Furnished property lettings and inheritance tax relief

Last summer, everything looked rosy for owners of holiday cottages who let them out. A tax tribunal had decided that the letting of a holiday cottage in Suffolk by the Pawson family was the type of business activity which would fall within the scope of Business Property Relief (“BPR”) – a 100% Inheritance Tax relief available for certain business interests. This would entitle an owner to gift the business or leave it in their will without triggering any Inheritance Tax (“IHT”) liability at all, provided that they had owned it for at least two years.

Such news no doubt brought joy to around 65,000 cottage proprietors who rent their seaside and country retreats out for part of the year. But that joy (like the British summer) was short lived: at the end of January, an appeal by HM Revenue and Customs (“HMRC”) against the decision succeeded, and now it will generally be very difficult to bring such a letting business within the scope of BPR.

The reasoning behind the tribunal’s decision was that the business was mainly one of deriving an income from an ‘investment’, a finding which was, in law, fatal to the owner’s claim that BPR should be available.

As a result, cottage owners face the prospect of paying more IHT if they gift the property to their children in their lifetime or leave it to them in their will. Gifts to a spouse or civil partner will however always be free of IHT; but if the spouse then leaves the cottage to the children, HMRC may well want their share in tax when the second spouse dies.

But is it all doom and gloom? The decision of the tax tribunal did not close the door on the letting of holiday properties qualifying for BPR. The reality is that owners will now have to show that they carry out far more in the way of additional services for their tenants before they can benefit from the relief. And in any event, the family have launched a fighting fund to take their case to the Court of Appeal.

So how might a cottage owner now qualify for BPR? The Pawson case concerned a family’s bungalow near Aldeburgh which they managed themselves and rented out to holidaymakers. They maintained the property and its grounds using a housekeeper and gardener, arranged for fresh linen for guests, had the bungalow cleaned between lets, provided a TV and telephone, and sorted out all those niggling problems that beset holiday homes. As you would expect, the property was stocked with cleaning materials, heated and lit and provided with hot water. When Mrs Pawson, the mother of the family, died, the family claimed her share should benefit from BPR.

The judge however disagreed with them and said that the services provided by the family were insufficient to tip the balance of the business away from being one of ‘mainly’ holding the property as an investment. He considered the services were either ordinary management activities, or were not enough to prevent the business being one of simply exploiting an investment.

Tantalisingly, the judge avoided listing the kind of services which would be sufficient to transform an investment business into one qualifying for BPR. But he made it clear that they had to ‘predominate to such an extent that the business ceases to be one of holding the property as an investment.’

At present there is no clear guidance on how to qualify for BPR, but until either the Pawsons succeed on appeal, or other cases come forward to provide enlightenment, owners need to prove that the services they provide loom larger in importance than the property element of the business.

Maybe those owners might consider turning their cottages into B&Bs or small hotels? That would work……

For further information please contact Jill MacMahon