The idea of owning a holiday home abroad is appealing to many. Despite the obvious advantages of having a second home in maybe a beach or ski resort, it also offers the opportunity to earn rental income. From a tax perspective, all holiday homes are not equal as the rules may vary depending on where the property is situated and the extent to which it is let.
The fact that a property is overseas does not place any income and gains outside the grasp of the UK taxman as a person resident, and ordinarily resident, in the UK is taxable on his or her worldwide income, regardless of whether it is remitted to the UK.
It is also important to appreciate that local taxes may also be payable and the tax rules of the country where the property is situated should be taken into account prior to purchase. Double taxation relief is available where income from an overseas holiday home falls with the ambit of the tax authorities of both the UK and the foreign country.
Overseas Property Income Business
Income from property outside the UK does not form part of a person’s UK property business. Instead a separate concept of an overseas property business applies. An overseas property business is treated as a single property rental business in the same way as is the case for a UK property business, such that all sources of income from land and property overseas are treated as deriving from the same single overseas property business.
The rules for computing the profits or losses of an overseas property business mirror those for a UK business. The profits and losses are computed in accordance with trading principles, with the crucial difference that an overseas property business is not generally treated as a trade (subject to an exception for certain EEA furnished holiday lettings).
Computing Profits & Losses
The profits and losses of the overseas rental business are computed globally such that all the income and all the expenses from properties throughout the world are thrown in the melting pot. This approach means that losses from one overseas property are automatically offset against profits from other overseas properties, to the extent that these remain available.
The exception to this rule is furnished holiday lettings in the EEA, the profits for which are computed separately as outlined below.
Where a person lets out a holiday home either outside the EEA (or one within the EEA which does not meet the furnished holiday lettings conditions), the income and expenditure in relation to that property is taken into account in computing the profits of the overseas holiday business.
It is important to note that the overseas property business includes all overseas properties let by the same person in the same legal capacity. As such the business is not restricted to holiday homes. For example, if a person owned a holiday home in the States and rented out a city flat in Paris on a long-term let, the profits and losses from each would be taken into account in computing the profits of the overseas property income business.
Where the business shows a loss overall, that loss can only be carried forward and set against future profits from the same overseas property income business. As an overseas property business is regarded as a trade, the more generous trading loss relief provisions do not apply.
Holiday Homes in the EEA
Special rules apply to the letting of furnished holiday accommodation in other EEA states. The rules largely mirror those applying to furnished lettings in the UK, which following consultation are amended from 2011/12.
Furnished holiday lettings in the UK have long enjoyed a tax-privileged status. The commercial letting of furnished holiday accommodation is treated as a trade, with the result more generous relief for trading loss is available as well certain capital gains tax (CGT) reliefs.
The furnished holiday lettings rules originally only applied to accommodation in the UK. However following concerns that this was not compatible with EU law, the provisions were extended to furnished holiday lettings in other EEA states from 2009. The original intention was for the rules to be abolished from 2010/11.
However, following consultation they have remained, with amended rules which restrict some of the former benefits, such as the generous relief for losses, applying in the main from April 2011. The amended rules applying to UK furnished holiday accommodation are mirrored in respect of EEA lets. However, the profits and losses, which are computed according to trading principles, must be computed separately for UK and EEA holiday lets.
To qualifying for the EEA furnished holiday lettings treatment several conditions must be met. These are:
• the availability condition;
• the letting conditions; and
• the pattern of occupation condition.
For 2011/12 and earlier years the availability condition requires the property to be let for at least 140 days in the tax year. From 2012/13 this is increased to a minimum of 210 days in the year.
The letting condition requires that, for 2011/12 and earlier years, the property is actually let for at least 70 days in the year. This is increased to a minimum of 105 days from 2012/13.
The ‘pattern of occupation’ condition requires that during the year no more than 155 days are periods in which the property is let to the same person for more than 31 days. This to ensure that the property is let as holiday accommodation for short periods for much of the year, but also allows for longer lets during the closed holiday season.
Where a person has more than one property and one or more of the properties fail to meet the letting condition, the condition can be met by averaging the actual letting for all properties. However, an election must be made for this basis to apply.
One of the changes to the rules to be introduced by Finance Act 2011 is a 50% increase in the period for which the property must be available to let (increasing from 140 to 210 days) and in the period for which it must actually be let (increasing from 70 to 105 days).
These changes take effect from 2012/13. However, a period of grace is allowed to provide time to meet the more stringent conditions. If the property meets the letting condition in 2010/11 or a subsequent year but then fails to meet it in the next or next two, the property can still be treated as let accommodation provided that there was a genuine intention to meet the condition and an averaging election has not been made.
This means that if the condition is met in 2011/12 on the old rules, but fails to meet the new letting condition in 2012/13 and 2013/14, if an election is made the property can continue to qualify as EEA furnished holiday letting accommodation for those years.
Being treated as EEA furnished holiday accommodation still confers some advantages, although not as many as in the past. Prior to 2011/12, losses could be relieved under the trading income rules, which meant that they could be set against general income.
However, from 2011/12 relief for losses is restricted such that they can only be set against the same EEA furnished holiday lettings business. However, capital gains tax (CGT) reliefs, such as entrepreneur’s relief and rollover relief, remain available.
If you are linking of buying a holiday home in the EEA, consider buying one before 2012/13. The more stringent letting and availability conditions do not kick in until 2012/13. If the conditions are met under the old rules in 2011/12, you effectively have until 2014/15 to meet the new rules as a result of the two-year period of grace.