Furnished Holiday Let changes for those on the Flat Rate Vat Scheme

The Flat Rate VAT Scheme (FRS) is a simplified option for paying VAT for businesses with lower turnover.

At an annual turnover of £90k of vatable supplies, a business must become VAT registered and pay VAT on sales. Businesses with a gross turnover of less than £180k can opt for the FRS. The FRS rate is set by HMRC and is sector specific. For FHL the rate is 10.5%. This is a generous rate for most FHL operators compared to standard VAT accounting.

Standard VAT accounting

Standard VAT accounting is likely to approximate at a rate of 14.5%, but this varies on the purchases made by businesses. If there were no vatable supplies to the business, then the net VAT payable would be 16.67%. This is the equivalent of 120% of after VAT sales. (it is reverse calculated from the gross). Therefore, if the reclaim of VAT on purchases amounted to 2.17% of sales, then the VAT cost would be 14.5% of the gross sales.

In this scenario, the savings of using the FRS would be 4% of sales.

However, the FRS, being simplified, does not distinguish between exempt and vatable supplies. Therefore, if your business has exempt supplies, the value of these sales must be included in the VAT calculation.

Furthermore, the exempt supplies are included in the upper threshold of eligibility for the FRS which is £230k of sales. Beyond this threshold, you must use standard VAT accounting.

For Furnished Holiday Lets (FHL), exempt supplies would include off-season stays if the property is holiday accommodation, subject to qualification criteria. If the FRS is used, these exempt supplies would be included in the VAT calculation.

A Vatable business entity

What constitutes a business entity for VAT purposes?

Currently, a solely (or jointly) owned property rental portfolio that comprises FHL and BTL properties is treated as two businesses for the purposes of the tax return.

From 6th April 2025, this will combine to be treated as one business. The benefits of this are that costs associated to FHL, for example, capital allowance losses carried forward, can be offset against the total income of the portfolio.

However, the VAT rules do not change. Where the entities are separate for VAT today, it is understood they will be separate for VAT after 6th April 2025.

The issue that may become much more prominent in the future is whether the businesses truly are separate for VAT purposes. The reason that this defining issue may draw more attention in the future is that the total income will be included in the same tax return box. This could be deemed to be a financial or organisational link.

The pertinent question is whether the businesses of BTL and FHL are truly separated for VAT purposes. This question applies today and will continue to apply post-6th April, but may receive more attention.

Whilst it is recognised that BTL and FHL are separate businesses for VAT purposes, if they are closely linked and deemed to be “associated” then they are not eligible for the FRS and would have to use standard VAT accounting.

Standard VAT accounting could increase the VAT payable by up to 4% of the FHL sales value, based on the approximations stated above.

How do you determine if your businesses are “associated”?

You’re associated with another business if:

• One business is under the main influence of another
• 2 businesses are closely bound by financial, economic and organisational links or another company has the right to give directions to you
• In practice your company repeatedly complies with the directions of another — the test here is a test of the commercial reality rather than of the legal form

One could assume that the use of one business bank account for both businesses would be binding the businesses with a financial link.

From 6th April, it is possible to offset losses in both businesses against income in both businesses for the purpose of calculating taxable income. If this were to occur, would that bind your business’s financial, economic and organisational links? This is a question yet to be tested.

Transitioning to other business structures

Due to the removal of discretionary income sharing, many FHL operators are considering alternative structures such as partnerships and limited companies. Should these include both BTL and FHL properties then the total income will be considered for VAT under the FRS. This could raise the income beyond the eligibility of the FRS and would certainly mean that the VAT will be due on the BTL sales.

Each case would need to be considered to determine whether paying the VAT on BTL sales is preferable to using standard VAT accounting.

If standard VAT accounting was used in a partnership or limited company which contained both FHL and BTL properties, then VAT would only be calculated on the FHL income, but the reclaim of costs would be restricted under the partial exemption rules.

Conclusion

In conclusion, whilst the VAT rules are not changing from 6th April, the change in the FHL taxation methods may bring into focus the eligibility of the FRS for owners of BTL and FHL properties.

Exempt supplies, such as off-season letting, are subject to VAT under the FRS

The transition of the business to a partnership or a limited company would mean that VAT is due on BTL income where the FRS is employed.

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