Types of residential property business and expenses allowed for tax relief
There are three main types of residential property business:
- Furnished holiday accommodation – where the property consists of property located in either the UK or the EEA, this activity is treated as if it were a trade for tax purposes, and there are conditions the property must meet in terms of the period of letting to customers in order to be treated as such. A UK furnished holiday lettings business is treated as a separate trade from an EEA furnished holiday lettings business. One of the consequences of categorisation this type of business is that capital allowances on plant or machinery used in the business can be claimed
- Unfurnished lettings – one of the features of this categorisation is that no capital allowances can be claimed on plant or machinery used in the business; this point may become contentious as claims for embedded capital allowances are becoming more common in commercial property
- Furnished lettings – this categorisation of property business is also not allowed to claim capital allowances on plant or machinery. However it is possible to elect each year for a deduction equivalent to 10% of the net of rental receipts and expenses (such as council tax and utilities) normally borne by the tenant.
For loss relief purposes the latter two activities are pooled with other property activities in either a UK pool or a non-UK pool (which would include furnished holiday lettings located outside the EEA). Leading to losses of a UK or overseas property business in these two categories can only be offset against current or future profits of those respective pools.
Repairs for unfurnished and furnished lettings
Prior to 1 April 2013 for corporation tax purposes and 6 April 2013 for income tax purposes both unfurnished and furnished lettings could claim a non-statutory concession permitting the replacement of plant or machinery to be claimed as a revenue deduction. This was only available where neither capital allowances, nor the wear and tear allowance, were claimed and had to be applied consistently.
For expenditure incurred since these dates however, this non-statutory concession is no longer permitted. Furnished lettings still have the option of claiming the 10% wear and tear allowance, but unfurnished lettings must rely on the case-law interpretation of the distinction between capital and revenue expenditure in relation to repairs. This will no doubt lead to more case law on the subject as time passes. Meanwhile we are left with uncertainty over certain issues which may arise.
For all businesses established case-law permits the replacement of a part of an entire asset to be regarded as a repair, subject to certain conditions. However where the replacement results in an improvement, this is not regarded as a repair.
It was therefore necessary for HMRC’s practice to change to keep up with modern standards. For example the replacement of single glazing with double glazing was previously held to be an improvement. It is now regarded as the nearest modern equivalent.
However, when it comes to items which are not part of the entirety, a complete replacement would be regarded as capital expenditure.
There is a statutory deduction available for 'tools' of the business, but HMRC's opinion is that this doesn't apply to the majority of equipment used in furnished and unfurnished letting businesses.
In the context of a property business, therefore it can make a significant difference to the taxable profit if the replacement of an item can be regarded as part of a larger unit (as would be the case for replacement of fitted white goods), rather than separate, free-standing items on their own (as would be the case for free standing white goods). The distinction between fitted and free standing white goods seems a fine and difficult distinction to make, but this is HMRC's current view.