The government's plans to allow landlords to use the cash basis for tax purposes were confirmed in the 2017 Spring Budget, but although the proposed legislation was included in Finance Bill 2017, it did not appear in the much reduced Finance Act 2017, which received Royal Assent on 27 April 2017. It is likely that the proposals have been temporarily shelved, pending the outcome of the General Election, and are expected to reappear in a second Finance Bill later this year. If the provisions are subsequently enacted, they are expected to apply retrospectively from 6 April 2017, i.e. for the current tax year.
Up to and including 2016-17, profits of a property business must be calculated in accordance with generally accepted accounting practice (GAAP), commonly referred to as the accruals basis. Although this remains the case for certain landlords (including companies, LLPs, corporate firms, and trustees of trusts), if the Finance Bill 2017 provisions are enacted, the position for 2017-18 onwards will be more complicated. The general rule is that the cash basis must be used. However, this is subject to some exceptions and there will be scope for the individual to elect to continue using the accruals basis if they so wish. The new property allowance will remove some landlords from income tax, whilst for others, it will provide a deduction from profits of £1,000.
The property allowance works as follows:
- Full relief: if income from a property business for the tax year is equal to or less than £1,000, no income tax will payable in respect of that property business for that year. Individuals may elect to use the rules normally applying to calculate profits.
- Partial relief: if income from a property business for the tax year exceeds £1,000, the individual may elect to deduct £1,000 from his income - rather than the expenditure actually incurred - in arriving at the profits of the property business.
A number of restrictions apply. The property allowance will not apply:
- to income on which rent-a-room relief is given; or
- where the 'alternative method' is not elected, but instead the actual allowable expenses are deducted.
The cash basis operates by reference to the tax year. This means that profits are calculated for the tax year by adding or subtracting:
- all income received in connection with the property business in the tax year;
- any income that is not taxable and for expenses which are not allowable.
Reform of capital expenditure rules
To date, the cash basis rules have prohibited a deduction for expenditure of a capital nature unless such expenditure would qualify for plant and machinery capital allowances under the ordinary tax rules. However, if the Finance Bill 2017 proposals are enacted this general disallowance of capital expenditure rule will be replaced from 2017/18 onwards with a more limited disallowance of capital expenditure incurred in relation to assets which are not used up in the business over a limited period.
So, if enacted, from 2017/18 onwards, relief will be prohibited only in relation to costs incurred in relation to the provision, alteration or disposal of:
- any asset that is not a 'depreciating asset' (to be defined as having a useful life of up to 20 years);
- any asset not acquired or created for use on a continuing basis in the trade;
- a car (but of course business mileage-based relief is available);
- land (as defined);
- a non-qualifying intangible asset, (as per Financial Reporting Standard 105) including education or training; and
- a financial asset.
Costs in relation to the acquisition or disposal of a business, or part of a business, will also be excluded.
On entering the cash basis, which many taxpayers will do for 2017-18, it will be necessary to adjust for:
- amounts which, applying the cash basis, would have been brought into account for a period before the change and were not brought into account; and
- amounts which, applying the cash basis, should be brought into account for a period after the change and were brought into account for a period before the change.
These adjustments are designed to ensure that no amounts are either left out of account or double counted. The adjustment income/expense is brought into account on the last day of the first period of account under the cash basis.
Similar rules apply where a taxpayer leaves the cash basis with the exception that adjustment income is automatically spread over six years unless an election is made to accelerate the charge.
Given the uncertainty of the current situation, clients are encouraged to ensure that all income and expenditure is recorded, particularly where clients are intending to make use of the property allowance. If the proposals are not enacted, or are delayed to a future tax year, the client will need to report their actual income and expenditure and so it is important that adequate records are kept.