Whilst this relief levels the playing field in terms of the tax relief available to landlords offering furnished, partly furnished or unfurnished accommodation, it adds complication in terms of establishing the amount of relief available.
Relief is not available for the initial expenditure on furnishings and domestic items. It is only available on their replacement. This is then complicated by the fact that relief is restricted if the replacement items are not ‘the same or substantially the same’ as the old item.
This restriction is familiar, as there was a restriction for ‘improvements’ in ESC B47, the non-statutory renewals basis. However, identifying whether a replacement is ‘substantially the same’ adds to the burden for landlords – particularly those with furnished lettings, where they would not have required detailed tax records if they were claiming the wear and tear allowance.
This was highlighted to HMRC during the consultation process. In the consultation outcome, published by HMRC on 9 December 2015, it stated:
‘2.20 Government response: Opinion was divided on the extent of the complexity excluding improvements brings. The Government remains of the view that this rule is necessary to make the relief fair, so that the initial cost of additional functionality is not available in the same way as the initial cost of assets.
2.21 To minimise uncertainty, HMRC will produce comprehensive guidance to enable taxpayers to apply this rule to their circumstances, particularly around what constitutes a modern equivalent.’
At the time of writing, no guidance has appeared in HMRC’s manuals concerning this new relief, and no draft manual guidance has been published for consultation.
Guidance for taxpayers
HMRC did update its guidance ‘Income Tax when you rent out a property: working out your rental income‘ (https://tinyurl.com/HMRC-rental-income) together with ‘Income Tax when you rent out a property: case studies‘ (https://tinyurl.com/Rental-case-studies) on 28 October 2016.
The examples are interesting. If they had been subject to consultation, no doubt they would have attracted some comment and questions. In the main guidance, it says:
‘Where the new item is an improvement on the old item, for example replacing a sofa with a sofa bed, the allowable deduction is limited to the cost of purchasing an equivalent of the original item. So, if a new sofa would have cost you £400 but a sofa bed cost you £550, you could only claim the £400 as a deduction and no relief is available for the £150 difference.
When considering if the new item is an improvement on the old asset, the test is whether the replacement item is or is not, the same or substantially the same as the old item.
Changing the functionally, say from a sofa to a sofa bed, means the replacement is not substantially the same as the old item.
Changing the material or quality of the item also means the replacement is not substantially the same as the old item. Say you upgrade from synthetic fabric carpets to woollen carpets, the replacement is not substantially the same as the old item so there has been an improvement.
Importantly, if the replacement item is a reasonable modern equivalent, say a fridge with improved energy efficient rating compared to the old fridge, this is not considered to be an improvement and the full cost of the new item is eligible for relief.’
The above is a very simplistic view, and does not state how you achieve this from a practical perspective. Take the sofa example. We are all aware that the choice of sofas and sofa beds is huge. If you build in the next point made by HMRC about choosing something made of a different material or of a different quality, the comparison becomes far more complex. What you need to be comparing is the price of the chosen sofa bed with the price of a new sofa that is substantially the same as the old one. How does the taxpayer or adviser judge this?
Quality is a matter of perception, and is not something that can be easily measured by consumers. Fashions change, so it may not even be possible to buy something that looks similar, whether or not it is of the same quality. Where the item being replaced is large (which most domestic items qualifying for relief would be), it is not practical to take it along to the showroom to ask for something the same or substantially the same. Manufacturers may no longer exist to establish the price of a current equivalent from the same manufacturer.
It is useful that HMRC accepts that improved energy efficiency of white goods does not necessarily lead to a reduction in relief. However, what if a fridge with substantially the same specification is purchased, but a more expensive brand? If an item is more expensive, it does not necessarily mean that it is of better quality (although paying more may provide a perception of better quality). There is an argument to be had that full relief can be claimed, particularly where warranty periods are identical.
The example in HMRC’s case studies leaves unanswered questions:
‘David has replaced a single, wooden framed bed in his rental property with a new double divan bed. The new double bed is an improvement on the old bed and David paid £500 for it, which is significantly more than the £150 it would have cost if he had replaced the old bed with a new equivalent wooden framed bed. Therefore, David cannot claim more than £150 of the purchase cost as a deduction.’
The new bed differs from the old bed in both size and style. The example does not elaborate what HMRC considers the improvement is. There is no mention of additional functionality (e.g. a storage divan). Many people would argue that a bed is a bed, regardless of its construction. Some people prefer the look of a wooden bedframe. Even if a divan was more expensive, they would not consider it an improvement (quite the opposite). This highlights the subjectivity of establishing whether something is the same or improved.
If HMRC adopts a hard line, landlords will have little incentive to provide quality items in their let properties and arguably, it will further encourage a ‘throw away’ society.
When it comes to preparing tax returns, whilst landlords may have invoices for items purchased as replacements, they may lack details concerning the item disposed of, particularly where records were not required because the wear and tear allowance was claimed.
Will common sense prevail?
HMRC’s Property Income manual (at PIM3230) states in respect of the former non-statutory renewals basis:
‘Sometimes it was impossible to find the current cost of replacing an old asset with something identical. In the previous example, the old washing machine may have been of a kind which was no longer available. Common sense had to be used to find the cost of a reasonable equivalent modern replacement.’
Let’s hope that a similar statement is contained in any new guidance.
Practical Tip:
Where possible, to evidence claims for full relief, landlords could try to obtain quotes for replacements for items that are ‘substantially the same’ where suppliers are willing to offer their expert view. This may be easier for items like replacement carpets where the supplier is more likely to come to the property to measure and quote.
