Buy to Let Landlords – Restriction of tax relief on interest

Written by Shakeel Butt on 10 July 2015

Individuals who currently use debt to finance the acquisition of residential properties can claim a full tax deduction for the interest paid on servicing the debt at their marginal/top tax rates. Typically for wealthier higher and additional rate landlords, this means tax relief on the interest is at 40% or 45%.

In the Summer Budget, the Chancellor announced that this tax relief will be restricted to the basic rate (currently 20%) for all individuals (but not companies) by April 2020. The changes will not affect qualifying furnished holiday lets.

This is generally bad news for higher rate taxpaying landlords and the only saving grace is that the restriction will be phased in over a period of four years starting in April 2017, so the full impact of this will not be felt until the 2020/21 tax year as the following table demonstrates.

 

Tax year

% Fully deductible finance costs

% Balance restricted to basic rate

Currently

100

0

2017/18

75

25

2018/19

50

50

2019/20

25

75

2020/21

0

100

The net result is that with the implementation of the above changes, landlords will be left with higher rental profits and hence higher taxes. For those fortunate enough to have no mortgage or debt secured on the property, then clearly this restriction will have no impact.

Landlords now need to consider what steps they should be considering going forward to mitigate the overall tax exposure. With the current low interest rate environment, the interest restriction will perhaps not have a major impact for many landlords; but with the prospect of higher interest rates looming in the future, this change may well have a significant impact in future years.

One solution would be to operate via a corporate structure and a limited company. This would enable continued full tax relief of the interest/finance costs and this coupled with the current low corporation tax rate of 20% which is planned to further drop down to 18% by 2020 looks very appealing.

However this it is not a ‘clear cut’ decision, as although operating via a limited company has its advantages, there are also drawbacks and other considerations that need to be taken into account before deciding to choose this option, including the additional administrative costs involved in running a company. For existing landlords, two major issues would be the crystallisation of the capital gain on the deemed ‘market value’ disposal of properties(s) transferred into the limited company, plus a charge to stamp duty land tax.

I would suggest for the serious long-term property investor, the limited company option should now be considered. For many landlords, the strategy is to have high gearing/minimum deposit and using the surplus funds for more property acquisitions. So this interest rate restriction will have a big impact on their tax exposure and the all important cash flow. For those who already operate within a corporate structure, this change will have no impact as they already enjoy the benefits of the low corporate tax rates.

Landlords have also been hit in this budget with the removal, from April 2016 of the 10%‘wear and tear allowance’, for furnished let properties, which allows landlords to reduce the tax they pay, regardless of whether they replace furnishings in their property. It will be replaced by a new system that only allows tax relief when furnishings are replaced. This change may well have a bigger impact on many landlords than the interest rate restriction.

I remember many years ago when Gordon Brown was Chancellor, he announced the abolition of corporation tax for the first £10,000 of profits. This encouraged many thousands of self employed to incorporate and operate via limited companies. Two years later the policy was reversed; the point being, many landlords may now choose to incorporate and then in the future George Osborne may restrict the interest deduction on corporate structures as well.

The important thing to remember is that with every budget, the Chancellor announces major changes and landlords, individuals, entrepreneurs, business owners etc, need to be ready to make changes and take appropriate action, to mitigate their overall tax exposure, with the help from their trusted tax advisors and accountants. Here at WSM, we try to ensure that our clients are given proactive and timely advice.

For further advice or information, please contact one of our Property Specialists, Shakeel Butt.

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Shakeel Butt
Private and Corporate Client Director