Restriction of tax relief for interest and other finance costs
From April 2017 the restriction of relief for finance costs including mortgage payments to basic rate will begin to be phased in. In 2017 relief will be restricted on 25% of finance costs, increasing to 100% of finance costs by 2020. This change can affect basic rate taxpayers as well as higher rate taxpayers. The scope of the restriction is not limited to interest, it includes arrangement fees as well as legal and valuation expenses if these are in connection with raising loan finance.
This tax relief will be calculated as 20% of the lower of the:
- finance costs not deducted from income in the tax year
- Profits of the property business in the tax year.
- total income (excluding savings income and dividend income) that exceeds the personal allowance
- Staggered introduction: As announced in the 2015 budget the change will be introduced gradually from April 2017 and the full impact will felt in the tax year 2020/21
|Year||Restriction as a% of finance costs Deductible
||% available as a basic rate deduction|
|2016/17||None –all allowable||0%|
Two examples below will explain how the changes will impact the landlords.
|Paul only source of income rental income. His income and expenditure is as follows:|
|£||Current Rules 2016/17|
|Repairs & maintenance||(15,000)||Paul is a basic rate tax payer and his tax|
|Professional fees||(1,000)||liability 2016/17 calculated as|
|Mortgage arrangement fee||(10,000)||Rental profit||30,000|
|mortgage interest||(40,000)||Personal allowance||(11,000)|
|Net rental||30,000||taxable income||19,000|
|tax @ 20%||3,800|
|New Rules 2016/17|
|If the new rules has been fully introduced for 2016/17 as they will be by 2020/21|
|Under the new rules, in 20/21 Paul would no longer be able to deduct the finance cost of £50,000 and his rental profits would increase to £80,000. After deducting the £11,000 personal allowance his taxable income is £69.000 and he is now an higher tax payer|
|Rental profit||30,000||Rental profit||80,000|
|Add Finance cost disallowed||50,000||Personal allowance||(11,000)|
|New net rental profit||80,000||taxable income||69,000|
|tax £32,000 @20%||6,400|
|tax £37,000 @40%||14,800|
|tax relief £50k @20%||(10,000)|
As a result of the changes Paul will have an extra tax liability of £7,400 (£11,200 less £3,800)
Loss of all tax relief altogether
For some they may not even get the 20% basic rate tax relief as the following example will demonstrate.
Gavin is a sole director of ABC Ltd. In 2017/18
- His salary from ABC Ltd £10,000 & dividends of £70,000
- Other side self employed business -£2000 Loss
- Buy to let properties. Rental profits £12,000,excluding Interest paid £8,000
- Pension contributions £10,000
If the new rules has been fully introduced for 2016/17 as they will be by 2020/21 his tax position will be as follows:-
Tax calculation 2020/21
|Less- Pension contribution||(10,000)|
|Adjusted total Income||
Tax relief on interest of £8,000 is 20% of the lower of
|1||Disallowed finance cost £8000 @20%=£1600|
|2||Rental profits – £12,000 @ 20%= £2,400|
|3||Adjusted total income= £nil|
In this instant Gavin is not entitled to any credit for the interest payments.
If possible Gavin could organise the pension contributions of £10,000 to be paid by ABC Ltd as employer contributions and will then be removed from the above calculation to give an adjusted total income of £8,500 . Alternatively Gavin would be advised to work harder and increase his income to fully utilise his tax free personal allowances.
The unused finance cost of £8,000 is carried forward to the calculation in the following year
- The increase in rental profits will lead to an increase in your total income for tax.
- Loss of personal allowance. £1 for every £2 over £100k.
- The knock on effects depend on your personal circumstances, other income, capital gains and other reliefs.
- For example, there is an impact for anyone claiming tax credits or if you or your partner claim child benefit and the change increases your income above £50,000, child benefit can be clawed back under the Higher Income Child Benefit Charge (HICBC).
- You could find that you are paying tax at 40% or higher or that capital gains are taxed at 28% instead of 18% (20% instead of 10% for non-residential property gains from April 2016).
- You may be able to reduce your taxable income if you carry back pension contributions or Gift Aid donations from the next year.
- If you plan ahead we may be able to anticipate whether you are likely to become a higher rate taxpayer as a result of the adjustments.
There are two possible alternative ways to hold and manage your property:
- Through a limited company. All profits are taxed at corporate rates, currently 20% but set to reduce to 19% in 2017 and to 17% by 2020.
- As a furnished holiday let. There are no current proposals to restrict relief for finance costs in connection with furnished holiday lets.
For each of the above there are significant other issues which should be taken into consideration before taking steps to change the existing structure.
For further advice or information, please contact one of our Property Specialists, Shakeel Butt.