Cash Basis for Landlords Explained - Accountants in Croydon

 HMRC's making tax digital' (MTD) strategy aims to transform the UK into one of the most technologically advanced tax administrations in the world. Businesses and landlords will be required to keep digital records and provide quarterly digital updates to HMRC, according to the proposals. To make this a reality, various other simplifications and initiatives are being implemented, including the possibility of certain landlords shifting to cash basis accounting.

Following a consultation, HMRC announced that the cash basis will be extended to unincorporated property businesses with a maximum rental income of £150,000 per property business.

Background

HMRC issued six consultation documents in August 2016. Each document concentrated on a different aspect of the MTD strategy. One of the documents was titled 'Simplified cash basis for landlords.' The document outlined proposals for extending cash basis accounting to unincorporated property businesses. Comments on the proposals were due by November 7, 2016, and HMRC published their response to the consultation on January 31, 2017.

Cash Basis

The consultation document proposed allowing the most basic property businesses to calculate their taxable profits on a cash basis. This is simply calculating profits on a 'cash in, cash out' basis. In contrast, the current standard, the accruals basis, accounts for income earned and expenses incurred during the accounting period regardless of whether the associated cash has been received or paid out. Moving to a cash basis will reduce the need for accounting adjustments and simplify transaction recording. Since 2013, small eligible trading businesses have had the option of operating on a cash basis.

According to the proposals, cash basis accounting would be available only to certain unincorporated businesses, i.e. those where a person (rather than a company) receives income from property. Trusts, unitholders in unit trusts, real estate investment trusts, partnerships with corporate members, and limited liability partnerships are also barred from using the cash basis.

Maximum Limit

The cash basis, as it currently applies to traders, 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 landlords should be subjected to a maximum limit for using the cash basis. While many respondents argued that a maximum limit should not be imposed for the sake of simplicity, the government felt that using the cash basis was not appropriate for the largest individual and partnership landlords.

The cash basis limit for traders was increased to £150,000 in April 2017, and this limit will also apply to property businesses. As a result, the cash basis will only be available to unincorporated property businesses with 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 will the cash basis be extended to unincorporated property businesses, but it will also become the default basis. As a result, unless they opt out, property businesses with receipts under £150,000 will be required to use the cash basis. Smaller property businesses will increasingly operate on a cash basis rather than an accruals basis in the future.

Larger unincorporated property businesses with receipts in excess of the £150,000 cash basis limit will have no choice. Their default will remain the accruals basis; they will not need to opt out of the cash basis because it will not be available to them.

Several Real Estate Businesses

The consultation also considered whether a decision to use the cash basis or not should apply to all businesses 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 over a global opt in or opt out. The ability to select the most appropriate basis for each business was thought to be especially important where an individual had both UK and overseas property businesses.

Following consideration of the responses, the legislation will allow for a separate decision to be made for each property business. The £150,000 limit will be applied separately to each property income business.

Property Owned Jointly

Joint owners of let property will also be free to make separate decisions about how to calculate their profits, and each individual's eligibility for the cash basis will be considered separately. This was regarded as a necessary complication, as the legislation treats joint owners as carrying on their own property business. In practise, most joint owners will most likely choose to work on the same basis.

There will be an exception to the general rule allowing each joint owner to choose which basis to use - where a property is owned jointly by a husband and wife or civil partners, both spouses or civil partners will be required to calculate their profits on the same basis. This is to simplify 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

Whether the cash basis or the accruals basis is used, relief for loan and finance costs will be calculated in the same way and subject to the same restrictions.

Lease Premiums

Existing rules provide that if a landlord receives a premium for granting a lease of less than 50 years, or if a tenant performs work in lieu of such a premium, an income tax and capital gains tax charge may apply. The government does not intend to allow landlords to apply the cash basis to these sums or to allow a deduction for landlords who have made payments or performed work under such an agreement.

Fees Charged by Letting Agents

When a property is let through a letting agent, as many are, the government believes that the date of receipt for the cash basis is the date on which the letting agent receives the money from the tenant on behalf of the landlord, not the date on which the landlord receives the rent from the agent.

The justification for this viewpoint is that the letting agent is acting as an agent for the landlord. However, this appears to contradict the simplification theme and the cash basis's pure cash in cash out nature. Furthermore, until the landlord receives the letting agent's statement, he may be unaware of the income and expenses received and paid out by the letting agent. HMRC has promised clarification in guidance materials to be published after the relevant legislation is enacted.


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