Changes to loan interest relief on residential property income – be aware and be prepared
Published: October 2017
As you may be aware, there have been significant changes announced with regards to the rules for those taxpayers with residential buy to let properties. One of these is how loan interest is utilised as an expense against rental income.
For the years up to the 2016/17 tax year, in order to arrive at a figure for taxable rental profit, allowable expenses were deducted from the amount of rental income due for the period.
These expenses have historically included:
Rents, rates, utilities and insurance
Repairs and maintenance
Finance costs, including mortgage interest
Legal and professional fees – e.g. agent’s fees
Services supplied to your tenants, e.g. gardening, cleaning
For a large number of landlords, the main expenses incurred on a rental property, which would usually reduce the profit subject to tax, are mortgage interest and agent’s fees.
However, the relief available in respect of the mortgage interest will change with effect from 6 April 2017. From this date, HMRC will be phasing in measures to reduce the relief that is given for this cost, and the amount of interest that can be deducted as an expense.
The ultimate result will be that, by the tax year 2020/21, finance costs (mortgage interest) will no longer be an allowable deduction when calculating rental profits. Rental profits will be calculated by ascertaining the rental income due for the year and deducting all allowable expenses, other than finance costs. The tax due on the rental profits will then be calculated at the relevant rate of tax. Relief for the finance costs will be taken into account by way of a deduction from the tax liability calculated, of 20% of the finance costs incurred (however this will be restricted if the profits calculated are lower than the interest charged).
This change will have the biggest impact on landlords who are higher rate and additional rate taxpayers, with a significant amount of borrowing against their rental properties. Whereas previously, by deducting finance costs to arrive at the net rental income subject to tax, each individual was effectively receiving tax relief at their marginal rate, relief will now be restricted to the basic rate of 20%. As a result, this new treatment could result in a higher taxable profit, and therefore an increased tax liability.
Basic rate taxpayers should also be aware, that they too could be significantly affected by these rules. By removing the deduction for finance costs from the calculation of rental profits, their total taxable income will be inflated, which could result in them exceeding the basic rate threshold and actually being charged to tax at the higher rate.
The phasing of the changes will take effect as follows:
Year | Loan interest deductible from rental profits | Amount of loan interest subject to new 20% relief
2016/17 | 100% | 0%
2017/18 | 75% | 25%
2018/19 | 50% | 50%
2019/20 | 25% | 75%
2020/21 | 0% | 100%
It is advisable to ensure that you are aware of these changes and how they may affect your tax position. It may be necessary to consider the options available if you are adversely affected.
Please get in touch with your usual Old Mill contact to confirm your position and explore any potential options.
Liz Kinder ATT
Direct: 01935 709306
Office: 01935 426181
– Commercial Property Transactions and the Option to Tax
Published: August 2017
This is an extremely complex area of VAT and one that requires a close attention to detail as well as ones that receives close scrutiny from HMRC.
The starting position is that for most transactions involving the sale or letting of commercial property the VAT treatment is VAT exempt. The exception to this is that the freehold sale of a commercial property within three years of its construction is automatically liable to VAT at the standard rate of the tax (currently 20%). In addition specific types of letting activities are also standard rated – e.g. car parking, charges for storage.
The usual implication of a VAT exempt property transaction is that it carries no entitlement or obligation to register for VAT as it is not a taxable business activity. In turn this also means that any VAT incurred on any associated costs such as the purchase or development of the property cannot be recovered from HMRC and so has to be accepted as a cost.
To sweeten the pill here the option to tax was introduced so that property owners and landlords could use the land and buildings for the purposes of making taxable supplies for VAT purposes and so register for VAT and thereby recover the VAT on any associated costs. The effect of opting to tax is that the supplies of the land/buildings concerned are liable to VAT at the standard rate.
Opting to tax would only usually be recommended where there are significant amounts of VAT involved because once taken the option to tax has to remain in place for a period of at least twenty years. This means that any transactions within that twenty year period would be subject to VAT unless the option to tax is covered by specific exclusions. This has the effect that future tenants or prospective purchasers may not be attracted by a rent or sale price that carries an additional cost in terms of VAT. This can be a particular problem for those organisations in the health, education and charity sectors as well those involved in the provision of financial services or insurance services.
An option to tax will come up frequently where commercial properties are bought or sold under the transfer of a business as a going concern (TOGC) provisions. These transactions will involve the transfer of commercial property letting businesses activities and there are special rules in place which allow an opted property to be transferred as outside the scope of VAT rather than subject to VAT at the standard rate. The option to tax does not flow with the property and one of the TOGC conditions is that the buyer must also opt to tax the property within certain time limits so that the rent received after the transfer continues to be chargeable to VAT. Although opting to tax does place additional constraints on the buyer it will generally be a good idea because if the purchase of the building is outside the scope of VAT there is a double benefit for the buyer:
- The Stamp Duty Land Tax payable on the transaction will be reduced as it is based on the total price paid and will include the VAT element where VAT is chargeable; and
- There is a cash flow benefit in that the buyer does not have to pay VAT and then wait to recover it from HMRC through a VAT return.
In other instances the sale of opted commercial property will carry VAT and it will be important for the buyer to exercise an option to tax, be VAT registered and have a timely VAT return in order to recover the VAT promptly.
A great deal of care is needed with the option to tax as there are certain situations where an option can be disapplied. In this scenario the supply of the property, whether a sale or a letting, cannot be standard rated and will revert to being VAT exempt. The knock-on effect can be that the supplier then has to revisit his initial VAT recovery and make adjustments to the VAT already recovered from HMRC.
Commercial property transactions will by their nature involve significant sums and therefore carry a significant VAT cost if they are not treated correctly. Add to this a penalty regime where the penalty imposed is based on a percentage of the VAT at stake means that there can be a particularly nasty surprise in getting it wrong. In any property transaction the recommendation is always to take advice on the VAT implications at the outset to ensure that VAT is accounted for correctly
The advice given in this summary is only an overview of the VAT regulations. If any further information or advice on a specific transaction is required please contact Andy Branson at Albert Goodman LLP.