A young man (over 18) wishes to buy a residential house in which to live. Cost cca £300K. He can raise £200K himself, and shortfall of £100K is to be provided by father. The house is sufficiently large that he expects to get some rental income from surplus accommodation within the property. Father will have no equitable or beneficial interest in the property, nor does he ever expect repayment of £100K nor interest thereon. However the arrangement is that any speculative rental income that may arise from letting part of the property will be paid over to the father.
Leaving aside any rent-a-room deduction that may be available to the son, we are concerned that, in the worst case scenario, the rental income will be taxable on the son, the amounts paid over to the father will likewise be (income) taxable on the father, and there may be no mechanism for tax relief in the hands of the son for the amount taxable on the father, giving rise to an overall double charge to tax on the rents. Any ideas? How should the transactions be categorised? Is the reality that the "rent" transferred from son to father is in fact interest in nature, albeit unquantifiable in advance at any instant?
2nd worst case scenario is that father is taxed in full on amount received from son, and son gets corresponding relief but which would largely be covered by rent-a-room, so there remains a net tax hit.
With kind regards
Clint Westwood
Replies (16)
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Father loans son £100,000.
Father loans son £100,000.
Son buys house.
Son rents room and claims rent-a-room relief.
As and when, son pays back loan to father.
Father doesn't die in next 7 years.
Legal question
The problem you have is that the payments from son to father (should any be made) are in a sort of legal limbo. Without a formal agreement between the two, any payments made are open to interpretation.
I think calling them interest is a non-starter. For them to be interest they would have to have some relation to the amount lent. That would clearly not be the case.
I think the best scenario is that it is an interest-free loan that the son will repay "as funds allow". This would allow the payments to the father to be treated as loan repayments rather than rental income. The rental income would still be taxable on the son (subject to rent-a-room relief as noted).
Is the son an only child? If not, then legal advice is a must as there is risk of other siblings seeking repayment of the loan as part of their inheritance. Regardless, to guard against the two having a falling out, I'd say some sort of legal agreement is at least advisable.
Under the proposed arrangements...
... why should any of the amounts paid over to the father be taxable income? As you describe it, they have no source, which is essential for the receipts (from the son) to be income; it is established law that income arises from sources.
If there is no loan from father to son, and the father has no interest in the property, where is the source?
They are just as much gifts as the father's gift of capital, in the circumstances described. As has been noted, what you describe is not legally enforceable.
I expect the reason that the loan is not repayable is the mortgage company will only lend their £200k (assuming all borrowed) if there is no other debt.
My point was that if they put a loan agreement in place per the above advice then he may not be able to get a mortgage.
Ok - so father has made a gift of £100k....
... in consideration of his son entering into a (let's imagine its legally binding) commitment by his son to pay to him any "surplus" rents.
That doesn't change the fact that the son may pay tax on the rents, so the notional legal agreement between father and son would have to be expressed in net of tax terms.
So father has exchanged one asset (cash) for another (the contractual expectant right to income). I don't see that there is any tax consequence arising from that exchange except (query) could the son be charged to income tax at the outset on the disposal of the right to income that he would otherwise have under the anti-avoidance legislation at ITA2007, Part 13, Chapter 5A?
The expectant right to income is a contractual right which presumably exists (potentially) for as long as his son is alive. So it must have a value, although an actuary would be required to value it because of the uncertainty of the amount of income.
Every time father receives surplus rent it seems to me that he makes a part disposal of the expectant right to receive income. That right must (I think) be a chose in action, so each receipt would be a part disposal of that asset and he would have to do the normal part disposal calculations. Which would involve a revaluation of the expectant right at the time of receipt.
I think that may well be the technical position. If so, it's hopelessly impractical. Who wants to pay for a new actuarial valuation (at least) once a year?
So, they should be persuaded if at all possible to have nothing contractual, and if son chooses to make a gift to father out of his income, then that's up to him, - as suggested above.
Yes - I agree ...
... that there is no compulsion for it to be net of tax rents.
Which kind of points up the absurdity of it all. If it were at arms length then the son simply wouldn't let the surplus space - why would he go to that trouble for no reward? So you might even argue that the father's retained right was of little or no value but an asset nevertheless that was partially disposed on the occasion of each rental receipt. It could then well be within annual CGT exemptions and not reportable at all.
Essential contradiction
The problem is that the father is said not to have a beneficial interest in the property, but the right to receive surplus rents shows that he clearly still does have a beneficial interest in the property. That is the substance of the arrangement, whatever the legal form.
It sounds like a case of wanting to have their cake and eating it.
Re your "Final Point"
Interesting question.
In essence what we have here is rent factoring - son has taken £100k from father which is partly gift and partly consideration for the assignment of the right to the rents. Only an actuary could split the total into those two heads.
My understanding of rent factoring is that the John Lewis case established that a rent factoring agreement is capital in nature and would thus prima facie be subject to CGT as a part disposal of son's property.
However, rent factoring was open to abuse - particularly by non resident property owners who could exchange taxable UK property income for a non taxable capital sum. Which is why we now have ITA2007 Part 13.
So, in summary, I think son is probably chargeable to income tax on the actuarial value of the right retained by father.
Most unsatisfactory.