Furnished holiday lettings: Government publishes draft legislation on abolition

We take a look at how the draft legislation to abolish the furnished holiday lettings tax rules will work in practice.

Jeremy Hunt’s last Budget as Chancellor saw the announcement of a proposal to abolish the furnished holiday lettings (FHL) rules. Taxpayers owning properties that meet the FHL criteria have historically been able to qualify for additional tax advantages over other rented properties. This includes the ability to claim capital allowances on furniture and equipment additions, a reduced capital gains tax rate of 10% where business asset disposal relief (BADR) is available, as well as the ability to claim business asset rollover relief or holdover relief. FHL properties were unaffected by the restriction on the tax deduction available for finance costs, plus FHL profits were treated as earnings for pension purposes.

Although the spring Budget declared the intention to abolish this special treatment, limited information was provided about how the change would apply or the transitional rules. We received feedback from members about the impact that this lack of clarity was having on their clients, particularly in respect of the capital gains tax position (given that it was announced that anti-forestalling rules would take effect from the date of the Budget).

Alongside the first speech by the new Chancellor, Rachel Reeves, to parliament on 29 July 2024, the government issued a policy paper and draft legislation on how the FHL rules will be abolished.

Income and corporation tax changes in the draft legislation

From 6 April 2025, the Income Tax Act 2007 will be updated to remove the references at Section 127 ITA 2007 (UK properties) and Section 127ZA ITA 2007 (EEA properties) to FHL properties being treated as a trade for individuals. The Income Tax (Trading and Other Income) Act 2005 will also be updated to ensure that FHL properties are no longer excluded from the restriction on finance costs, from claiming replacement of domestic items relief and from claiming a tax deduction on energy-saving item expenditure. Additionally, Section 189 Finance Act 2004 will be changed to remove the references to FHL properties in the UK and European Economic Area from the definition of relevant UK earnings for pension purposes.

For accounting periods beginning on or after 1 April 2025, the Corporation Tax Act 2010 will be updated to remove the references at Section 65 CTA 2010 (UK properties) and Section 67A CTA 2010 (EEA properties) to FHL properties being treated as a trade for companies. Similar provisions to the income tax changes will apply when it comes to ensuring that FHL properties owned by companies are excluded from the restrictions on claiming replacement of domestic items relief or a tax deduction on energy-saving item expenditure.

Capital allowances changes in the draft legislation

From 6 April 2025 (income tax) and 1 April 2025 (corporation tax), Section 13B CAA 2001 will no longer apply, meaning that expenditure on plant and machinery in a FHL property won’t be eligible for capital allowances. In the future, expenditure on replacement furnishings may instead qualify for replacement of domestic items relief after the changes to that relief mentioned above.

Existing FHL businesses with an established capital allowances pool in relation to qualifying expenditure (before the change in capital allowances rules) can continue to claim writing down allowances as they would have previously. This is a particularly welcome development, as our members raised concerns about the potential imposition of a balance charge based on the market value of the asset in April 2025. Only expenditure from April 2025 onwards will be treated under the property business rules that already applied to non-FHL properties.

Capital gains tax changes

In a welcome clarification, the main capital gains tax changes will now take effect from 6 April 2025.

For BADR purposes, if the FHL conditions are satisfied in respect of a business that ceased before 6 April 2025, relief may still be available on a disposal within the normal three-year period for cessation. This will be relevant for properties owned by individuals who cease their FHL business, as well as the disposal of shares in companies carrying out a FHL business (subject to other criteria).

Where a FHL property has been gifted, the reference to Section 241(3) TCGA 1992 has been removed from Section 165A TCGA 1992 for holdover relief purposes. This means that the gift of a FHL property by an individual will be subject to capital gains tax going forward. To avoid capital gains tax being payable on gifts in future years, consideration of the use of a trust as an intermediary (and claiming holdover relief under Section 260 TCGA 1992 instead) would be a possibility - although there are much wider considerations to be explored before entering into a trust.

A FHL property owned by an individual or company will be treated as a qualifying asset for rollover relief under Section 152 TCGA 1992 before 6 April 2025 (individuals) or 1 April 2025 (companies).

In respect of all the capital gains tax changes, the timing of transactions is vitally important. If a transaction happens on or after 6 April 2025 (individuals) or 1 April 2025 (companies), this will either mean that capital gains tax is payable or that an existing capital gains tax liability increases due to BADR not being available.

Where arrangements have been made to create a tax advantage through securing FHL capital gains relief, there are anti-forestalling rules which apply in respect of transactions on or after 6 March 2024 to prevent relief being available. However, it is pleasing to see that these rules shouldn’t apply to genuine commercial transactions or transactions that aren’t between connected parties (provided that the contract was entered into for commercial reasons). This should give those FHL owners who are carrying out routine transactions the comfort and clarity that wasn’t provided at the spring Budget.

Loss relief