of the property. This will be capital expenditure and it can’t be deducted as an ordinary revenue business expense. 

    steve@bicknells.net

    Zero Rating Commercial Conversion First Grant of Major Interest (Residential)

    Conversion of Commercial Buildings for example Office Buildings, Shops, Warehouses, Barns into Residential qualify for 5% reduced rate VAT in relation to the Conversion Costs. But when the first major interest is granted it will be Zero Rated giving full VAT recovery.

    Note that Building Materials supplied separately to the contract for the conversion will be charged at 20% standard rate but you will recover that VAT.

    The most common approach is to create a group with the subsidiary carrying out the conversion work and granting the first major interest, either by directly selling the first major interest or transferring the completed residential property as first major interest to the holding company

    A Group will qualify for Group SDLT Relief (subject to conditions).

    This means that full recovery of VAT has been achieved and no SDLT suffered, however, the converted property will be transferred at Market Value which could create a profit in the developing subsidiary.

    If this isn’t done and the subsidiary rents out the property partial exemption may apply reducing the VAT recovery or limiting it.

    Below are the key sections relating to VAT.

    VAT Notice 708 Section 5.3 Non-residential conversion

    A ‘non-residential conversion’ takes place in 2 situations. The first is when the building (or part) being converted has never been used as a dwelling or number of dwellings (see paragraph 5.3.1) for a ‘relevant residential purpose’ (see paragraph 14.6), and it is converted into a building ‘designed as a dwelling or number of dwellings’ (see paragraph 14.2), or intended for use solely for a ‘relevant residential purpose (see paragraph 14.6).

    The second situation requires that in the 10 years immediately before (see paragraph 5.3.2) the sale or long lease, the building (or part) has not been used as a dwelling or number of dwellings or for a ‘relevant residential purpose’ and it is converted into a building either ‘designed as a dwelling or number of dwellings’ (see paragraph 14.2), or intended for use solely for a ‘relevant residential purpose’ (see paragraph 14.6).

    Examples of a ‘non-residential conversion’ into a building ‘designed as a dwelling or number of dwellings’ include the conversion of:

    • a commercial building (such as an office, warehouse, shop)
    • an agricultural building (such as a barn)
    • a redundant school or church

    VAT Notice 708 Section 7 Reduced rating the conversion of premises to a different residential use

    Section 7.3

    A qualifying conversion includes the conversion of:

    • a property that has never been lived in, such as an office block or a barn

    But Zero Rating (0%) applies on the first grant of a major interest where a developer has converted a non-residential building into a home.

    VAT Notice 708 Section 5.6 First Grant of a Major Interest

    Subject to the conditions at paragraph 5.1.2, you can only zero rate your first sale of, or long lease (see paragraph 4.2) in, a building (or part of a building).

    If you enter into a second or subsequent long lease in the building (or sell the building after leasing it on a long lease) you cannot zero rate your supply and it would normally be exempt from VAT

    VAT Notice 708 Section 4.2 Granting a major interest in a building

    You’re granting a major interest in a building when you sell, assign or surrender:

    • the freehold
    • in relation to England, Wales and Northern Ireland, a lease for a term certain exceeding 21 years
    • in relation to Scotland, the estate or interest of the owner
    • in relation to Scotland, the tenant’s interest under a lease for a term of not less than 20 years

    steve@bicknells.net

    HMRC Making Tax Digital for Landlords – its easy isn’t it?

    Making Tax Digital for the self employed and landlords with gross income over £10,000 will be compulsory from April 2023, but lets look at some the potential requirements and issues

    Reporting

    MTD means reporting to HMRC 4 times a year plus a 5th year end return. The records have to be digitally linked using HMRC approved software Find software that’s compatible with Making Tax Digital for VAT – GOV.UK (www.gov.uk)

    The information will probably be the same as Self Assessment Returns, we won’t know exactly what is needed till September 2021 when HMRC release the API requirements.

    Landlord report in quarters start from 6th April (some are suggesting this should be moved to whole months – as having 6th to 5th each period doesn’t seem logical)

    Many landlords have other businesses so they may have a separate quarter for VAT and possibly yet another one based on their Sole Trader or Partnership reporting period (year end).

    So you could be reporting 3 separate quarters or more where as previously they were just doing an annual self assessment. That’s a lot of extra returns to file!

    Software/Accounting

    Accounting is the next problem area, here are the issues

    Properties

    Its likely that you will use Tracking Codes or Projects to account for each property within you software. This will mean you can report by property.

    Cash Accounting or Traditional

    Landlords can choose to use either cash accounting or traditional accounting, Cash Accounting is the default.

    Most software is not set up for cash accounting (except in the case of VAT, but thats not applicable to landlords as Residential Rent is Exempt from VAT)

    Furnished Holiday Lets or Residential

    Many Landlords now have a mixture and they are reported in separate sections of the Self Assessment Return.

    Potentially you could EU or other Property income too, how will HMRC handle that?

    These need separating within the accounting system to produce the information needed.

    Jointly Owned Property

    Its unlikely that a Landlord with jointly owned property would maintain two sets of accounts with 50% in each (or whatever the split needs to be), so software will need to be able to deal with this. Some Landlords may have a mixture of jointly owned and sole owned.

    Rent a Room

    Rent a Room can be used even by those exceeding the £7,500 limit, the balance above this level is then taxed Rent a Room – What if Rent exceeds £7,500? « Steve J Bicknell Tel 01202 025252

    Lots to consider and the clock is ticking.

    Steve@bicknells.net