The UK government recently announced plans to crackdown on tax avoidance, referred to as tax conditionality, in what is often described as the “hidden economy”. In a straightforward yet highly effective move, various licence applications will now be considered with proof that the parties have completed a tax check with HMRC. Initially, the scheme will target taxi drivers and scrap metal dealers, just two of many activities within the hidden economy, with suggestions this will be rolled out to other areas in due course.
As government finances are stretched, tackling the hidden economy is seen by many as one of the low hanging tax fruits. As a result, owners of Houses in Multiple Occupation (HMOs) were explicitly mentioned at the outset. However, this was before the scope of the initial scheme was reduced.
The hidden economy
Before we look at the specific challenges of tax conditionality facing those operating HMOs, it is worth delving into the dark world of the hidden economy. A Research note by the UK government back in 2017 cast a fascinating light on this area. The most common industries reported for hidden economy activity included:-
- Services (13%)
- Human health and social work (12%)
- Accommodation and food service activities (10%)
- Wholesale and retail trade (10%)
Interestingly, 64% of activity was associated with supplementary work such as:-
- Buying and selling (30%)
- Casual work (25%)
- Making money from a hobby (14%)
- Renting out assets (6%)
On a worldwide scale, the UK hidden economy is relatively small at circa 8% (2015) of GDP compared to the likes of Spain at 22% and Portugal at 17.8%. While the UK figure is likely to have fallen in recent years, in the 2018/19 tax year, it is estimated the tax shortfall was in the region of £2.6 billion.
How will the new tax conditionality test work?
Currently, the changes planned for April 2022 will impact taxi drivers and scrap metal dealers. The original idea was to include others such as:-
- Private security staff
- Waste management operators
- Market traders
- Owners of HMOs
- Selective licensing in the private rental sector
Compared to historic complex tax regulations, the scheme is surprisingly straightforward and involves a simple online process.
Licence renewals
Individuals will need a tax check reference number to apply for licence renewals, which can only be obtained through the online procedure. The tax check will ensure that applicants are registered for tax where applicable.
First-time applicants
Those applying for a licence for the first time will not have to undertake a tax check. Instead, the relevant licensing authorities will provide them with access to HMRC guidance explaining how to register for tax. Whether there will be an additional check to see if these applicants have registered for tax is unclear.
HMRC is already in detailed correspondence with licensing bodies, licence holders and representative industry bodies. Yet, surprisingly, many who fail to pay their due taxes are often oblivious to their obligations. So, while some tax avoidance is deliberate, there is also a need to educate the wider public and businesses about their legal responsibilities.
Will HMO owners be next on the list?
In recent times we have seen various adjustments regarding the definition of HMOs, their legal obligations and licensing requirements. Parliamentary research estimated there were around 497,000 HMOs in England and Wales at the end of March 2018. Additional studies estimate the HMO market to be worth circa £20 billion around the same time as the parliamentary research. So, it would not take a big stretch of the imagination to see HMOs included in any expansion of tax conditionality regulations.
Current licensing of HMOs
While most landlords take a responsible approach to their tax obligations, this is not always the case. If even a relatively small percentage of landlords failed to pay their due taxes, this would be significant. Hence, as Part Two of the Housing Act 2004, a two-tier approach to industry licensing was introduced.
Larger HMOs are now required to be licensed to operate, with further discretion has been given to local authorities regarding the licensing of smaller HMOs. So, if future tax conditionality laws bring in HMOs, there is already a licensing system with which to work. It is also interesting that landlords are now obliged to place tenant deposits in a government-approved tenancy deposit scheme. It would be reasonably simple to cross-check landlords participating in these schemes to see if they are registered for tax?
HMRC beginning to join the dots
If you sit back and think about it, many HMO owners are already part of various registers and industry schemes. Moreover, we live in a world of electronic communication where it is relatively simple to connect databases, check tax statuses and monitor the activities of individuals and companies in various industries.
Considering that HMRC estimated lost revenue in the tax year 2018/19 to be in the region of £2.6 billion, these are considerable sums of money. Even though the initial scheme will only take in taxi drivers and scrap metal dealers, tax conditionality is almost certain to be rolled out to other commercial activities. As we touched on above, recent research has highlighted those areas which play a significant role in the hidden economy. There is already an HMRC hit list, and it has been made public!
Rental income and taxation
Rental income from HMOs is treated as investment income, and profits are taxed accordingly. While there will be some individuals who have failed to register for tax in years gone by, it is essential to take advice from your accountant as soon as possible. This advice will include ways in which you can reduce your tax bill by offsetting expenses such as:-
- Utility bills
- Landlord insurance
- Cost of services such as cleaners
- Letting agent fees
- Legal fees
- Accountants fees
- Rent, ground rent and service charges
- Administration costs such as phone calls, stationery and advertising
There are also investment allowances that landlords can use, addressing capital expenditure, although these are not generally offset against rental income. Instead, you may be able to reduce your capital gains tax bill as and when you come to sell your property. This is another area of taxation in which your accountant may prove invaluable.
The taxman is shining a light on the hidden economy
The use of licensing bodies to introduce mandatory tax registration has been on the cards since the first consultation in 2016/17. While HMRC will continue to address more complicated tax avoidance, chipping away at the estimated £2.6 billion hidden economy tax gap was always going to be a tempting low hanging fruit. Consequently, you must be up-to-date with your licensing, registered for tax where applicable and offset as many expenses as allowed under tax regulations.