Making Tax Digital - Cash accounting for landlords - do you need an accountant?
In the second of a series of articles on the Making Tax Digital consultations, Philip McNeill, outlines some of the implications of the consultation on Simplified cash basis for unincorporated property businesses.
Income from land and property is a specialist area of tax. From rent a room to wayleaves, and sporting rights to holiday homes, it is a broad canvas with its own sub sets of rules.
The starting point for most income from land and buildings is preparation of ‘trading’ accounts on an accruals basis using GAAP. Specific tax rules then impact the results; bringing, for example, restrictions on loss relief and modifying expenses rules for capital expenditure for furnished holiday lettings.
Overall, there is at least the hint that quarterly submissions on a cash basis will be cheaper than the current self-assessment arrangements of accruals accounting and one return as year. But is the hint justified?
For the simplest, smallest cases, accruals accounting as against cash accounting may make minimal impact to the work involved. Four (or more likely, given the timescale, five submissions a year), however is likely to increase costs.
For large businesses, where accruals adjustments would be significant, they may also be necessary (to support lending) and only a small part of the complexity.
Topping and tailing for digital tax
How can an estimated 2.5 million unincorporated ‘small property businesses’ be brought more easily into quarterly reporting and digital record keeping?
The starting point, according to the consultation, is to make a new form of cash accounting available to all unincorporated property businesses; without an upper turnover limit. This would range from an individual letting out a former home, which they have been unable to sell; to potentially very large, complex property portfolios run by partnerships.
HMRC’s primary target is presumably individuals with one rental property. On HMRC figures, this covers two-thirds of individuals making income tax self-assessment returns for property income.
Excluded are companies, trusts, real estate investment trusts, limited liability partnerships and partnerships with a corporate member. Other ‘similar, more complex entities’ would also be precluded from using the new cash basis.
If you have a view on what should be excluded, or on other aspects of the proposals, you can email your views to firstname.lastname@example.org.
The starting point
Cash accounting for property income is optional, and will follow the cash accounting for traders rules, with certain exceptions.
The most significant differences are the absence of an upper turnover limit and modified rules for interest, equipment and furnishing, and partnerships. Overseas property could be included: it is yet to be decided if a separate opt in would be available for UK and overseas property owned by the same individual(s).
Interest relief restrictions
The 2015 Budget introduces a restriction of tax relief to basic rate for interest payments on residential property lettings. This would also apply to property income taxed on the new cash basis.
Cash basis for traders has a £500 limit for deduction of interest and finance charges; this would be set aside for property income. Instead, for all properties, interest relief would be restricted to mortgages tied to property assets used in the business; and interest would be disallowed where mortgage values exceed the value of property.
Equipment and furnishing
Furnished holiday lets would be permitted to deduct initial and replacement costs for equipment and furnishings currently eligible for capital allowances.
For other property, rules would mirror the April 2016 replacement furniture allowance, with a deduction for replacements, but nothing for the initial cost.
Jointly held property
There is potential complexity here as the proposal is to let individuals who jointly own property make separate decisions on using cash basis. But, if there is a ‘partnership property business’ then the business would be expected to decide, and all partners would be expected to use the same basis.
Property income losses are already restricted (under s120 Income Taxes Act 2007), with very limited ‘sideways’ relief being available.
Cash basis for property income would deny all sideways relief, in line with the cash basis rules for traders. This would leave only carry forward relief.
Deposits, premiums and bad debts
The position for uncollected rent is simplified by giving immediate relief at source; but the situation with deposits potentially becomes complex.
Deposits would be treated as income and taxed on receipt by the landlord, whether they are repayable security deposits or advances of rent. Only on repayment to the tenant, or transfer to a third party tenancy deposit scheme, would they be deducted as an expense.
Lease premium could be tricky and might be a reason for staying out of cash accounting. Para 3.22 of the consultation states that receipts normally charged to Capital Gains Tax would continue to be excluded from property income. This would include premiums on long leases and property sales.
But premiums paid on long leases would not be allowable expenses (para 3.30). To access the apportionment rules (ITTOIA 2005 chapter 3), accruals accounting would be required.
Transition - moving in and out of cash
Transition could be tricky, with particular care needed to avoid double counting of income and expenses. Capital expenditure too could bring unexpected consequences.
Moving into cash accounting, unrelieved allowable expenditure could be claimed in full (though with AIA available there may be few occasions when this would apply).
Capital expenses which have been written off under cash accounting would need to be brought back into a capital allowance pool at nil value; with the possibility of a balancing allowance on subsequent sale.
And a worrying finale
It is well known that most people browse a book from the back page forwards. Do that with the current consultation and you will start with the impact assessment. Here we read that:
‘The simplification provided by the cash basis is expected to make it easier and cheaper for unincorporated property businesses to calculate tax liabilities by no longer having to compute profits in accordance with GAAP, so many property businesses will avoid the need to carry out time-consuming accruals based adjustments at the end of each period.’ (emphasis added).
For further clues, we have consultation question 4:
‘Does the above advice give you enough information to decide whether or not to use the cash basis with/without (please indicate) professional advice? If not, what else would you need to know about the new rules?’
The punctuation in question 4 is a little ambiguous; but there is a real underlying challenge. Taxpayers are being encouraged to think of the new system as being simpler and cheaper; and that they might be able to make decisions on the suitability of cash accounting, without taking appropriate professional advice.
So what is the role of agents in future?
Anyone with gross rental income of £10,000 or more will need to keep records digitally and make quarterly online submissions to HMRC. It is likely that most taxpayers who use an agent will continue to do so, but the change in workload needs to be factored in.
How ready are your clients to go digital? Are they aware of how the MTD changes will impact them? What are the cost, staffing and software implications? Who will prepare and submit the quarterly updates? In most cases, a fifth year-end submission will also be needed – to be filed within nine months of the accounting date. As 31 March / 5 April is the usual accounting date for property income, will this mean 31 December becomes the new peak return period for income tax?
ICAS is developing a guide to digital practice which should be available soon. It will set out options and implications of cloud and standalone software solutions.
Getting involved – influencing the outcome
What do you judge to be the likely impact of these proposals?
To be part of the ICAS response, please let us have your comments at email@example.com and complete our short poll below.
You can also give your views to HMRC. There is an HMRC webinar on Tuesday 25 October 2016. You can register for this, as well as for face to face and other events here.