In most cases, “business property” attracts 100% relief for the purposes of inheritance tax once it has been owned for two years, so if you own such property when you die, its value will not be counted when working out the taxable amount of your estate for inheritance tax.
It is also possible to make gifts of business property during your lifetime without worrying about the usual requirement to survive the gift by seven years, provided the property remains in use for business in the hands of its new owner.
It used to be the case that HMRC accepted that Furnished Holiday Accommodation (FHA) qualified for business property relief provided the owner was involved at least to some extent in running the business. In November 2008, without telling anyone, they changed the wording of one paragraph of their Inheritance Tax Manual, to say that unless significant extra services were provided in addition to the basic ones of cleaning and laundry, they no longer accepted that FHA was business property.
Their logic for this was that owning and operating FHA fell within the definition of “holding investments”, which is one type of business that does not qualify for business property relief. It is well established that running a property portfolio, of residential or commercial properties, falls within this “investment” exclusion, but it is quite a stretch to equate FHA, where the occupants change every week or fortnight and the place has to be cleaned and prepared for the next customers, with longer term property letting where the tenants may be in place for many years and as a general rule do their own cleaning and decoration.
In December 2011 the First Tier Tax Tribunal decided the case of the late Mrs Pawson, whose executors had claimed business property relief on her one-quarter share in a holiday cottage. The decision was published on 27 January 2012, and could represent good news for those owning FHA.
Mrs Pawson owned a quarter share in a family owned holiday cottage, which was let out as FHA when it was not being used by members of the family. She was not personally involved in either finding customers or in the cleaning and laundry, which were subcontracted to agencies.
When she died (in 2006) her executors claimed business property relief – note that this was before HMRC’s change of mind in 2008, so presumably HMRC refused the relief at first on the grounds that Mrs Pawson was not “hands-on” enough to qualify. They then modified their argument to say that FHA was an “investment” and so excluded from relief.
The report of the case makes amusing reading, as the Tribunal Judge poured scorn on HMRC, both for the logic of their case, and the way they had conducted it. The following quotation gives you the flavour:
“We have no doubt that an intelligent businessman would not regard the ownership of a holiday letting property as an investment as such and would regard it as involving far too active an operation for it to come under that heading. The need constantly to find new occupants and to provide services unconnected with and over and above those needed for the bare upkeep of the property as a property lead us to conclude that no postulated intelligent businessman would consider such a property as Fairhaven to be correctly characterised as an investment. He would consider it to be a business asset to be exploited as part of the provision of services going well beyond an investment as such.”
HMRC may appeal against this ruling, but after such a lucid explanation by the Judge of why FHA cannot be called an “investment”, it will be interesting to see how they get on!
It would be prudent to keep a close eye on the Inheritance Tax Manual in relation to your holiday let just in case a word or two has been changed which may be to your detriment or not.