In the previous chapters we have covered the income tax computation,
including tax reliefs on certain investments.
This chapter starts with the taxation of income arising from the letting of
property in the UK. It looks at the basis of assessment of such income and at
the computation of assessable profits and losses, and then covers the special
rules for furnished holiday lettings and the rent a room relief.
The chapter then covers the accrued income scheme.
Finally, it deals with the taxation of trust income received by beneficiaries.
The following chapters will deal with income from employment and selfemployment.
|1||Income and income tax liabilities in situations involving further overseas aspects and in relation to trusts, and the application of exemptions and reliefs|
|(a)||The contents of the Paper F6 study guide for income tax and national insurance, under headings:||2|
|||B4 Property and investment income|
|(e)||Property and investment income:||3|
|(i)||Recognise income subject to the accrued income scheme|
|(iii)||Income from trusts and settlements: Understand the income tax position of trust beneficiaries|
The computation of income from a UK property business is a generally straight forward matter, but you need to look out for the special areas of lease premiums, furnished holiday lettings and rent a room relief.
You need to watch out for the accrued income scheme if fixed interest securities are bought and sold.
Although you are not required to know how to calculate the income tax liability of trustees, you need to know how the trust income is taxed in a beneficiary’s hands.
Property income was dealt with at the F6 level. The rest of the material in this chapter will be new to you at the P6 level.
There are no changes in 2015/16 from 2014/15 in the material you have studied in F6.
1 UK property business
1.1 Profits of a UK property business
Income from land and buildings in the UK, including caravans and houseboats which are not moved, is taxed as non-savings income.
- A taxpayer (or a partnership) with UK rental income is treated as running a business, their ‘UK property business’. All the rents and expenses for all properties are pooled, to give a single profit or loss. Profits and losses are computed in the same way as trading profits are computed for tax purposes, on an accruals basis.
Expenses will often include rent payable where a landlord is himself renting the land which he, in turn, lets to sub tenants. For individuals, interest on loans to buy or improve properties is treated as an expense (on an accruals basis). The rules on post-cessation receipts and expenses apply to UK property businesses in the same way that they apply to trades (see later in this Text). Relief is available for irrecoverable rent as an impairment loss.
- Capital allowances are given on plant and machinery used in the UK property business in the same way as they are given for a trading business with an accounting date of 5 April. Capital allowances are not normally available on plant or machinery used in a dwelling. As a taxpayer who lets property furnished cannot claim capital allowances on the furniture, he can instead claim a wear and tear allowance.
Under such a claim, the actual cost of furniture is ignored and instead, an annual deduction is given of 10% of rents. The rents are first reduced by amounts which are paid by the landlord but are normally a tenant’s burden. These amounts include any water rates and council tax paid by the landlord.
If plant and machinery is used partly in a dwelling house and partly for other purposes a just and reasonable apportionment of the expenditure can be made to determine the capital allowances that are available.
1.2 Losses of UK property business
A loss on a UK property business is carried forward to set against future profits from the UK property business.
A loss from a UK property business is carried forward to set against the first future profits from the UK property business. It may be carried forward until the UK property business ends, but it must be used as soon as possible.
Over the last few years, Peter has purchased several properties in Manchester as ‘buy to let’ investments.
5 Whitby Ave is let out furnished at £500 per month. A tenant moved in on 1 March 2015 but left unexpectedly on 1 May 2016 having paid rent only up to 31 December 2015. The tenant left no forwarding address.
17 Bolton Rd has been let furnished to the same tenant for a number of years at £800 per month.
A recent purchase, 27 Turner Close has been let unfurnished since 1 August 2015 at £750 per month. Before then it was empty whilst Peter redecorated it after its purchase in March 2015.
Peter’s expenses during 2015/16 are:
No 5 No 17 No 27
£ £ £
Insurance 250 250 200
Letting agency fees – – 100
Repairs 300 40 – Redecoration – – 500
No 27 was in a fit state to let when Peter bought it but he wanted to redecorate the property as he felt this would allow him to achieve a better rental income.
Water rates and council tax are paid by the tenants. Peter made a UK property business loss in 2014/15 of £300.
Peter claims the wear and tear allowance where relevant.
What is Peter’s taxable property income for 2015/16?
No 5 No 17 No 27
2015/16 £ £ £
Accrued income 12 £500 6,000 12 £800 9,600 8 £750 6,000
Insurance (250) (250) (200) Letting agency fees (100)
Impairment loss (irrecoverable rent)
3 £500 (1,500) Repairs (300) (40) Redecoration (N) (500)
Wear and tear allowance
£(6,000 – 1,500) 10% (450)
£9,600 10% (960)
Property Income 3,500 8,350 5,200
Total property income 17,050
Less loss b/fwd (300) Taxable property income for 2015/16 16,750
Note: The redecoration of No.27 is an allowable expense. This is an example of the application of the case of Odeon Associated Theatres Ltd v Jones 1971 (covered in more detail later in this Text) which showed that the cost of initial repairs to remedy normal wear and tear of a recently acquired asset was an allowable expense. This contrasts with the case of Law Shipping v. CIR 1921 where the cost of initial repairs to improve an asset recently acquired to make it fit to earn profits was disallowable capital expenditure. The key point in relation to No. 27 is that it was fit state to let when acquired.
1.3 Premiums on leases
Part of the premium received on the grant of a short lease is taxed as rent.
When a premium or similar consideration is received on the grant (that is, by a landlord to a tenant) of a short lease (50 years or less), part of the premium is treated as rent received in the year of grant. A lease is considered to end on the date when it is most likely to terminate.
The premium taxed as rental income is the whole premium, less 2% of the premium for each complete year of the lease, except the first year. This is shown in the following formula:
|Less 2% (n–1) P||(a)|
|Taxable as income||X|
Formula to learn
This rule does not apply on the assignment of a lease (ie one tenant selling their entire interest in the property to another).
1.4 Premiums paid by traders 12/15
Where a trader pays a premium for a lease, he may deduct an amount from his taxable trading profits in each year of the lease. The amount deductible is the figure treated as rent received by the landlord divided by the number of years of the lease.
1.5 Example: deduction for premium paid by trader
On 1 July 2015 Bryony, a trader, pays Scott, the landlord, a premium of £30,000 for a ten year lease on a shop. Bryony makes up accounts to 31 December each year.
Scott is taxable on property income in 2015/16 of £30,000 (£30,000 (10 1) 2%) = £24,600.
Bryony can therefore deduct £24,600/10 = £2,460 in each of the ten years of the lease. She starts with the accounts year in which the lease starts (year ended 31 December 2015) and apportions the relief to the nearest month. Her deduction for the year ended 31 December 2015 (basis period for 2015/16) is therefore:
1 July 2015 to 31 December 2015: 6/12 × £2,460 £1,230
1.6 Real Estate Investment Trusts (REITs)
Property companies may operate as Real Estate Investment Trusts (REITs).
REITs can elect for their property income (and gains) to be exempt from corporation tax and must withhold basic rate (20%) tax from distributions paid to shareholders (who cannot own more than 10% of a REIT’s shares) out of these profits. These distributions are taxed as property income, not as dividends.
Distributions by REITs out of other income (ie not property income or gains) are taxed as dividends in the normal way.
2 Furnished holiday lettings 12/13, 6/14
|Special rules apply to income from furnished holiday lettings. Whilst the income is taxed as normal as property business income, the letting is treated as if it were a trade. Capital allowances are available on the furniture and the income is relevant earnings for pension purposes. However, only carry forward trade loss relief is available.|
There are special rules for furnished holiday lettings (FHLs). The letting is treated as if it were a trade. This means that, although the income is taxed as income from a property business, the provisions which apply to actual trades also apply to furnished holiday lettings.
- Capital allowances are available on furniture instead of the 10% wear and tear allowance.
- The income from a UK furnished holiday lettings business qualifies as relevant earnings for pension relief (see earlier in this Text).
- Capital gains tax rollover relief, entrepreneurs’ relief and relief for gifts of business assets are available (see later in this Text).
However, losses from FHLs are not treated as trade losses for relief against general income, early years loss relief and terminal loss relief. If a loss arises on a FHL, the only trade loss relief available is carry forward loss relief by deduction from the first available future profits of the FHL. Trading loss reliefs are dealt with later in this Text.
Note, however, that the basis period rules for trades do not apply, and the profits or losses must be computed for tax years.
A FHL must be situated in the UK or in another state within the European Economic Area. Separate computations must be made for a UK furnished holiday lettings business and an EEA furnished holiday lettings business (which consists of lettings in one or more EEA countries other than the UK).
Exam focus The examination team has stated that any question in the exam would make it clear whether or not a point property was situated in the EEA.
The letting must be of furnished accommodation made on a commercial basis with a view to the realisation of profit. The property must also satisfy the following three conditions.
- The availability condition – during the relevant period, the accommodation is available for commercial let as holiday accommodation to the public generally, for at least 210 days.
- The letting condition – during the relevant period, the accommodation is commercially let as holiday accommodation to members of the public for at least 105 days (the days let exclude any days that are longer term occupation as defined in condition (c) below).
If the landlord has more than one FHL, at least one of which satisfies the 105 day rule (‘qualifying holiday accommodation’) and at least one of which does not, (‘the underused accommodation’), they may elect to average the occupation of the qualifying holiday accommodation and any or all of the underused accommodation. If the average of occupation is at least 105 days, the underused accommodation will be treated as qualifying holiday accommodation.
point It is possible to make an election so that a rental property continues to qualify as a furnished holiday letting for up to two years after the 105 day test ceases to be met. This election is not examinable.
(c) The pattern of occupation condition – during the relevant period, not more that 155 days fall during periods of longer term occupation. Longer term occupation is defined as a continuous period of more than 31 days during which the accommodation is in the same occupation unless there are abnormal circumstances.
If someone has a UK furnished holiday lettings business and other UK lettings, draw up two income statements as if they had two separate property businesses. This is so that the profits and losses can be identified for the special rules which apply to FHLs. The same rule also applies where someone has an EEA furnished holiday lettings business and other overseas lettings.
3 Rent a room relief
The first £4,250 of rent received from letting a room or rooms in a main residence is tax free.
One of the competencies you require to fulfil Performance Objective 17 Tax planning and advice of the PER is to mitigate and/or defer tax liabilities through the use of standard reliefs, exemptions and incentives. You can apply the knowledge you obtain from this section of the text to help to demonstrate this competence.
If an individual lets a room or rooms, furnished, in his or her main residence as living accommodation, a special exemption may apply.
The limit on the exemption is gross rents (before any expenses or capital allowances) of £4,250 a year. This limit is halved if any other person (including the first person’s spouse/civil partner) also received income from renting accommodation in the property while the property was the first person’s main residence.
If gross rents (plus balancing charges arising because of capital allowances in earlier years) are not more than the limit, the rents (and balancing charges) are wholly exempt from income tax and expenses and capital allowances are ignored. However, the taxpayer may claim to ignore the exemption, for example to generate a loss by taking into account both rent and expenses.
If gross rents exceed the limit, the taxpayer will be taxed in the ordinary way, ignoring the rent a room scheme, unless he elects for the ‘alternative basis’. If he so elects, he will be taxable on gross receipts plus balancing charges less £4,250 (or £2,125 if the limit is halved), with no deductions for expenses or capital allowances.
An election to ignore the exemption or an election for the alternative basis must be made by the 31 January which is 22 months from the end of the tax year concerned.
An election to ignore the exemption applies only for the tax year for which it is made, but an election for the alternative basis remains in force until it is withdrawn or until a year in which gross rents do not exceed the limit.
Exam focus Note the different elections carefully and the relevant time limits. point
Sylvia owns a house near the sea in Norfolk. She has a spare bedroom and during 2015/16 this was let to a chef working at a nearby restaurant for £85 per week which includes the cost of heating, lighting etc.
Sylvia estimates that each year her lodger costs her an extra £50 on gas, £25 on electricity and £50 on buildings insurance. The wear and tear allowance applicable under the normal method would be £435.
How much property income must Sylvia pay tax on?
Sylvia’s gross rents are above the rent a room limit. Therefore she has the following choices:
- Under the normal method (no election needed), she can be taxed on her actual profit:
Rental income 4,420
Less expenses (50 + 25 + 50 + 435) (560)
- Under the ‘alternative basis’ (elect for rent a room relief):
Total rental income of £85 52 = £4,420 exceeds £4,250 limit so taxable income is £170 (ie 4,420 – 4,250) if rent a room relief claimed.
Sylvia would be advised to claim the ‘alternative basis’.
|4 Accrued income scheme||6/14|
The accrued income scheme taxes interest that arose up to the date that a security was sold cum interest and gives relief for interest arising between the sale and next interest payment date for sales ex interest.
If the owner of securities sells them before a certain date, he will not be entitled to the next interest payment on them. The new owner will receive it. This is called selling cum interest. However, the sale proceeds will include interest accrued to the date of sale.
If securities are sold after a certain date, they are sold ex interest and the original owner is entitled to the whole of the next interest payment despite the fact that they have sold the securities to a new owner. This time, the sale proceeds will exclude interest accruing after the date of sale.
Under the accrued income scheme, where securities are transferred cum interest, the accrued interest reflected in the value of securities is taxed separately as savings income. The seller is treated as entitled to the proportion of interest which has accrued since the last interest payment. The buyer is entitled to relief against the interest they receive. This relief is equal to the amount assessable on the seller.
Conversely, where the transfer is ex interest, the seller will receive the whole of the next interest payment. He will be entitled to relief for the amount of interest assessed on the purchaser. The purchaser is treated as entitled to the proportion of the interest accrued between the sale and the next payment date and it is taxed as savings income.
The accrued income scheme does not apply where the seller:
- Carries on a trade and the sale is taken into account in computing trading profits
- Did not hold securities with a nominal value exceeding £5,000 during the tax year in which the interest period ends
- Was not resident in the UK during any part of the period in question (see later in this Text) Is taxed on the interest under the manufactured payment rules (not examinable).
Nigel bought £10,000 5% Loan Stock many years ago. Interest is payable on 30 June and 31 December each year. Nigel sells the loan stock to Evie on 30 November 2015 cum interest.
What are the amounts assessable for Nigel and Evie in respect of the loan stock for 2015/16?
Interest paid 30.6.15 £10,000 5% 6/12 250
Accrued interest deemed received 31.12.15
£10,000 5% 5/12 208
Total assessable 458
Interest paid 31.12.15
£10,000 5% 6/12 250
Less relief for accrued interest
£10,000 5% 5/12 (208)
Total assessable (ie 1 month’s interest) 42
|5 Trust income||6/10, 6/15|
Income from trusts must be grossed up by either 100/55 (discretionary trusts) or by 100/80 or 100/90 (interest in possession trusts).
A trust is a vehicle in which assets are legally owned by the trustees for the benefit of the beneficiaries.
There are two types of trust for income tax purposes:
- An interest in possession trust (a ‘life interest’ trust) where the income must be paid out to the beneficiary (often called the life tenant).
- A discretionary trust where the income is distributed at the trustees’ discretion.
Income from discretionary trusts is received net of 45% tax. Gross it up in the income tax computation by multiplying by 100/55 and give credit for the tax already suffered when working out the final amount of tax payable. Such income is always treated as non-savings income.
If income from an interest in possession trust is paid out of the trust’s non-savings income or savings income, it will be received by the beneficiary net of 20% tax and must be grossed up by multiplying by 100/80. If it is paid out of dividend income it must be grossed up by multiplying by 100/90. Each type of income is then taxed on the beneficiary under the normal rules. As usual, the notional tax credit on dividend income cannot be repaid.
Exam focus June 2010 Qu 2(iv) Poblano required an explanation of the income tax treatment of trusts. The examiner point commented that ‘There was the need to be specific and precise, as regards grossing up fractions and tax
rates, rather than superficial and general in order to maximise the marks obtained.’
If a minor beneficiary receives income from a trust set up by a parent, then under the anti-avoidance rules the income is taxed as the parent’s income. As we saw earlier, there is a £100 de minimis limit.
Non-savings Savings Dividend
income income income Total
£ £ £ £
Building society interest ( 100/80) 7,750
Dividends ( 100/90) 2,500
Income from discretionary trust ( 100/55) 12,500
Income from life interest trust ( 100/80) 1,600
Net income 14,100 7,750 2,500 24,350 Less PA (10,600)
Taxable income 3,500 7,750 2,500 13,750
Tax on non savings income £3,500 20% 700 Tax on savings income £7,750 20% 1,550 Tax on dividend income £2,500 10% 250
Less: Dividend tax credits (250)
Tax on building society interest (1,550)
Discretionary trust (5,625) Life interest trust (320)
Income tax repayable (5,245)
Exam focus Although you need to know the rate of tax deducted from income distributions from trusts, you do not point need to know how to calculate the trustees’ income tax liability.
|||Income from a UK property business is computed for tax years on an accruals basis.|
|||A loss on a UK property business is carried forward to set against future profits from the UK property business.|
|||Part of the premium received on the grant of a short lease is taxed as rent.|
|||Special rules apply to income from furnished holiday lettings. Whilst the income is taxed as normal as property business income, the letting is treated as if it were a trade. Capital allowances are available on the furniture and UK income is relevant earnings for pension purposes. However, only carry forward trade loss relief is available.|
|||The first £4,250 of rent received from letting a room or rooms in a main residence is tax free.|
|||The accrued income scheme taxes interest that arose up to the date that a security was sold cum interest and gives relief for interest arising between the sale and next interest payment date for sales ex interest.|
|||Income from trusts must be grossed up by either 100/55 (discretionary trusts) or by 100/80 or 100/90 (interest in possession trusts).|
- Describe the 10% wear and tear allowance.
- What are the conditions for a letting to be a furnished holiday letting?
- What are the tax consequences of selling fixed interest stock cum interest one month after the normal interest payment date?
- Michela is a beneficiary of a discretionary trust. In 2015/16, she receives £495 income from a trust.
How much does she enter as the gross amount in her tax return? Is it savings or non-savings income?
Answers to quick quiz
- 10% wear and tear – cost of furniture ignored
– annual deduction of 10% of rents (less water rates and council tax)
- FHL is – available for letting at least 210 days per tax year
- actually let at least 105 days per tax year
- not more than 155 days fall during periods of longer occupation (continuous period of more than 31 days).
- The sale price of the stock will reflect the fact that one month’s worth of interest is included in the price. This amount is excluded from the proceeds but is taxed as interest (ie savings income).
- £495 = £900 gross. Non-savings income.