Sarah Bradford looks at the extension of the cash basis to unincorporated property businesses as part of the move to a digital tax world.
HMRC’s ‘making tax digital’ (MTD) strategy aims to transform the UK into one of the most digitally advanced tax administrations in the world. Under the proposals, businesses and landlords will be required to maintain digital records, and to provide digital updates to HMRC quarterly. For this to become a reality, various other simplifications and initiatives are being introduced, including the prospect of certain landlords moving to cash basis accounting.
Following its consultation, HMRC announced that they will be extending the availability of the cash basis to unincorporated property businesses with maximum rental income of £150,000 per property business.
Background
In August 2016, HMRC published six consultation documents. Each document focussed on a different aspect of the MTD strategy. One of the documents was entitled ‘Simplified cash basis for unincorporated property businesses’. The document set out proposals for the extension of cash basis accounting to unincorporated property businesses. Comments on the proposals were sought by 7 November 2016, and HMRC published their response to the consultation on 31 January 2017.
Cash basis
The consultation document proposed allowing the most straightforward property businesses to calculate their taxable profits using the cash basis. This is simply working out profits on a ‘cash in, cash out’ basis. By contrast, the accruals basis, which is the current standard, takes account of income earned and expenses incurred in the accounting period, regardless of whether the associated cash has actually been received or paid out. Moving to a cash basis will reduce the need for accounting adjustments, and will simplify the recording of transactions. The cash basis option has been available to small eligible trading businesses since 2013.
Under the proposals, the cash basis accounting would only be available to certain unincorporated businesses – i.e. those where a person (but not a company) receives income from property. Trusts, holders of units in unit trusts, real estate investment trusts, partnerships with corporate members and limited liability partnerships are also excluded from the option of moving to the cash basis.
Maximum limit
As it currently applies to traders, the cash basis can only be used by businesses whose turnover does not exceed the VAT threshold (set at £83,000 from 1 April 2016). The consultation considered whether a maximum limit for use of the cash basis should be imposed on landlords. While many respondents argued that, on the grounds of simplicity, a maximum limit should not be imposed, the government felt that use of the cash basis was not appropriate for the largest individual and partnership landlords.
The cash basis limit for traders was increased to £150,000 from April 2017 and this limit will apply to property businesses, too. Consequently, the cash basis will only be available to unincorporated property businesses that have annual receipts of £150,000 or less. According to government figures, 2.36 million property businesses would be eligible to use the cash basis.
Cash basis default
Not only is the cash basis to be extended to unincorporated property businesses, it is also to become the default basis. Consequently, property businesses with receipts below the £150,000 ceiling will be required to use the cash basis, unless they opt out of doing so. Going forward, the cash basis rather than the accruals basis will be the norm for smaller property businesses.
Larger unincorporated property businesses whose receipts are in excess of the £150,000 cash basis ceiling will not have a choice. Their default will remain the accruals basis; they will not need to opt out of the cash basis as it will not be available to them.
Multiple property businesses
The consultation also considered whether a decision to use the cash basis or not should apply to all business where an individual had more than one property business, or whether the option to choose should be available in relation to each business. Respondents preferred a business-by-business opt in or opt out, rather than a global opt in or opt out. The ability to choose the basis most suitable for each business was felt to be particularly important where an individual had both UK and overseas property businesses.
Having considered the views of respondents, the legislation will allow a separate decision to be made for each property business. The £150,000 limit will apply separately to each property income business.
Jointly-owned property
Joint owners of let property will also be free to make separate decisions as to how to calculate their profits, and the eligibility of each individual for the application of the cash basis will be considered separately. This was regarded as a necessary complexity, as the legislation treats joint owners as carrying on their own property business. In practice, most joint owners will probably choose to work on the same basis anyway.
There will, however, be an exception to the general rule allowing each joint owner to make their own decision as to which basis to adopt – where a property is owned jointly by a husband and wife or by civil partners, both spouses or civil partners will be required to calculate their profits on the same basis. This is to facilitate the existing legislation, which treats income from assets jointly-owned by spouses or civil partners as being split 50:50, unless the actual beneficial ownership is not 50:50 and an election has been made to allocate income in accordance with underlying beneficial ownership.
Loan interest
Regardless of whether the cash basis or the accruals basis is used, relief for loan and finance costs will be calculated in the same way and be subject to the same restrictions.
Lease premiums
Under existing rules, where a landlord receives a premium for granting a lease of less than 50 years, or where a tenant carries out work in lieu of such a premium, an income tax charge and a capital gains tax charge may arise. The government does not propose to allow landlords to apply the cash basis to these sums or allow a deduction for landlords who have made payments or undertaken work under an agreement of this nature.
Letting agents’ fees
Where a property is let through a letting agent, as many properties are, the government’s view is that the date of receipt for the cash basis is the date that the letting agent receives the money from the tenant of the landlord’s behalf, not the date on which the landlord receives the rent from the agent.
The justification for this view is that the letting agent is acting as an agent for the landlord. However, this does seem to run contrary to the simplification theme and the pure cash in cash out nature of the cash basis. Further, the landlord may not be aware of income and expenses received and paid out by the letting agent until he receives the letting agent’s statement. HMRC has promised clarification in guidance materials to be published after the relevant legislation has been enacted.
Security deposits
Security deposits are held on the tenant’s behalf. Under the cash basis rules, there will be no requirement to account for the security deposit when it is received. The landlord will only need to account for any element of the security deposit which is retained once it has been established that the retained element is legally the landlord’s property.
Example: Cash basis or accruals basis?
Tony owns three properties in the UK, which he rents out. His rental income is £50,000 a year. He also owns a number of properties in Paris and Madrid, in respect of which he receives rental income of £200,000 a year. Tony and his wife Shirley jointly own a flat in respect of which they receive rental income of £10,000 a year.
The cash basis will be the default for the UK properties, unless Tony chooses to opt out. By contrast, he will need to use the accruals basis for the overseas property business as the rental income exceeds the cash basis ceiling of £150,000.
The cash basis will also be the default for the flat, unless both Tony and Shirley decide to opt out.
Cash basis legislation
Legislation to give statutory effect to the extension of the cash basis will be included in Finance Bill 2017, and will take effect from 6 April 2017.
Practical Tip:
The new rules came into effect in April 2017. Landlords will need to ensure that they understand them and how they apply to them.
