With the enactment of the 2015 Summer Finance Act we have seen the introduction of new rules which will restrict the deductibility of finance costs available for rental properties.
These rules are likely to change the economics of ‘buy-to-let’ investments, particularly for higher rate and additional rate tax payers, and landlords who have borrowed significantly to purchase their rental properties. Companies, which are not affected by the rules, are also likely to become more attractive to hold buy-to-let UK residential property portfolios, although not in all circumstances.
An overview of the new rules
Individual buy-to-let landlords of residential property are currently able to deduct the full amount of any finance costs against their rental profits. The new restriction will operate so that landlords will no longer get a deduction against their rental profits and instead basic rate relief (currently 20%) on the interest will be given as a tax reduction against the individual’s income tax liability.
The Government’s intention is to phase in the introduction of the rules from 6 April 2017 over a 4 year period to allow landlords time to adjust to the changes, as follows:
- 2017/18 – 75% interest deduction against profits: 25% interest relieved at basic rate of income tax;
- 2018/19 – 50% interest deduction against profits: 50% interest relieved at basic rate of income tax;
- 2019/20 – 25% interest deduction against profits: 75% interest relieved at basic rate of income tax;
- 2020/21 – 100% interest relieved at basic rate of income tax.
An illustrative example
Here is an example to show how this would work in practice. Let’s assume James, a buy-to-let landlord, has a residential property portfolio and receives £110,000 of rental income with interest payable of £75,000. To keep things simple I have assumed that he does not have any other income for these purposes.
Under current rules, for the 2015/16 tax year James would be allowed a deduction of £75,000 against his rental profit giving net income of £35,000 with income tax of £4,880 payable, after deduction of the personal allowance.
If we now jump ahead to the 2020/21 tax year when the new rules apply in full (but assuming current tax rates and tax bands still apply) James would no longer be allowed a deduction against his rental profits. His net income would now be £110,000 (meaning his personal allowance is partially restricted as his income is above £100,000) and his total tax liability would be £35,403. He would then be able to offset basic rate tax on the interest of £75,000 (so £15,000) resulting in a tax charge of £20,403 – this is an increase of £15,523 compared to 2015/16.
Who and what do the rules apply to?
- Who? As well as individual landlords, the rules will apply to trustees of accumulation and discretionary trusts, beneficiaries of interest in possession trusts and individuals who obtain loan finance to invest in a property letting partnership, however, the rules do not currently apply to UK companies.
- What? These rules apply only to “dwellings” and therefore they do not apply to commercial properties or properties qualifying as Furnished Holiday Lets. In addition, the rules should not apply to property development trades or loans secured on a dwelling which are applied for the purposes of a trade.
Should buy-to-let investors hold or transfer their property portfolio to a company?
The approach will vary depending on a landlord’s individual circumstances and their long term plans. In addition, a key factor will be whether a new property portfolio is being acquired or there is an existing property portfolio already in place.
When setting up a new property business a company may well have advantages if the long term business plan is for profits to be reinvested in the business to promote future growth enabling the business to pay corporation tax rates on profits and to benefit from the finance cost deduction from rental profits. However, with such a structure, the extraction of rental profits will also need to be considered in comparison to owning the property directly – particularly in light of the increased dividend tax rates coming into effect from 6 April 2016.
Individual buy-to-let landlords considering incorporating an existing buy-to-let business will need to review the likely Capital Gains Tax and Stamp Duty Land Tax charges arising, which in some circumstances may be substantial.
It is not yet clear to what extent companies will be impacted by the new SDLT rules on buying second properties announced in the Autumn Statement. To the extent companies are affected by these rules, then the new SDLT rules will be another factor to be considered.
Overall, these rules will be a big change for buy-to-let landlords, however, there is around a year and 3 months for landlords to get their affairs in order before the rules come into effect so I would encourage all buy-to-let landlords to seek advice as soon as possible to ensure they understand their position.
Whilst every effort has been made to provide information current at the date of publication, tax laws around the world change constantly. Please note that this article has been produced based on information contained in the Autumn Statement announcement documents and prior to any draft legislation being produced. Accordingly, the material should be viewed only as a general guide and should not be relied on without consulting your local KPMG tax adviser for the specific application of a country’s tax rules to your own situation.
If you need assistance with any related matters, please do e-mail Simon at simon.johnson@kpmg.co.uk.