It was introduced by the Finance (No 2) Act 2017 and as such will be relevant to all 2017/18 tax returns being prepared now. It is bad enough that it applies seven months before the relevant legislation was even enacted, but to make matters worse, if the landlord’s circumstances meet the relevant criteria it applies automatically from April 6, 2017 unless you ‘elect out’ of it!
One of the tenets of good tax system design is ‘simplicity’ and that is what the government have tried to achieve here. The problem they may not have foreseen is the potential disparity between reporting systems of letting agents and taxpayers. It is understood that HMRC intend to take reports from letting agents about their client landlords’ property income and expenses to each individual landlord’s own personal tax return file, in an attempt to prevent taxpayer mistakes by pre-populating their returns. Fair enough, you may well say, but this will all be undone if the accounting system used by the letting agent is different to that used by the taxpayer! Therefore if the agent is using accruals accounting (which is likely) and the taxpayer accounts on a cash basis (due to the new system) then income and expenditure will not be recognised in the same way at the same time causing incongruence of data. Unlike standard accounts which are prepared according to GAAP (generally accepted accounting practice – also known as the ‘accruals basis’) receipts and expenses are recognised only when physically received and paid. So under this ‘cash basis’, unpaid rent invoices outstanding at year end are ignored in calculating rental profits. This also means that expenses incurred which are unpaid at year end will have to be claimed the following year. Hence from an accounting point of view there are no debtors, creditors, prepayments or accruals! Landlords are automatically brought into the cash basis unless:
- the business involves a corporate or trustee landlord or an LLP and if one co-owner is one of the above the cash basis does not apply.
- Receipts for the year are over £150,000 (pro -rated)
- The business renovation allowance has been claimed and a balancing adjustment would be required.
- The landlord elects out of the cash basis, no later than January 31, the year after the tax return filing deadline.
- Spouses and civil partners who let property jointly must use the same method (so if one elects out or is ineligible then the other must follow)
I can’t mention all the complications here but one which is most displeasing is for landlords who run property ‘businesses’. In these cases under traditional GAAP/accruals accounting, losses derived from capital allowances can be ‘sideways relieved’ against an individual’s general income under s120 of ITA 2007 often generating personal tax refunds! Under the new cash basis they can’t be, meaning that if you don’t ‘elect out’ it could cost you a tax refund! Be wary and vigilant this year!