Lee Sharpe looks at the implications for landlords whose tenants are struggling to pay rent in the Coronavirus era.
Some (predominantly online) businesses have prospered from the coronavirus pandemic while millions of people have been encouraged to stay at home, but most businesses have suffered.
Of course, landlords are not immune:
- Retail outlets have closed, factories have been shuttered, and the outlook for hospitality venues, from small cafes to football stadia, looks bleak indeed.
- On the residential front, while the self-employed income support scheme and coronavirus job retention scheme are helping many traders and employees to stay afloat, even those that have so far kept their livelihoods may nevertheless see significant reductions in personal income.
Meanwhile, landlords:
- Are generally unable to access the self-employment income support service, because property letting is not a trade.
- Will qualify under the Coronavirus job retention scheme only if they are directors/employees of their letting companies and only in relation to the salary they take (and even then may struggle to qualify as ‘furloughed’)
- Are unlikely to get business support grant funds unless:
- they have business premises that qualify for small business rate relief; or
- where they themselves account for business rates on premises they let out to ‘small’ tenants
Landlords may get a three-month suspension of repayments on buy-to-let mortgages but this may be offset by tenants taking advantage of the effective ‘moratorium on repossessions’ by withholding rent payments. That moratorium is currently applicable for three months but may be extended.
Waiting for payment: Income tax position
If you are not cash accounting, the general rule for practically all businesses including landlords is that you have to recognise income as it falls due, even if payment is overdue at the end of the accounting period.
Having said that, while the landlord is still required to recognise all rental income, he or she is also allowed ‘to provide for’ (i.e. to deduct as an expense) any debts that either will not be, or are not expected to be, recovered in full. The income entitlement has to be recognised, but the landlord should then consider the likelihood of its being realised.
A bad debt is a specific debt that is practically certain not to be paid. For example, where a tenant has disappeared without trace, or been declared insolvent or bankrupt with little hope of recovering the sums owed.
A landlord may also make a reasonable adjustment for debts not yet definitely bad, but where full payment is unlikely. This should be a specific provision against specific debtors (tenants) but a formulaic approach to a category of debtors may be adopted where there are a lot of debtors and the individual debts are not too large in relative terms.
In no case does the landlord (i.e. the creditor) have to advise the tenant/debtor. These adjustments are between the landlord, their adviser, and the accounts and tax return.
Example: Property with multiple tenants
Sam has a large mixed-use property: two retail units occupy the ground floor with four large private apartments above, and with 24 small studio flats in the upper floors. Sam charges rent quarterly in advance and in mid-April 2021 (i.e. while drafting her 2020/21 tax return) is evaluating the likelihood of receiving the payments originally due on 1 March 2021, for the quarter to 31 May 2021 – nobody has paid yet!
Retail Unit 1 is a card shop, which closed in March 2020, and has re-opened only intermittently since. The business owner has not responded to Sam’s correspondence since the busy Christmas period, (although payment was made up to February 2021), and Sam understands that the business has since gone into administration with substantial liabilities. Sam’s solicitor advises that there is negligible chance of recovering the debt; it is at least highly doubtful and almost certainly bad. Sam deducts 100% of the rent charge as a bad debt provision, effectively cancelling out the rental income formally due on 1 March 2021.
Retail Unit 2 is a pharmacy, which seems busier than ever, despite new distancing measures. The tenant has never been late before, and Sam sees no reason why they will not pay eventually, so makes no deduction against the rental income chargeable on 1 March.
Flat 1 is occupied by a long-term tenant who has not been able to pay since May 2020. The cumulative debt is so large that Sam will pursue it, but Sam’s solicitor estimates that only 50% will be recovered, so Sam makes a provision (deduction) to net off, to the 50% that is likely recoverable.
Sam makes similar assessments as regards the other three flats, on a case-by-case basis.
Sam approaches the studio flats more holistically, categorising according to the tenants’ income sources (such as professionals or students). Based on her assessment of past experience and the likely impact of the pandemic, she makes careful provision against specific tenant categories. Sam must apply a degree of rigour to those provisions, because a simple general provision is not allowable for tax purposes.
If Sam ultimately recovers only 40% of the amount owing on Flat 1 in 2022, she can make a further adjustment in later accounts. Likewise if she were actually to recover 60%.
Income tax: Cash basis for smaller landlords?
‘Smaller’ landlords (i.e. broadly those with gross rental incomes not exceeding £150,000 a year) are supposed to operate the cash basis of recognising income and expenditure by default (if one is so ‘caught’ but does not want to use the cash basis, then one must elect out of the regime, on each annual tax return).
Operating the cash basis means that the landlord recognises income only if and when it is actually received; debtors are irrelevant. Likewise expenses can be deducted only when they are paid, not immediately they are due. Sam might initially prefer the cash basis as she can avoid having to worry about if and when tenants will pay when drawing up her accounts, but:
- Sam would have to count the whole of the receipt for the quarter 1 March to 31 May 2021, and not just the first months’ worth to reflect receipts relating to the 2020/21 tax year (i.e. up to 5 April 2021 only).
- Sam would not be able to claim any of her own expenses unless they were actually paid in the 2020/21 tax year, so (for example) might have to ignore any interest relief still deferred under a ‘mortgage holiday’ agreement.
Generally, a profitable rental business that charges rent in advance will pay more tax sooner, if it allows itself to fall within the scope of the cash basis (which is one of the reasons why HMRC wanted it to apply by default).
Corporation tax and bad or doubtful debts
Companies operating rental businesses cannot use the cash basis, so have no choice but basically to adopt Sam’s approach as in the above example, to determine if any of the debts at the annual balance sheet date might be ‘impaired’ (i.e. need to be written off completely or partly written down).
Provisions for bad and doubtful debts are, like mortgage interest, dealt with through the non-trading loan relationship regime, which means that they are initially disallowed from property business profits for tax purposes, but will then usually be claimed separately against the company’s total profits for the chargeable period, with effectively the same overall result (the company has other options with such losses).
Conclusion
Most property businesses will not have to deal with VAT, so the specific regime for VAT and bad debts is not covered here.
Experienced landlords will have an ongoing appreciation of how their rent book will pan out over time; but should still take advice on how the governments’ new measures affect their tenancy agreements (and whether they should be updated). Note there are different measures in Scotland, and in some respects Northern Ireland has its own legislation. Estimating the recoverability of debts outstanding at the balance sheet date forms part of that larger exercise.
I am not a fan of landlords opting for the cash basis instead but will grudgingly admit that it can simplify (avoid) the bad/doubtful debt exercise, although it is complex in other respects.
When providing for bad or doubtful debts, one can adjust for information received after the balance sheet date but before signing off the accounts, which is why many businesses will delay formally approving their accounts until they are confident of the extent of their recoverability.
