Replies to Queries - 1 - Maximising rental income

My clients, a husband and wife, are buying a new house and intend to rent out their existing property, which is jointly owned. As the wife is a non-earner, having given up work to look after a baby, would it be effective for tax purposes for the rent to be treated entirely as hers simply by making the rental agreement in her name alone?

Presumably section 282A, Taxes Act 1988 is relevant, but would subsection 3(a) take effect so that subsection (1) shall not apply?

If this is the case, however, would section 660A, Taxes Act 1988 then become applicable?

If the income were to be treated entirely as the wife's, notwithstanding these sections of the Taxes Act, could the wife then pay rent to her husband sufficient to cover his half-share of mortgage interest?

(Query T16,092) - Backwoodsman.

The situation described by 'Backwoodsman' is fraught with danger, particularly if any element of artificiality or restructuring is introduced. We are not given any figures which would have been helpful. However, it is not simply a question of looking at the tax questions. Any professional advice in these circumstances should take into account:

'Backwoodsman' should therefore, as a priority, consider how his advice will look in the eventuality of the death of a spouse or separation/divorce. He would not wish to be sued for the repercussions of his tax advice.

Bearing these comments in mind, it is clear that the Revenue's interpretation of section 282A is as set out in its helpful booklet IR150: Taxation of rents. This states that income from property jointly owned by husband and wife is treated as arising to them in equal shares. This applies to most cases, as ownership is normally 'joint', i.e. each owner has a joint interest in the ownership of the whole property to the extent of 50 per cent. If the ownership is structured as tenants in common the parties may elect to divide the income accordingly to their fractional shares; this type of ownership allows each spouse to own a specific share of the property that can be separately identified. Such ownership does not result in the automatic transfer of each share to the surviving spouse on death.

There is nothing to prevent the husband and wife converting the ownership of the let property to that of tenants in common (with, say, 95 per cent wife, 5 per cent husband). Permission of the mortgagor would be necessary. Legal assistance would also be necessary to effect the necessary documentation and deal with possible stamp duty (the transfer of responsibility for the mortgage debt could well be treated as consideration for the transfer).

The spouses could amend their wills to leave their respective shares to the survivor. The creation of a tenancy in common would be effective for tax purposes from the date the relevant notification (on form 17) was submitted to the Inland Revenue. The allocation of the rent would reflect the actual interest of the spouses in the property and would be charged to tax under section 21(I), Taxes Act 1988. Section 660A would not be invoked.

It is not thought that this arrangement, if followed, would affect the relationship with the tenant who would still have a rent agreement with the husband and wife, but the record keeping and distribution of funds should reflect the actual interest of the parties. An eye for detail is essential. - Mike.

Regarding the proposed rental agreement between the husband and wife clients, I have assumed that 'jointly owned' means owned as joint tenants, rather than tenants in common. I think it would be wise to first quote what the Revenue's opinion of the division of the income would be, taking into account the conditions needed to substantiate this. In its Independent Taxation Manual, at paragraph 143, the Revenue says:

'A married couple do not have a general option to split joint income in any way they like. They can only depart from the standard 50:50 split where:

'Where both conditions are met, the couple can make a declaration to this effect. They are then taxed on their actual entitlements …

'A declaration cannot be made where an asset is in the joint beneficial ownership of a husband or wife. In these circumstances the couple do not own the property in unequal shares, but are each entitled to the whole of both the asset and the income …'

If we then look at section 282A(1), Taxes Act 1988, this gives the general rule where husband and wife are living together: income from a jointly held property is treated
as being received equally. However, if the property is not owned in equal shares, a joint declaration must be made to the Inland Revenue on form 17, with income being divided in the same proportion as ownership of the property.

Therefore, in this case, as they own the property as joint tenants, the declaration would not be possible as their ownership is on a 50:50 basis. It would only be possible if they owned the property as tenants in common and then on an unequal basis.

(The replies to query T15,863 in Taxation dated 23 August 2001, page 539 cover the subject as does section E5.103A of Simon's Direct Tax Service).

The wording of section 282(3)(a) states 'Subsection (1) above shall not apply to income to which either the husband or the wife is beneficially entitled to the exclusion of the other.' Therefore at present in order to make this effective, and to negate any section 660A implications, the husband and wife need to adjust their current ownerships of the property on a legal basis and not just by making the proposed declaration.

Extract from reply by 'Jim'

In such circumstances, it is worthwhile maximising the wife's 'duties' as invariably the time and effort involved in the letting of a property runs to a considerable number of hours each month.

Here, the guidance at paragraph 232 of the Inland Revenue booklet IR150: Taxation of rents could prove to be very useful:

'You cannot deduct anything for the time you spend yourself working in your rental business. You can deduct any wages or salaries you pay to your spouse or other relations for working in the rental business provided the amounts paid represent a proper commercial reward for the work done. Your spouse or relative will be taxable on their earnings if their income is large enough.'

By apportioning the share of profits to reflect the suitable remuneration for the spouse in question and giving a full explanation on the 'additional information' space of the tax return, with specific reference to paragraph 232 of IR150, I have not encountered any problems with a declaration in this format.

Editorial note: The suggestion proposed by Jim would seem to work where one spouse owns the property which is 'managed' by the other, but does it work where they both have a share? Possibly, if one were to use the argument that one spouse is 'managing' the half share of the other and this cost is deductible from the other's share rather than their own?

Those going down that route should of course be aware of any other complications. What is the nature of this management income? Is this an employment with pay as you earn implications or a self-employment with registration/declaration implications?

Are there National Insurance contributions implications? One would assume that the spouse's income from this source would be below the contribution limits (although, if self-employed, presumably a Class 2 exception should be claimed), but supposing that he or she were also employed in the spouse's business, should the earnings be aggregated?

Issue: 3879 / Categories: