As an inducement to sign a lease you’re offering a prospective tenant a rent-free period. This can create tax problems. What steps can you take to avoid these?
VAT and rent
Generally, VAT only applies where there has been a supply of goods or services (letting a property counts as a service) in return for consideration. Consideration, i.e. payment, doesn’t have to be in the form of money, it can be something with monetary value. There may be circumstances where seemingly there is no supply of goods or services but special rules deem there to be one. It follows that where there’s no supply or no consideration there’s no VAT to account for. However, when it comes to rental properties the position isn’t always clear.
Is there consideration?
It’s not unusual for landlords to offer a rent-free period (often referred to as a rent holiday) at the start of a rental agreement or lease. Allowing a tenant to occupy the property is a supply for VAT purposes, but as long as there’s no reciprocal arrangement which could be construed as consideration you can forget about VAT. An example of an arrangement which would count as consideration is the tenant agreeing to meet the cost of repairs to a building where that would normally be the liability of the landlord.
Tip. If, as the landlord, you haven’t opted to tax the property the rent is exempt from VAT anyway. Therefore, even if there is consideration there are no direct VAT consequences of granting a tenant a rent holiday. In fact, because of the partial exemption rules, if you’re VAT registered and you grant a rent holiday on an exempt property it might increase the amount of VAT you can recover on expenses relating your other property or business activities.
Direct tax
Granting a rent-free period should mean that you, or your company if it’s the landlord, aren’t liable to tax on the rent you waive. However, the arrangement must be properly executed, otherwise you could remain liable to tax on it. This isn’t an issue if you personally own the property and your total rental income (from all UK properties) in the tax year in which you waive rent isn’t greater than £150,000. In that situation you’re only taxed on rental income you receive because for tax purposes the “cash basis” of accounting applies.
Formalise the waiver
However, if you are the landlord and have elected not to use the cash basis, or your company is the landlord (and so the cash basis can’t be used), formalising the waiver is especially important because the taxable profit from your property rental business must be worked out using the accruals basis. This means that rent due but not paid counts as taxable income. Without a formal waiver HMRC might argue that the payment of the rent could still be enforced and therefore must be treated as income.
Tip. Whether or not you’re using the cash basis it’s advisable to formalise a rent-free period by drawing up a waiver (normally in the form of a deed). As well as ensuring that you aren’t liable to tax on rent you don’t receive, it should ensure there’s no argument with your tenant over the terms of the waiver. If you’re not sure how to create a waiver, ask a solicitor to do it for you.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.