Tax Warning for Landlords – Disclose the Rental Income to HMRC

Reporting rental income to HMRC is a legal obligation for all landlords in the UK. Whether you are a resident or non-resident, failing to declare rental income can lead to significant penalties, as HMRC continues to crack down on tax evasion. 

Determining which portions of your income are taxable can be confusing. UK residents are taxed on their worldwide income, while non-residents are only taxed on income earned within the UK. This can lead to UK residents overlooking foreign income and non-residents failing to report UK-sourced income. 

The consequences of failing to declare income to HMRC can be severe. For example, in 2020, a market trader in Leeds incurred a £22,253 penalty for undeclared income, resulting in £37,400 in unpaid taxes. Landlords must remain vigilant to avoid making similar costly mistakes. This article explores the risks of undeclared income, the potential penalties involved, and how landlords can take proactive steps to reduce these penalties through the Let Property Campaign (LPC). 

How is Rental Income Taxed in the UK? 

As a landlord, you are required to declare rental income to HMRC and pay tax on any profits. For individuals, profits are calculated by deducting allowable expenses from the total rental income. Most landlords use the cash basis, meaning income is taxed when it is received, but landlords with property income over £150,000 must use the accrual basis. 

The accrual basis means the income and expenses are accounted in which tax year it occurred, instead of when the cash is received or paid. For instance, if a landlord pays for the next year’s insurance fees in the current year, it is reflected in the current year’s return if the taxpayer uses a cash basis and in the next year’s return if an accrual basis is used. 

The following rates will apply to your income tax calculations for property income: 

Taxpayers with earnings above £100,000 will see their Personal Allowance reduced by £1 for every £2 earned over £100,000. Consequently, personal allowance for individuals with income over £125,140 is nil. 

Rental Income Taxes for Non-Resident Landlords 

For non-resident landlords, tax obligations differ slightly but remain equally important. If you are renting out property in the UK while living abroad, you may still be required to pay tax on your rental income and report any capital gains upon selling the property. 

While filling out the self-assessment, you must settle any tax due or reclaim overpaid tax. You can receive the full amount of your rental income or have the tax already subtracted by your letting agent or tenant. If you opt to receive the reduced rent, your property manager or tenant will: 

• Deduct basic rate tax, i.e. 20% from your rent and 
• Give you a certificate at the end of the tax year showing how much they have deducted. 

If you do not have a letting agent and your tenant pays you more than £100 a week in rent, they will deduct the tax from their rent payments to you. 

However, Non-resident landlords can apply to receive their rental income in full, i.e. with no tax withheld, if they wish to do so. The application is sent via the NRL1i if the landlord is an individual, NRL2i and NRL3i if the landlord is a company and a trustee, respectively.  

HMRC decides whether to approve or reject the application at its discretion. Generally, HMRC approves landlords: 

• Whose UK tax affairs are up to date, 
• Who have never had any UK tax obligations, or 
• Who do not expect to be liable to UK tax for the tax year in which the application is submitted. 

If HMRC approves the application to receive the rent in full, non-resident landlords must declare their income in the Self-Assessment Tax Return. As non-residents cannot use HMRC’s online services, individuals must send their tax returns by post or get help from a professional accountant who can use commercial software to file tax returns. 

Failure to declare the rental income in the tax return will result in penalties based on the lost revenue to HMRC.  

Penalties on Undeclared Income 

Failing to declare rental income is considered a criminal offence. If the HMRC suspects that a landlord has intentionally evaded taxes, they have the authority to recover tax payments from up to 20 years in past. In addition to reclaiming unpaid taxes, fines can be imposed, with the potential penalty amounting to the total value of the unpaid and underpaid taxes.

Penalties for undisclosed income can be substantial, up to 100% of the unpaid rental income tax. The penalty percentage depends upon the taxpayer's behaviour and the taxpayer’s willingness to disclose the income. Following are the standard penalty rates that apply to errors by taxpayers. 

Standard penalties for errors 

Individuals can voluntarily disclose unpaid taxes by informing the HMRC about rental income from previous years. These disclosures are considered ‘unprompted disclosure’, and there will be a higher scope of penalty reduction regarding these. However, if the disclosure is a result of HMRC finding out about the income and sending a notice to the taxpayer, it is a prompted disclosure, and the penalty rate is increased in such disclosures. 

Therefore, the proactive approach to rectifying the situation can result in lower penalties compared to the consequences if the HMRC discovers the unreported income. So, landlords must disclose rental Income to HMRC through self-assessment tax returns. 

Taxpayer Behaviour Assessment 

As stated, HMRC charges a penalty based on the taxpayer's behaviour, resulting in revenue loss to HMRC. In this section, we will explore the various types of behaviour, explaining what falls within such behaviour along with an example. 

The term ‘careless’ simply refers to the failure to take reasonable care. A reasonable care may be defined as the behaviour which is expected of a prudent and reasonable person in the position of the person in question. Most of the tiny errors in the tax returns are deemed ‘careless. Below is an example of careless behaviour in a real-life scenario. 

Paul, a self-employed plumber, does not pay much attention to his record-keeping responsibilities and has no structured system for making sure that his records are accurate. 

When Paul completes his Self-Assessment tax return, he cannot be certain that his figures are correct and is unable to check them. This attitude towards record-keeping indicates a lack of reasonable care. 

When a taxpayer gives HMRC a document that they know contains an inaccuracy, the inaccuracy is considered ‘deliberate’. Examples of activities that indicate a ‘deliberate’ inaccuracy may include knowingly failing to record all sales by intentionally omitting certain transactions or deliberately claiming a deduction for personal expenses of an uncommon size or frequency. Below is a demonstration of how this behaviour could be seen in a taxpayer’s affair. 

Sarah takes £50 per week from her takings as ‘pocket money’. This money goes unrecorded when she adds up her weekly takings and enters the total into her records. Those records form the basis of Sarah’s turnover figure on her tax return, which she knows to be incorrect. 

Sarah deliberately recorded the wrong sales figures in the business records. However, there is no evidence of additional artificial or false records being produced to conceal this deliberate inaccuracy. 

The most serious level of behaviour is a deliberate and concealed inaccuracy, which occurs when a taxpayer gives HMRC a document that contains a deliberate inaccuracy and actively takes steps to hide the inaccuracy either before or after sending the document to HMRC. Under these types of inaccuracies, the taxpayer takes active steps to cover their tracks by making arrangements to conceal the inaccuracy. Examples may include creating false invoices to support invoices, backdating or postdating contracts, destroying books and records, etc.  

To follow up on the previous example, suppose that during a compliance check of her return, Sarah produces false invoices that she has prepared to support the figures of takings in her records. If that’s the case, preparing artificial invoices and giving them to HMRC represents an attempt to conceal a deliberate inaccuracy. 

Disclosing the Undeclared Income: Let Property Campaign

The Let Property Campaign (LPC), introduced by HMRC in 2013, is a disclosure initiative designed to encourage landlords renting out residential properties to declare any previously undeclared rental income. It provides a broad opportunity for landlords to rectify their tax affairs, though some exceptions exist.

Any landlord with undeclared rental income from residential property can apply to the LPC, including those who:

• Rent out a room in their main home above the Rent a Room Scheme threshold (£7,500)
• Rent out single or multiple properties
• Live abroad while renting out UK property
• Live in the UK and rent out property abroad
• Rent out a holiday home, even if it is also used for personal purposes

The LPC process consists of three main steps:

To calculate the tax you owe, you must first determine the total rental income you failed to report in previous years. Be sure to exclude any income already declared to HMRC in prior tax returns, as taxes on that income should have been paid.

Next, subtract any allowable expenses associated with generating the rental income to arrive at your taxable profit. Your tax rate depends on how much your income exceeds your Personal Allowance, which is the annual tax-free income threshold.

Once you've calculated the amount owed, you need to submit a formal disclosure to HMRC. This involves completing a disclosure form and providing the previously undeclared rental income details. When accepted by HMRC, this forms a legally binding agreement between you and HMRC.

Payment to HMRC must be made within 90 days of receiving your notification acknowledgment, unless you’ve requested an extension. Use the Payment Reference Number (PRN) provided by HMRC when submitting your disclosure to ensure the payment is properly allocated.

Conclusion

In conclusion, landlords must take their tax obligations seriously and ensure all rental income is declared to HMRC. Failure to do so can result in severe penalties, potentially costing far more than just the unpaid taxes. By proactively disclosing any previously undeclared income through initiatives like the Let Property Campaign, landlords can reduce penalties and avoid further legal consequences.

Whether you are a resident or non-resident landlord, staying compliant with tax laws not only helps you avoid financial pitfalls but also provides peace of mind in managing your property investments responsibly.