IHT: Door closes on tax exemption

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Letting furnished holiday accommodation is treated as a business for income tax and CGT, but it doesn’t qualify for business relief to reduce IHT on death. Andy Keates explores why this is the case.

Background

Inheritance Tax Business Property Relief (BPR) is a fairly straightforward concept: if, for the two years prior to death, the taxpayer was carrying on a qualifying business, then the taxable value of that business in their death estate is cancelled by a 100% relief (IHTA 1984, s103). What complicates this is that BPR is disallowed for businesses which consist wholly or mainly of dealing in land or buildings or making or holding investments (to summarise IHTA 1984, 105(3)).

Those businesses which fall into the “wholly” camp don’t qualify for the relief. The problems arise around the area of “mainly”: if you have a business which includes both legitimate trading activity and investment activity, there is a risk that you won’t get a penny off your IHT bill using BPR. There is no apportionment between business and investment: it’s an all-or-nothing proposition.

This is why so many BPR cases heard by Tax Tribunals involve caravan parks and furnished holiday lettings. Those activities firmly straddle the dividing line between property investment and trade. Also, the IHT at stake tends to be high, especially if the land has a large development value in the hands of the executors.

A recent First Tier Tribunal (FTT) case; Executors of Marjorie Ross (TC05959), concerned a group of furnished holiday lets in the West Country.

The facts

Mrs Ross, who died in 2011, had a two-thirds share in the Green Door Cottages Partnership (GDC), which owned eight holiday cottages and two flats in Cornwall and a separate property, UpsideDown House, in Dorset. On her death, her share was valued at between £1 million and £1.5 million.

HMRC agreed that GDC was carrying on a business, and that it was not “wholly” one of making and holding investments. However, they argued that it was a business “mainly” of investment in land, and so BPR would not be due. The executors argued that the business consisted of much more than mere investment.

The eight cottages and UpsideDown House were let out as holiday cottages. UpsideDown House was managed by an agent who charged a 21% commission. The other properties were managed initially by Mrs Ross but, from 2002, her daughter took over the day-to-day management.

Of the two flats, one was rented to GDC’s employee, a handyman, while the other was rented to a neighbouring hotel and used by its staff. This hotel had been owned by the Ross family until 2002, and she and her husband had seen the cottages as a good business fit. The hotel was sold because managing it had become too much for Mrs Ross.

Its new owner, Mr Sylvester, also saw the benefit of continuing a close business relationship with the cottages, and agreed to provide services and facilities to guests of GDC in exchange for the tenancy of the flat and 14% of GDC’s turnover.

The services the hotel supplied to GDC’s guests were: administration (including handling bookings); personal guest services (turning on heating, accepting left luggage, answering queries); food services (delivery of bar meals and discounts on bar meals in the hotel); and ordering milk and newspapers. In Sylvester’s words “the business continued to be run in conjunction with the hotel, the cottages on occasion being let as hotel bedrooms i.e. fully serviced, as well as separate self-catering cottages”.

The executors suggested that GDC’s business is providing services “more akin to a hotel than a typical self-catering holiday, and those services should include the services provided by the

hotel as agent for the partnership. Those services in particular set this business in a different category than even the most actively managed holiday lets.”

Earlier decisions on BPR

By emphasising the level of services provided the executors were seeking to distinguish their case from the cases of:

In both of those cases, the additional activities carried out by the taxpayers were mainly related to marketing, taking bookings, maintaining the property and providing clean linen between lets.

The Tribunals had held that what was being done by Pawson and Green was essentially managing their investment, and that anything over and above this was merely ancillary to the main business of receiving rent. GDC, the Executors argued, was doing so much more.

HMRC pointed out that, while the level of services provided by GDC was undoubtedly higher than in other cases of furnished holiday lets, those services were not enough to count as the greater part of the business.  In HMRC’s view: “what is really being provided is land, or the right to rent land in a particularly attractive location in Cornwall and that is the main reason why people stay at these properties”.

The decision

The executors lost – the business of GDC was mainly that of investment, in respect of all the properties it held.

Some of the points raised by the FTT in giving judgement were:

  • The starting point for owning and holding land to earn rental income is investment. However, there may also be non-investment activities. The test for BPR is whether those activities are more significant than the investment activities - a question of fact and degree.
  • The holding of land may be incidental to running a business (e.g. hotel, holiday camp) or it may be the very essence of the business. There is a spectrum of possibilities in between, and the trick is establishing where on the spectrum a given case lies.
  • Additional services provided alongside the letting of a property will, in most cases, either be incidental or will not be sufficient to prevent the business being one of mainly holding investments.
  • To come to a conclusion the business must be looked at in the round, seen through the lens of an intelligent business person.
  • The mere fact that a profit has been made from land does not inevitably mean that land is held as an investment.

Conclusion

Of the various cases on furnished holiday lets that have come through in recent years, this case might have been thought to have had the best chance. The decision, however, reinforces just how high the hurdle is for a taxpayer to get BPR. The accommodation itself will need to be truly secondary to the services being provided – for most furnished holiday lets, which are sold on the basis of the property and location, this is probably not achievable.

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