The Office of Tax Simplification has put forward its recommendations for changes to the property tax system. The OTS Property income review – published in November 2022 – focuses on the UK taxation of income from residential property, mainly in relation to individual taxpayers. The report aims to help reduce complexity and improve understanding of taxpayers’ obligations.

Here, we look at the key findings and share our reaction…

What is the OTS Property income review?

The report examines the complexities and challenges of the taxation of income from residential property, looking mainly at property businesses. Nearly one in 10 income tax payers earn money from property, highlighting its importance to the UK economy and tax system.

The survey issued as part of the review was completed by 3,559 people – the highest survey response the OTS has received. Most issues raised by respondents concerned income tax, rather than corporation tax.

The report builds on the comments made by the wide range of people who responded. It brings together recommendations for possible action over the short and medium term, and makes proposals for improved guidance in several areas.

Residential property can be treated for tax purposes as a place to live, an investment, a business, or even as a trade, with quite different tax consequences.

Overview of the key findings and priority recommendations

Non-UK residents

Non-UK resident landlords are taxable in the UK on income from land. Significant parts of the administration for non-UK residents present challenges, including registration for online services and in some cases no online service being provided.

Unless a non-UK resident landlord registers to file and pay with HMRC, the Non-Resident Landlord Scheme (NRLS) requires the deduction of tax at source from rents paid to them. This obligation falls on letting agents or, if there are none, on tenants.

The OTS recommends the Government considers reviewing the policy of tenant withholding, because of the potential burden and its effectiveness for residential tenants. If tenant withholding is kept, the Government could think about raising the threshold. It could make the withholding obligation on tenants clearer in guidance and find ways to raise awareness. And it could clarify the process to correct matters if tenants initially don’t withhold.

Furnished holiday lettings

Around 127,000 furnished holiday lettings (FHL) businesses owned by individuals are declared to HMRC in personal tax returns, including 17,000 relating to properties in the European Economic Area (EEA).

Respondents in general were neutral on the benefits of the regime compared to its administration, and those who were positive felt the scope of who was included was too wide. The key benefits are seen as the availability of full relief for interest and the reduction in capital gains tax (CGT) on disposal.

The OTS recommends the Government considers whether there is continuing benefit to the UK in having a separate tax regime for FHLs.

If the FHL regime is abolished, the OTS suggests the Government considers whether certain property letting activities subject to income tax should be treated as trading. Also, would it be appropriate to introduce a statutory ‘bright-line’ test to clearly define when a property trading business is being carried on?

If the Government concludes the furnished holiday lettings regime be retained, the OTS recommends the Government then considers:

  • Removing the current distortion of allowing the regime for properties in the EEA, either by permitting worldwide properties to qualify, or by limiting the regime to UK properties
  • Restricting the regime to properties used for commercial letting by removing the potential for personal occupation

Repairs, replacements, and improvements

This is still an area of great uncertainty, not just for landlords, but also for advisers and HMRC staff.

Should costs be allowable straight away as repairs and replacements? Or do they represent capital expenditure as improvements and therefore be disallowed for income tax?

The OTS says HMRC should improve the guidance in respect of the boundary between repairs and improvements to include clear examples of common situations. It wants the Government to also consider introducing a broader immediate income tax relief for all property costs – except for work that is part of the capital cost of the building.

Any costs allowed for income tax would (as is the case under current rules) not be allowable for CGT.

Jointly owned property

HMRC data indicates almost half (1.5 million) of all taxpayers renting out property do so jointly, mainly with a spouse or civil partner, or with others.

Those not married, or in a civil partnership, will by default declare the split of income based on beneficial ownership. Alternatively, they can choose any other split they like without any form of election.

But spouses and civil partners (providing they live together) default to equal 50:50 shares for property, except for furnished holiday lets. Respondents said the process to instead use a split based on beneficial ownership is complex and burdensome, even for advisers, and taxpayers themselves aren’t normally aware of the need. This creates an unnecessary complexity and burden, and potentially accidental non-compliance.

The OTS recommends the Government should think about removing the old-fashioned 50:50 rule for spouses and civil partners. It should align treatment to that of other joint owners and to the position for spouses under CGT and inheritance tax (IHT). And, to prevent abuse, the default beneficial ownership position shouldn’t be capable of being displaced.

The Government may also wish to consider removing the ability for joint owners to decide on a split other than beneficial ownership.

Making Tax Digital for Income Tax

From April 2024, landlords in scope of Making Tax Digital (MTD) for Income Tax will need to keep digital records and file updates quarterly using compatible software. There was a high level of concern among the respondents about how the rules would apply to landlords.

The OTS recommends HMRC should establish a system to deal with MTD for Income Tax for jointly owned properties.

HMRC needs to be able to authorise MTD for Income Tax filing agents alongside tax agents. This is needed because letting agents and bookkeepers will maintain digital records and may support quarterly submissions on behalf of some landlords. Specific professional standards and responsibilities will be needed for MTD for Income Tax filing agents.

The OTS says HMRC should consider increasing the minimum gross income threshold for MTD for Income Tax for landlords above £10,000, at least for the medium term.

It also suggests MTD for Income Tax shouldn’t apply to landlords until these major points have been dealt with by HMRC and by a range of software providers. Time will be needed to test new systems before adoption.

Diversified agricultural-based businesses

Over recent years, 66% of agricultural businesses are diversified. They need to include other sources of income to maintain the core agricultural production as a viable business, and this includes income from property.

If the Government feels support should be made available to secure UK agricultural production, then HM Treasury and HMRC should work with the Department for Environment, Food & Rural Affairs (Defra). Together, they would explore the potential for a ‘Rural Business Unit’ or similar regime for tax, with the aim of simplifying the obligations on relevant parties and reducing the complexity of rules applying to diverse rural businesses.

Our thoughts on the OTS Property income review

Property taxation is a complex area, and it’s become more difficult for landlords because the rules have tightened over the last few years.

Although landlords are an intrinsic part of an economy where there is insufficient social housing to fulfil demand, the system is very penal in many respects and unnecessarily complicated.

Hopefully, the OTS review will result in some kind of simplification of the system. It may also prompt an acknowledgment that some property rental businesses are the same as a trading business, which is currently difficult to get HMRC to accept.

Property tax advice

Our property tax specialists will help ensure your property business is tax efficient and compliant with the law. Plus, we can provide specialist tax advice for intermediaries acting on behalf of their clients.

Call the Churchill Taxation team on 07813 434195 or email: stephanie.churchill@churchilltaxation.co.uk

Steph Churchill

Stephanie Churchill

Managing director & co-owner of Churchill Taxation