26th June 2007

1.  Executive Summary

Page 955 of Billet D’Etat XIV 2007 (Implementation of the Economic and Taxation Strategy) provides as follows:

 “Following the most recent consultations it is evident that further consideration needs to be given to wider issues such as whether the development of property, and associated building trade activities, should continue to be subject to the 20% rate of tax.  In addition, the availability of interest relief for property investments also requires further, careful consideration to ensure that the final proposals do not undermine the rental market.  It is therefore proposed that a States Report on the treatment of property-related matters will be presented at the July States meeting.”

This report covers the following matters: -

 (1)  Profits arising from the development of land and property

At their May 2007 meeting, following consideration of the Policy Council’s Report on the implementation of the Economic and Taxation Strategy the States resolved that rental income derived, by a company, from Guernsey¹ property should continue to be taxed, at 20%, in all cases with effect from 1 January 2008 (i.e. irrespective of the residence status of the shareholders in the company).

  ¹ For income tax purposes, “Guernsey” includes Alderney and Herm, and references in this Report to Guernsey should be construed accordingly.
 
This report contains a proposal that, with effect from 1 January 2008, profits arising to a company from the business of property development and exploitation of land in Guernsey should also continue to be taxed, at 20%, on an annual basis, (again, irrespective of the residence status of the shareholders in the company) rather than being subject to the “distribution basis” of taxation.

 (2) Statutory Repairs Allowance

Under the Income Tax (Guernsey) Law 1975, as amended (“the Law”) persons in receipt of income from land and buildings situated in Guernsey receive a fixed deduction, called a Statutory Repairs Allowance (“SRA”), instead of making a claim for actual expenditure on repairs etc.  In addition, there are provisions that enable a landlord to claim extraordinary expenditure known as the excess repairs allowance (“ERA”).  Such provisions have existed since 1920, when income tax was first introduced in Guernsey.

In the case of furnished lettings, 40% of the income received is attributed to the hire of furniture and a 33.33% concessionary deduction is made in place of the landlord claiming annual allowances (on account of depreciation) under the Law.

This Report proposes reductions in the levels of SRA currently granted and, in place of the entitlement of the landlord to receive a deduction of, or on account of, annual allowances, there be introduced different rates of SRA as between furnished and unfurnished lettings.  However, it is proposed that the ERA should continue.

The effect of the tax changes will be to increase States revenues, and whilst it is not possible to predict accurately the amount involved, a survey suggests that this could be up to £1m per year.

 (3) Interest Relief

The current position, as provided in the Law, is that there is no restriction on the type or level of interest relief that can be claimed by individuals and companies.  In June 2006, the States resolved that from 2008 relief should be limited to business interest and, in respect of mortgages, up to a limit of interest on £400,000.  This Report proposes some revisions to that Resolution principally in relation to allowing relief in connection with let property, and deals with some further areas of technical detail. 

2. Profits arising from the development of land and property

Current position

Under section 2 of the Law, tax is chargeable on income from businesses, including profits derived from ventures involving land and property.

Background

Following the June 2006 States Resolution on Billet XI of 2006, such ventures carried out through companies would, with effect from 1 January 2008, be taxed at the standard rate of 0%.  Whilst these profits would subsequently be chargeable to tax when distributed, or deemed to have been distributed, to Guernsey resident shareholders, to the extent that those profits relate to non-resident shareholders, they would escape liability to Guernsey tax.

At their May 2007 Meeting, arising from their consideration of the Policy Council’s Report, the States resolved “that Guernsey rental income will continue to be subject to the 20% rate (after allowable deductions) regardless of the residential status of the company or its shareholders ...”.

Paragraph 4(d) of the same Report noted that “following the most recent consultations it is evident that further consideration needs to be given to wider issues, such as whether the development of property and associated building trade activities should continue to be subject to the 20% rate of tax”.

Proposal

The Department is of the view that there is a strong economic argument that, as land is a finite resource, Guernsey tax should continue to be charged at 20% on an annual basis, on the profits derived from the development or exploitation of land, irrespective of the residential status of the owner.  This rationale, as regards residential status, is the same as is already being applied to Guernsey rental income (the term “rental income” meaning the amount of income assessable to income tax after allowable deductions).

The Department proposes that, for the purposes of the above, income derived from the business activity of land and property development in Guernsey where the company receiving the income had a beneficial interest in the land, which would include a “flying freehold” (subject to anti-avoidance provisions that would deal with the situations where the owner and developer/contractor were not the same but were connected/related) should constitute the development of land.

This proposal seeks to retain the status quo with effect from 1 January 2008 in respect of these particular categories of business, carried on by companies.

For the avoidance of doubt, other activities, carried out by companies, involving the development of land, other than as shown above, would only be taxable with effect from 1 January 2008 in accordance with the distribution basis but only in the hands of Guernsey resident shareholders.  For example, this would cover ancillary building trades carried on through companies, such as electrical contractors and building merchants.

The following are examples of some activities/sources of income that would be taxed on the distribution basis:

• property development where the developer was not the owner of the land (but subject to the anti-avoidance provisions referred to above);

• horticultural and agricultural activities;

• fees received relating to the purchase or sale of land or property, such as estate agents’ fees and conveyancing fees.

The following example demonstrates how the proposals would work if adopted by the States:

Company X Limited carries on property development activities in that it acquires plots of land and builds houses for sale.   In addition, it also carries out general building/construction/repairs/maintenance works for customers.

The company is owned 50% by Guernsey residents and 50% by UK residents.

Its taxable profits are £500,000 which are made up of:

 - £300,000 from development activities; and

 - £200,000 from general building activities.

After 1 January 2008 the company’s liability to Guernsey tax would be computed as follows:-

 - Profits from development activities £300,000 @ 20% = £60,000.

 - Profits from general activities £200,000* @ 0% = NIL.

 * of which;

 - £100,000 (50%), relating to the non-resident shareholders, would never be taxed; and

 - £100,000 (50%) relating to the Guernsey resident shareholders would be taxed when the profits were distributed or were deemed to have been distributed.

Future Work relating to Land and Property

The Department is continuing to work closely with the Policy Council’s Fiscal & Economic Policy Steering Group on exploring other possible options by which revenues could be raised from land and property in the Island.  As this work is ongoing, it is unlikely that any proposals in this regard would be brought before the States prior to 1 January 2008 particularly as consultation with interested parties will need to take place.

 
3. Statutory Repairs Allowance

Background

Under section 2 of the Law, income tax is charged on four classes of income.  Class 3 is income from land and buildings situated in Guernsey.

The rules for calculating the assessable income arising from the ownership of any land or buildings situated in Guernsey are laid down in sections 9 – 16 of the Law. 

Under section 9, the assessable income is the annual rental value (which, broadly, is the reasonable rent at which the land or building could be expected to be let from year to year, if the landlord was liable for all repairs, landlord’s rates, taxes and insurances, or the actual amount of income received if higher) less authorised deductions as specified in section 11.

Section 11 specifies, inter alia, that amounts may be deducted on account of repairs (the SRA) as set out in section 12. 

Section 12 provides that the amounts of SRA are to be:

• in the case of land (other than a quarry) – 5%;

• in the case of a dwelling house or a glasshouse – 25%;

• in the case of a building other than a dwelling house or a glasshouse – 15%.

 (In each case the percentage refers to a percentage of the annual rental value).

The SRA is intended to replace a specific claim for actual expenditure on repairs having to be made by the landlord.

Under section 13 of the Law, however, if the owner of land or a building situated in Guernsey can prove that the cost to him of the maintenance, repairs, insurance and management of the land or building has, over the previous five years, exceeded the amount of the SRA claimable under section 12, he may, in addition to the SRA, claim an additional allowance (called the Excess Repairs Allowance (“ERA”)).

Where the property being let is furnished, the amount of the rent received by the landlord is apportioned:

• 60% to “pure” rent; and

• 40% to the hire of furniture.

Against the “pure” rent the landlord is able to claim SRA and ERA as set out above, and against the income relating to the hire of furniture a concessionary 33.33% deduction is made on account of annual allowances that could be claimed by the landlord on account of depreciation of the furnishings, under section 90 of the Law.

The following example shows how all of the concepts referred to above work in practice:

During 2006 a landlord received £20,000 rent from a furnished dwelling.

 “Pure” rent (60% x £20,000) £12,000
 Less SRA (25%)  £  3,000
 Average expended on repairs etc over the previous 5 years  £  2,000
 Therefore ERA due  nil 
 Chargeable rental income (£12,000 - £3,000 SRA) £  9,000

 Hire of furniture element (40% x £20,000)  £  8,000
 Less 33.33% concessionary capital expenditure allowance £  2,666
 Taxable income from hire of furniture £  5,334

Of the £20,000 rental income, therefore, £14,334 (£9,000 + £5,334) is actually charged to tax.

Reason for change

The Administrator of Income Tax (“the Administrator”) has brought to the attention of the Department the fact that few claims to ERA are made in practice and he concluded that the rates of SRA granted overall may be excessive with a consequent cost to general revenue.

The Administrator has ascertained that for the Year of Charge 2004 (which, currently, is the most reliable complete year of charge for statistical purposes) £52.5m income was charged to tax, arising from land and buildings situated in Guernsey.  This would be the amount net of SRA, ERA and the apportionment of the “hire of furniture” element.

The only body of taxpayers for which the Administrator has reliable details of the actual expenditure on repairs, maintenance, insurance and management, in relation to Guernsey based land and buildings, is companies (as the Administrator receives the financial statements for companies and the expenditure would be reflected in the profit & loss account).

The Administrator has undertaken a sample review of such companies from which he has established that if tax relief had been allowed on expenditure that had actually been incurred by those companies rather than on the basis of SRA/ERA, substantial amounts of extra tax would have arisen to general revenue.

In the sample reviewed, the total assessed income was £4.95m.  Had actual expenditure been deducted instead of SRA/ERA, an additional £475,000 income would have been charged to tax.

Extrapolating the outcome of the Administrator’s review across the taxpaying population suggests that if SRA/ERA was to be replaced with a system of allowing only actual expenditure, the potential saving could be £1m (approximately) in tax terms.  This would be additional tax collected from the rental sector.

It must be emphasised that, based on the survey carried out, this is, in effect, the recouping of tax reliefs that are currently given in respect of expenditure that is not actually incurred by the landlord.

To remove SRA/ERA and replace it with a system of allowing only actual expenditure would have a resultant adverse effect on the Administrator’s finite resources and may cause additional compliance costs for landlords, because each landlord would be required to keep and submit to the Administrator the equivalent of a profit & loss account in relation to income from land and buildings situated in Guernsey, which the Administrator would have to examine to ensure that only allowable expenditure was being deducted.

Proposal

As an alternative to removing SRA/ERA, and requiring landlords to claim actual expenditure on repairs etc, the Department proposes that the rates of SRA that are currently given, and which the Administrator’s review suggests may be excessive, should be reduced.

To ensure that landlords were not unduly disadvantaged, however, the Department proposes that the ability for the landlord to claim ERA should be continued.

The Department also proposes at this time, however, that the tax system be simplified insofar as the right to claim annual allowances under section 90 of the Law, in relation to furnishings that form part of a furnished letting, should be removed and replaced with an SRA for furnished lettings that is higher than that for an unfurnished letting.

The Department proposes the following levels of SRA:

• for land (other than a quarry) – 2½%;

• for a glasshouse – 10%;

• for a dwelling house (where it is let furnished) – 15%;

• for a dwelling house (where it is let unfurnished) – 10%;

• for other buildings – 10%.

If, in the opinion of the Administrator, a landlord was providing low, or minimal, levels of furnishings for the principal purpose of obtaining the higher level of SRA applicable to furnished lettings then the Administrator would challenge that under the general legal avoidance provision contained in section 67 of the Law.

The Administrator has a number of Statements of Practice relating to specific situations involving the letting of property viz:

• where the gross receipts of a guesthouse business do not exceed certain limits (for the Year of Charge 2006 the limit was £7,700) the taxpayer may elect to be assessed on the basis of 40% of the gross receipts of the business instead of submitting accounts;

• where a guesthouse or boarding house provides only bed and breakfast, and where the gross receipts do not exceed a certain limit (for the Year of Charge 2006 the amount was £7,700) the owner may elect to be assessed on the basis of 65% of the gross receipts of the business instead of submitting accounts;

• where sleeping out accommodation is provided, the landlord may elect to be assessed on the basis of 80% of the gross receipts instead of submitting an itemised account of expenses;

• where an individual lets his own residence while he is away on holiday for any period(s) not exceeding two months in a calendar year, an overall deduction of 33.33% is allowed against the gross rent received in lieu of a claim on the strict statutory basis.

For the avoidance of doubt, it is not intended that the proposals contained in this part of this Report will have an effect on these Statements of Practice.

The intended changes to the regime for taxing companies (to be effective from 1 January 2008) are not expected to have any effect on the above proposals.

Consultation

The Department has consulted with the Housing Department and the Guernsey Private Residential Landlords’ Association, which bodies broadly support the proposals relating to Statutory Repairs Allowance.

4. Interest Relief claimed by individuals and companies

In the Policy Council’s May 2006 Report (Billet XI of 2006) paragraph 76 provides that, as well as allowing business interest:

“The Policy Council ... recommends that ... interest relief should only continue to be provided on principal private residences.  The Policy Council believes that a maximum value for mortgages of not exceeding £400,000 is, at this time, appropriate.”

(“Principal private residence” is hereafter referred to as a “PPR”.)

Currently the cost of granting tax relief in respect of all mortgage interest is estimated at £10m per annum.  It is further estimated that this figure will be reduced by £2m per annum once the £400,000 cap on PPRs takes effect.

Arising from the recent consultation process, the Department is of the view that it would not be appropriate to increase the £400,000 cap for any reason, for example to take account of inflation, interest rate increases or changes in the housing market.

Following the period of consultation, a number of representations were subsequently received in relation to the practical impact of the 2006 Report, the most significant aspect of which was criticism that interest relief would not be available against income from let property.

Having taken account of the various representations received, the Department considers it appropriate to recommend that relief should be available in the following circumstances, which are in part a variation of the proposals contained in the May 2006 Report and, in part, issues of technical detail required for the purposes of drafting the necessary legislation.

The issues covered in the remainder of this report concern interest relief relating to individuals and companies.

General Issues

• For Guernsey property only, relief would only be given where, at the time the relevant loan was advanced, the lender was a Guernsey based financial institution or other resident provider.  This restriction would only apply to advances made on or after 1 January 2008. 

• In relation to a property loan, interest would only be eligible for relief to the extent that the loan was used for the acquisition, construction, reconstruction, extension or repair of the property.  The term “property” would include structures within the curtilage of the principal building, for example the construction of a conservatory, swimming pool, etc.

• Where a property was held through a company but interest to acquire the property was paid by the beneficial owner, interest relief may be allowed as if the beneficial owner had held the property direct.  The same would apply to a loan taken out to acquire the shares in a company that held the property.

Let Property

• Interest should be allowed against letting income of the same year only.  Where the interest for any year exceeded the rental income for that year, the excess interest would not be available for carry forward or for offset against any other income of the same year.

• Where there was more than one property let, the income received and the interest paid for all such properties may be aggregated into one income tax computation.  However, this would be subject to the restrictions set out below on interest relief relating to properties that were also used for purposes other than letting.

• If an individual or company acquired a loan to purchase land on which a property was to be built to let, the interest paid during the course of construction would be “rolled forward” and available for off set once rental income commenced to be received.  This would also apply where a dilapidated property was purchased but could not be re-let until refurbished.

• Where interest was paid on a loan on a property which was let, relief would only be granted for the periods that the property was let, or available to be let (which would mean actually marketed).

For example, a cottage in France is let for six weeks in a year and used as a holiday home for eight weeks.  For the remainder of the year it is available for letting but not actually marketed.  Rents received are £2,400 and interest on the mortgage (with a French bank) of £80,000 is £4,000.  Other allowable expenses are £600.  Relief would be limited to £4,000 x 6/52 = £462.  Tax on the rent would be due as follows:

Rent £2,400
Less interest £  462
Less other deductions £  600
 £1,338  @  20%  =  £267.60

• Where surplus accommodation within a PPR was let, relief would only be restricted by reference to the £400,000 limit and not by reference to the amount of rental income received.

Principal Private Residence

• The States have decided that relief should only be provided on a PPR.  However, there are occasions on which occupation of a residence may be unavoidably interrupted.  For example:
  
 - absence from the property for short periods, such as holidays;

 - absence from the property on business/secondment;

 - absence from the property whilst it was being renovated due to flood/fire or some other cause;

 - absence from the property due to other enforced absence, e.g. military service.

It is proposed that the legislation should give the Administrator power to disregard these absences for the purpose of granting relief.

• Relief would only be available in respect of a PPR that was situated in Guernsey and if the claimant was solely or principally resident.  Where an individual had more than one residence in the island and it was not clear which of these constituted the PPR, it is proposed that the Law should give the Administrator the power to make a determination for the purposes of interest relief. 

• For the purposes of the £400,000 limit on loans on a PPR that were eligible for relief, all loans on the property would be aggregated, e.g. two unmarried individuals purchase a property in equal shares for £800,000 with a mortgage of £600,000.  Of the £600,000, relief would be due on £400,000 (i.e. £200,000 per individual).  This would ensure that married couples were not disadvantaged compared to single persons.

• Where an individual takes out a loan to acquire, construct, reconstruct, extend or repair a property situated in Guernsey (but not elsewhere) which was occupied as the PPR of a divorced or separated spouse, relief would be made available to the borrower subject to the £400,000 limit (as if his PPR and that of his divorced or separated spouse was the same property).

• Interest paid on a loan to build or renovate a property would be counted as eligible for relief, so long as it was in fact occupied as the claimant’s PPR once building work had been completed.

• For the avoidance of doubt, in determining the extent to which relief was due, regard would be had to the actual use to which a loan advanced was put rather than the asset upon which the loan was secured, e.g. an individual extends his existing £300,000 mortgage on his PPR by £150,000, which is used:

 
- £50,000 to build a conservatory;

- £75,000 to buy a holiday home in Spain (which is not let);

- £25,000 on a car.

  Only the interest on £50,000 would be eligible for relief.

Issues relating to businesses, trades and employment

• Interest would be allowed to a person who borrowed funds to lend to a company in which he had at least a 10% shareholding and was actively engaged (this term to be defined) in the company’s business activities, so long as the company utilised the funds for a bona fide business purpose.  This would not include monies lent to an investment company to fund the purchase of its investments.

• For the avoidance of doubt, interest paid on advances used wholly or in part to fund the personal drawings of a sole trader or partner in a business, or with any other duality of business or private purpose, would not be allowable.

• Interest paid on a loan to acquire a business or part of a business, including the acquisition of goodwill in the assets of a business or shares in a company that carried on a business, would be allowed subject to the claimant being actively engaged in the business at the time the interest was paid.

• Interest on a loan to an employee that was used to buy assets used wholly, exclusively and necessarily in the performance of the employment, which were not provided by the employer, would be allowed, e.g. the purchase of a laptop.

5. Resource Requirement

The Department does not envisage that the proposals above would have an adverse impact on the resources of the Income Tax Office.

6. Recommendations

Following consideration of this Report the States are recommended to agree that:

(i) With effect from 1 January 2008, profits arising to a company from the development, or exploitation of land, in Guernsey should continue to be taxed, at 20%, on an annual basis, (irrespective of the residence status of the shareholders in the company) rather than being subject to the “distribution basis” of taxation.

(ii) Income derived from the business activity of land and property development where the company receiving the income had a beneficial interest in the land, which would include a “flying freehold” (subject to anti-avoidance provisions that would deal with the situations where the owner and developer/contractor were not the same but were connected/related) should constitute development of land.

(iii) There should be reductions in the levels of SRA currently granted and, in place of the entitlement of the landlord to receive a deduction of, or on account of, annual allowances, there be introduced different rates of SRA as between furnished and unfurnished lettings as set out in section 3 of this report.

(iv) In respect of property, the regime governing interest relief should be as described in section 4 of this report.

Yours faithfully

L S Trott
Minister

Billet XIX of 2007