The Government has passed
legislation which will increase UK tax bills for most individuals (whether UK
resident for tax purposes or not) owning UK residential let property, where the
property has been part financed through mortgage debt. The changes take effect from 6 April
2017. Those with high gearing and
significant interest payments will be particularly affected.
The changes come on top of an
alteration to wear and tear allowance for landlords of furnished residential
lets, coming into effect in April 2016, but in this blog, I focus on
residential landlords with mortgages.
The current position
At the moment, if an individual
takes out a loan to purchase UK residential property for letting, broadly he
can deduct all the interest he pays to service the loan from the gross rental
income. There is no upper limit on the
amount of interest that can be deducted but the loan must be incurred wholly
and exclusively for the purposes of the rental business. UK Income Tax is paid on the net rental
income only.
The rules from 6 April 2017
Under the new rules, interest
payments on mortgages and other financing costs cannot be deducted from the
gross rental income. Income Tax will be
paid on the gross rental income (assuming there are no other allowable expenses
to be deducted, of course). Once the tax
has been ascertained, a new relief – a tax deduction – will be allowed. The amount of the tax deduction will be basic
rate relief (currently 20%) calculated with reference to the total interest
payments and financing costs that tax year – at least, this will be the
position from April 2020 when the new rules are fully phased in. In tax year 2017/2018, the new rules will apply
to 25% of the interest payments, then 50% in 2018/2019 and 75% in 2019/2020,
before applying to all interest payments in tax year 2020/2021.
The tax deduction operates as a
tax credit, therefore, but it results in a much less generous tax treatment, as
this basic example illustrates:
Assume a higher rate individual taxpayer owns a number
of rental properties, in total generating £100,000 of rental income per
annum. He pays £60,000 of mortgage
interest per annum.
Current position
|
New rules (tax year 2020/2021)
|
|
Rental income
|
£100,000
|
£100,000
|
Less:
Mortgage interest
|
£60,000
|
(not deductible)
|
Net profit
|
£40,000
|
£100,000
|
Tax @ 40%
|
£16,000
|
£40,000
|
20% mortgage interest tax deduction
|
N/A
|
£12,000
|
Income Tax
payable on rental income
|
£16,000
|
£28,000
|
How will this affect you or your clients?
The changes affect individuals,
trusts and partnerships (but not corporates, or corporates in partnership with
an individual, unless the corporate is acting as a nominee for an individual or
a trustee). The extent to which these
landlords will be affected will depend upon factors such as their other taxable
income and the rate at which they pay UK tax (basic, higher or additional rate),
the extent to which the property is geared and the interest rate applicable to
the loan.
Landlords will be concerned to
understand whether the tax changes erode their net profit to such an extent
that the letting is no longer profitable.
Landlords may wish to take the last two or three
years’ letting accounts and their UK tax returns and re-run the figures using
the new rules.
For planning ideas on how to deal with this change, see the full version of this article on Fladgate's website:
