New Cash Basis: What Does It Mean For Landlords?

Lee Sharpe looks at the new cash basis of assessment, and what it means for landlords.

The new cash basis for landlords was introduced in Finance (No 2) Act 2017, and applies automatically to most landlords from 6 April 2017, so will be relevant to 2017/18 tax returns being prepared now; and yes, that does mean that the cash basis applied seven months before the relevant legislation was even enacted. What is worse, if the landlord’s circumstances fit the relevant criteria, it has applied automatically from 6 April 2017 – one has to elect out of the cash basis. 

The aim of this supposedly simple regime is not really simplicity for the landlord but consistency of information to be processed by HMRC. It is understood that HMRC intends to take reports from letting agents about their client landlords’ property income and expenses to each individual landlord’s own personal tax return file, so as to pre-populate their returns, so that they cannot make any mistakes. This would all be undone if the landlord and letting agent did not both use the same cash basis of accounting, to recognise income and expenditure in the same way and at the same time.

The cash basis applies to rent from commercial and residential properties, from in the UK or from overseas.

The key distinction is that, unlike standard accounts prepared according to generally accepted accounting practice, (GAAP – also known as the ‘accruals basis’), receipts and expenses are recognised only when physically received and paid. So, unpaid invoices or rent arrears that are outstanding at the end of the year are ignored. 

This means:

In theory, the net position over the life of the property business should be the same as under GAAP: what is not recognised in one year will normally be picked up in the following year, etc.

Landlords are automatically brought within the cash basis unless:

Co-owner landlords who are not married do not have to adopt the same basis; the tests are applied to each separate property business, so if a person has his or her own property business, and a separate business run in partnership with another party, he or she can elect out of the cash basis for either or both businesses separately. But all properties within a particular property business must be dealt with consistently: cash basis or accruals.

No simplification would be complete without a raft of additional measures to complicate matters and reduce the tax cost to the Exchequer.

(a) Losses – There can be no ‘sideways loss relief’ against general income. With property businesses operating under the traditional GAAP/accruals basis, losses derived from capital allowances may be set against an individual’s general income (under ITA 2007, s 120), rather than having to be carried forward against future property business profits from the business. This is particularly useful to landlords with commercial properties, where capital allowances claims can be substantial, such as when acquiring a ‘new’ commercial property. 

(b) Capital Expenditure – As noted above, the distinction between capital expenditure and ongoing ‘revenue’ expenses is supposedly removed under the cash basis. The cost of a capital asset is deducted in full from rental income as incurred, and any sale proceeds are added to rental income. However, the following categories of expenditure are excluded:

Taken together, these largely put cash businesses on a similar footing to businesses operating under GAAP. 

(c) Finance costs – The restrictions to income tax relief introduced from 6 April 2017 (under ITTOIA 2005, s 272-274 for most landlords) apply under the cash basis just as under the accruals basis. There is also a further statutory test under the cash basis, which limits finance costs relief if the total property business-related borrowings exceed the aggregate value of property when each was first introduced to the lettings business, together with any improvement costs incurred to date. This new statutory test (which broadly mimics established case law) is applied first, and the remainder is then subject to the income tax relief restriction.

(d) Private use – Exclusions and apportionments of expenses to reflect private or other non-business use apply to the cash basis just as they do under the accruals basis.

(e) Letting agents – Receipts and payments made through letting agents should be recognised as they arise, rather than when the net proceeds are transferred to the landlord. In other words, the letting agent ‘stands in the shoes’ of the landlord when reckoning up under the cash basis. This is to be expected, given that the whole point of the cash basis is for the information a landlord should put on his or her tax return ought to tie in as closely as possible to the information provided directly to HMRC by letting agents about their landlord clients.

(f) Tenant deposits or bonds – HMRC initially toyed with treating all deposits as income when received but ultimately agreed that deposits should be recognised only when, and to the extent that, the landlord becomes legally entitled to retain funds following a claim against the deposit.

Bearing in mind the more detailed aspects of the new cash basis, it seems reasonable to conclude that it retains most of the complexity and conditionality of the traditional accruals basis. That is because the cash basis is only about ensuring that the figures reported by letting agents will be as close as possible to the amounts landlords will be entering into their tax returns anyway – which is why landlords have to elect out of the new regime, rather than elect in.

Commercial property landlords may well prefer to elect out of the cash basis, to remain under GAAP and be able to continue to access the comparatively favourable losses available for capital allowances under that regime.

One rather uncomfortable part of the incoming ‘making tax digital’ regime for property businesses is that they will have to report their results every three months, which is difficult to reconcile with the legislation that says landlords have a year after the filing deadline to elect out of the cash basis – for all practical purposes, the decision has to be made long before the legal deadline, unless the software being used is clever enough to accommodate the results according to both cash and accruals bases, simultaneously. 

But it will probably have to be that clever, at least for landlords who let out in partnership with non-spouses, etc.; if another partner incorporates their part of the property business, or a corporate partner is otherwise introduced, no other partner will be able to use the cash basis, as noted above, so the implication is that co-owning landlords will have to be able to adapt their accounting systems at very short notice, or have some means to prevent corporate partners.