Restriction on finance cost relief for residential.. | KPMG | UK

Restriction on finance cost relief for residential landlords

Restriction on finance cost relief for residential..

Interest relief restriction is likely to increase tax liabilities and may impact on entitlements to child benefit and tax credits.

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Starting from 6 April 2017, new rules are coming into force dealing with how individual landlords renting out residential property obtain relief for finance costs (e.g. mortgage interest). The transition will occur over the tax years 2017/18 to 2019/20 inclusive. Broadly speaking, the new rules mean that landlords will no longer be able to deduct all their finance costs from their gross property income before calculating their tax liability. Instead, they will have to work out their tax liability (without any deduction for finance costs) and then deduct an amount from their tax liability equal to 20 percent of their finance costs. 

How will it impact taxpayers?

While this may sound like semantics it does in fact have some very real consequences:

  • Under the current rules taxpayers effectively get tax relief on their finance costs at their marginal rate. So for example, a higher rate (40 percent) taxpayer paying £100 of mortgage interest per annum effectively gets tax relief of £40. Under the new rules however, the relief will be restricted to £20 (i.e. 20 percent of £100). 
  • Aside from the fact that the rate of relief will be lower under the new rules, the manner of calculating the tax is changing as outlined above. Under the current rules, a taxpayer with £300 of rent and £100 of finance costs has a net profit of £200. That net profit of £200 is then allocated to a tax band to determine whether it should be taxed at 20 percent, 40 percent or 45 percent. Under the new rules it will be the gross income of £300 which will be allocated to tax bands to work out the tax. Once the tax is calculated, relief will then be granted for finance costs of £20 (i.e. 20 percent of £100). The key point though is that it is the £300 and not the £200 which is treated as taxable income under the new rules. 
  • This means that even some basic rate taxpayers could find that they have more tax to pay under the new rules – generally those who are close but below the higher rate threshold (currently £32,001 ignoring the personal allowance). Under the new rules their taxable income could be pushed up over the threshold making them higher rate taxpayers.
  • The same rationale will also mean some taxpayers see their personal allowance and/or their pension contribution allowance curtailed as their taxable income is pushed up over the relevant threshold.
  • And yet other taxpayers still could see their entitlement to tax credits and child benefit reduced or eliminated as their taxable income breaches those thresholds.

In all cases however, and this is particularly relevant for the last group, the taxpayer is not economically better off even though their taxable income indicates otherwise. In fact most, if not all of them, will be worse off due to the increased tax liability.

What are the transitional rules?

As mentioned above, the new rules are being phased in from 2017/18 through to 2019/20 as follows:

Tax
year
Percentage
of finance costs deductible from rental income
Percentage
of basic rate tax reduction
2017
to 2018
75% 25%
2018
to 2019
50% 50%
2019
to 2020
25% 75%


2020 to
2021

0% 100%

As the table shows, each year the rules get closer and closer to their final state so every year between now and 2020/21 more taxpayers will be caught by the issues listed above. 

Who is impacted?

The new rules only apply to individuals who own residential property. Landlords who own commercial properties or furnished holiday lettings are not affected, neither are companies holding residential property.

 

For further information please contact :

Seamus Murphy

Patrick Martin

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