Yet Another Stealth Tax

The Association of Retirement Housing Managers (ARHM) has lobbied against a measure originally designed to offer protection to lessees, which resulted in interest on service charge funds being taxed.
By John Mills

In 1987, Parliament made the decision that leaseholders of private landlords and their agents should have extra protection for the service charge monies that they pay to landlords. Often the landlord could hold large sums of reserves for major works. What was decided was that such funds would be deemed in law to be “in trust”. This meant if anything happened to the business of the landlord or agent, the service charge monies held would be protected from any creditors seeking payment for other debts. Parliament decided to exclude public sector landlords because we all know they can be trusted and cannot go bust. Entirely sensible it would seem.

Yes, but Parliament forgot about the Treasury and the complex rules surrounding the taxation of trusts. So a measure originally designed to offer protection to lessees resulted in any interest on service charge monies being taxable. Does this matter? Yes, it does, because lessees contribute to reserve funds for future repairs and the interest earned on these funds is meant to offset inflation in costs. And the tax payable was not 10% or 20% or basic income tax, no, it was the rate applicable to trusts, which is always higher. For many years it was 32%, but four years ago, the Chancellor increased the rate to 40%.

So a measure to protect lessees’ funds meant extra tax is payable and the tax rate is at a high level, which assumes lessees are higher rate tax payers. A double whammy. For many years this situation went on with no change. Protests fell on deaf ears. Indeed many landlords and agents were unaware of the tax position, except those caught by the taxman and penalised with requests for backdated tax.

Trust taxation increase

When the Chancellor increased the tax on these flat management trusts to 40% in 2004, the ARHM and The Association of Residential Managing Agents (ARMA) complained. We were told that the increase to 40% was to stop higher rate taxpayers from using trusts as tax shelters. It was argued that lessees were not higher rate taxpayers and the situation was unfair. The following year there was some recognition of the problem. In the detail of the budget, the Chancellor announced that the first £500 of interest earned by flat management trusts would be taxed at 20%, not 40%. But any sums over £500 would be taxed at 40%.

ARHM and ARMA were not happy with the position and set out to show that most flat management trusts would still pay tax at 40%.
In the 2006 budget, the Treasury showed they had been listening but they also had a surprise. Welcome news, the first £1,000 of interest earned by flat management trusts would be taxed at a lower rate of 20%, not £500. But the surprise was the announcement that flat management trusts operated by housing associations would have the concession of a 20% tax rate on all interest earned, they would never be expected to pay tax at 40%.

Why a surprise? The requirement in statute for landlords to hold service charge monies in trust has not and still does not apply to social landlords; the requirement only applies to private landlords. So most social landlords were not expecting to pay tax at all on service change monies held. The reaction of social landlords to the Chancellor’s concession was that it was no concession at all. Indeed it was an announcement that the taxman intended to take tax where none had been taken before. The threat has been carried out and a new group of lessees, those with social landlords, has found that it can be taxed for obscure reasons.

So what should happen next? With the third lot of changes to trust tax in four years we are left with lessees of private landlords in a slightly better situation, lessees of social landlords realising that they will be taxed and an uneven playing field between private and social landlords.

The uneven playing field is unsustainable. Housing associations are bidding to become managing agents for private landlords; private house builders can now bid for Government grants to build social housing; and the Government wants mixed tenure developments with private and social lessees in the same blocks. The different tax rates make no sense.

The right thing to do would be for all tax on interest earned by service charge monies in flat management trusts to be abolished. The trust status of such monies was created by Parliament to protect the monies, not to make them a target for tax collectors. However, this is unlikely to happen. The next best thing will be for the unfair and unsustainable difference in tax between social and private lessees to be abolished. Make the tax rate 20% for all flat management trusts. Both the ARHM and ARMA have submitted evidence to Government supporting the case for further change.

This stealth tax on lessees is not fair.

John Mills is Policy Officer for the Association of Retirement Housing Managers www.arhm.org.uk