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The Summer Budget and Autumn Statement contained a quartet of tax changes that will have a massive impact on the on the Buy-To-Let property sector.
In this first of a two-part newsletter series, we look at the impact of the changes in mortgage interest relief announced in the Summer Budget and how running a property portfolio through a Limited Company is now a much more attractive option.
The second newsletter next weekend will look at the impact the changes in Stamp Duty and Capital Gains Tax, the abolition of the Wear and Tear Allowance for furnished properties and what may be around the corner.
The change in mortgage interest relief, which will be phased in between 2017 and 2020, was totally unexpected and implemented without the usual consultation process. Moreover, the new system is complex and, although the stated intention is to prevent Higher Rate tax payers gaining an unfair tax advantage, it could also impact Basic Rate tax payers and lead to a situation where investors will have tax to pay even if their property is making a loss.
Before we look into the mechanics of how this tax change will work, it is noteworthy that a pair of private landlords have raised the monies through crowdfunding to seek a judicial review on the basis that this change runs contrary to “a long-established principle of taxation that expenses incurred wholly and exclusively for the purposes of the business are deductible when calculating the taxable profits”.
As those who followed the judicial review on Accelerated Payment Notices will be aware, these are notoriously difficult to win. Nevertheless, the group has until mid-February to submit their challenge.
Under the change, mortgage interest relief will be phased out over time by being restricted to:
Instead, individuals will be able to claim a basic rate tax reduction from their Income Tax liability on the portion of finance costs not deducted in calculating the profit. In practice this tax reduction will be calculated as 20% of the lower of:
Importantly, this will apply to existing Buy-To-Let properties as well as future purchases.
Taking the example of the two landlords, one a Basic Rate Taxpayer and the other a Higher Rate Tax Payer, who each have property income of £12,000 per year, mortgage interest of £8,000 per year and £2,000 of other allowable costs. The impact would be:
| Basic Rate Landlord
Mortgage interest disallowed |
|||||
| 2016-17 | 2017-18 | 2018-19 | 2019-20 | 2020-21 | |
| 25% | 50% | 75% | 100% | ||
| Rental income | £12,000 | £12,000 | £12,000 | £12,000 | £12,000 |
| Mortgage interest | £8,000 | £8,000 | £8,000 | £8,000 | £8,000 |
| Other costs | £2,000 | £2,000 | £2,000 | £2,000 | £2,000 |
| Operating Profit | £2,000 | £2,000 | £2,000 | £2,000 | £2,000 |
| Mortgage interest restriction | – | (£2,000) | (£4,000) | (£6,000) | (£8,000) |
| Taxable Profit | £2,000 | £4,000 | £6,000 | £8,000 | £10,000 |
| Tax @ 20% | £400 | £800 | £1,200 | £1,600 | £2,000 |
| Tax deduction at 20% | – | (£400) | (£800) | (£1,200) | (£1,600) |
| Total Tax Payable | £400 | £400 | £400 | £400 | £400 |
| Higher Rate Landlord
Mortgage interest disallowed |
|||||
| 2016-17 | 2017-18 | 2018-19 | 2019-20 | 2020-21 | |
| 25% | 50% | 75% | 100% | ||
| Rental income | £12,000 | £12,000 | £12,000 | £12,000 | £12,000 |
| Mortgage interest | £8,000 | £8,000 | £8,000 | £8,000 | £8,000 |
| Other costs | £2,000 | £2,000 | £2,000 | £2,000 | £2,000 |
| Operating Profit | £2,000 | £2,000 | £2,000 | £2,000 | £2,000 |
| Mortgage interest restriction | – | (£2,000) | (£4,000) | (£6,000) | (£8,000) |
| Taxable Profit | £2,000 | £4,000 | £6,000 | £8,000 | £10,000 |
| Tax @ 40% | £800 | £1,600 | £2,400 | £3,200 | £4,000 |
| Tax deduction at 20% | – | (£400) | (£800) | (£1,200) | (£1,600) |
| Total Tax Payable | £800 | £1,200 | £1,600 | £2,000 | £2,400 |
For the Basic Taxpayer there would be no change whilst the Higher Rate taxpayer would see a steady year-on-year increase on their tax due until in 2020-21 the tax would actually exceed the Operating Profit.
As a result, it will be the small property investor with a couple of to Buy-To-Let properties in their overall savings portfolio who will bear the brunt of these changes.
Large companies investing in residential property will be unaffected as will those wealthy landlords investing with cash rather than mortgages.
However, with the extraordinary decision to announce in December that the 3% surcharge in Stamp Duty Land Tax on second homes would come into effect from April 2016, continued low interest rates and the volatility in world stock markets, the demand to invest in property shows no signs of abating.
Instead, landlords are seeking to mitigate the tax increases. For many, using a Limited Company structure is providing a solution. In October 2015, the proportion of Buy-To-Let mortgages advanced to companies was roughly 15% of the total. Now this figure stands at over 30%.
Under a Limited Company, the mortgage interest is classed as a business expense and, therefore, wholly deductible in calculating the Taxable Profit of the business. Corporation Tax is a standard 20% irrespective of the personal tax bands of the shareholders. Indeed, Corporation tax is set to reduce to 19% from April 2017.
At CooperFaure, we are currently working with a number of clients with both individual and corporate property portfolios and would be pleased to review your circumstances. Please email us at welcome@cooperfaure.co.uk for an initial, free consultation.
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