10 minute read.
This article is from our monthly tax newsletter Tax Insider Professional.
Lee Sharpe looks at the recently-introduced cash basis of assessment applicable to landlords.
The cash basis for property businesses was introduced via F(No 2)A 2017 Sch 2, and its effect is felt liberally around ITTOIA 2005 Pt 3, dotted mainly around ITTOIA 2005 ss 271A–276A, and ITTOIA 2005 ss 307A–307F.
It was, in fact, introduced several months after the date from which it was scheduled to have an effect – that is, from 6 April 2017. HMRC guidance is in the Property Income manual at PIM1090-PIM1098, but it does not reflect the full complexity of the regime.
It is essential readers beware that, where the cash basis can apply, it is deemed to apply automatically, unless the taxpayer elects out of the regime. This is unlike the cash basis for trading entities, which requires a positive election into the regime (ITTOIA 2005, s 25A).
The cash basis for property businesses therefore applied by default in 2017/18, and landlords who want to elect back out of the regime will need to do so no later than 31 January 2020 (and for every subsequent tax return year where the regime could apply). Note that the cash basis does not discriminate between the letting of dwellings or commercial property.
Accruals basis
Tax and accounting professionals will, of course, be familiar with the key distinction between accruals accounting and cash accounting principles, being that the accruals basis recognises income and expenditure by reference to the period in which they are ‘earned’, while cash accounting focuses instead simply on cash in versus cash out.
Generally speaking, the accruals basis offers precision and, in many cases, better consistency in results, taking one year with another, while the cash basis offers simplicity. For most practitioners, however, accounting on the accruals basis is all but as natural as the cash basis, leaving the cash basis needing to offer ‘something more’, such as a simplified tax regime; or, as in this case, just to apply by default.
When does the cash basis apply?
As noted above, the cash basis effectively applies automatically to a property business; practically speaking, most property businesses subject to income tax will fall within scope, the exceptions being where:
- Carried on by a company, LLP or trust, or in a partnership where at least one of the partners is not an individual
- Annual gross receipts (as calculated per the cash basis) exceed £150,000
- The taxpayer is in business jointly with his or her spouse or civil partner, and that spouse or civil partner has adopted GAAP in their own tax return (see below)
- The taxpayer elects out of the cash basis, as above
- There would be a balancing event under the business premises renovation allowance if GAAP were adopted
For many businesses, it will be the receipts threshold that is the most relevant limiting factor. Here, however, ‘business’ is mutable. Readers will be aware that a landlord is generally deemed to have only one property business, except where they undertake letting in a different capacity (for example, as a partner or as a trustee).
It follows that the £150,000 annualised receipts test applies to the individual’s aggregate property income, in relation to property owned personally or as co-owner, but where the income derives from a partnership the threshold is applied at the partnership level. Of course, the question of whether a co-owned property business is actually a partnership or simply a joint investment is another potential source of friction with HMRC.
Also, in relation to spouses and civil partners, they will have to adopt the same approach (cash or accruals) only where they are deemed to split the income equally under ITA 2007, s 836. This could be displaced, for example, by election (and notice to HRMC using Form 17) or where there is furnished holiday accommodation, as defined.
Implications of the cash basis
The legislation covering the cash basis covers roughly twenty pages. It might be summarised as attempting to deliver a simple tax regime, except where there is a risk of tax loss to the Exchequer; it is, therefore, far from simple. For example:
- Relief for capital expenditure is theoretically allowed as it is incurred, except that there are numerous exceptions, such as for finance and for intangibles, and capital gains tax will still apply to the acquisition/enhancement (and disposal) of land, buildings, and businesses themselves.
- Capital allowances are ignored, except that capital allowances are retained for cars. Where items such as fixtures might otherwise have ranked for capital allowances (such as when they are not in a dwelling) there is a new restriction based on the expected useful life of the item – basically, there is no deduction if it is expected to last for more than 20 years.
- The transition to (and from) the cash basis from the traditional accruals basis will potentially require adjustments in relation to capital assets on which capital allowances have been claimed, and to ongoing finance and hire purchase or similar contracts.
- Note that adjustments for private use of assets trigger a notional part-disposal of the asset, and the restriction of relief for dwelling-related loans at ITTOIA 2005, s 272A continues to apply under the cash basis; the principle that interest should not be fully relieved where the owner’s capital account is overdrawn is also broadly re-worked onto a statutory footing.
- The cash basis also restricts relief that a landlord might otherwise get, such as:
- Discounting (prepaying) letting income received for a later period, as applies commonly in the rental market; this is implicit in adopting the cash basis and is likely to far outweigh any benefit from ignoring rental income until it is actually received
- Sideways loss relief against other income for losses derived from capital allowances
- Lease premium payments
Simplification – or is it?
The cash basis for property businesses was sold on simplicity. But the regime sits uncomfortably atop legislation that protects the Exchequer’s interests, and arguably makes things worse than before – particularly given that the regime applies by default.
Landlords and their advisers will still have to identify capital expenditure in case it falls foul of any of the numerous restrictions in the cash regime, and they will still have to maintain a balance sheet of sorts to ensure that finance costs may be claimed in full (aside from the separate restriction for dwelling-related loans, which still applies), and they will still have to consider capital allowances either on cars or on what they could have claimed under separate loss reliefs in (say) commercial property.
Perhaps worst is that the cash basis could be switched on or off accidentally, thereby triggering transitional adjustments purely for tax purposes.
For example, take two unrelated landlords who let property as an investment, but then over time take on a few more properties such that they effectively become a partnership; their annual rental incomes individually are around £120,000 and the cash basis has applied by default; when they commence to operate in partnership, the threshold is set against the partnership’s annual receipts and easily outstrips the £150,000 limit, forcing them out of the cash basis and triggering a transition to accruals. Similar problems could arise between spouses and civil partners when the distribution of beneficial ownership in a let property changes or there is a divorce or death.
The writer therefore strongly recommends that in all but the smallest and most straightforward of letting businesses, landlords and their agents carefully consider opting out of the cash basis by default every year (including 2017/18), if appropriate.
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