"HMRC say in their latest guidance that ‘all residential landlords with finance costs will be affected, but only some will pay more tax"
According to London Chartered Accountants Blick Rothenberg LLP, buy-to-let landlords need to pay attention now to changes to the tax rules for residential property taking effect in April 2017 or they could be in for costly tax consequences.
The changes were announced in last year’s Summer Budget, but HMRC has only issued guidance yesterday and it could be misleading as to how many landlords the new measures could affect.
The additional 3% stamp duty land tax (‘SDLT’) applying to second properties has dominated discussion amongst residential buy-to-let landlords, but there is a more worrying change which takes effect from April next year – the restrictions to tax relief for residential landlords.
The measure will restrict the amount of interest a buy-to-let residential landlord can deduct to calculate their income tax liability. The restriction comes into effect from April 2017, and is being phased in over 4 years (interest is restricted by 25% in each year) until it takes full effect in April 2020.
Nimesh Shah, partner at Blick Rothenberg, said: “Investors in residential property need to be aware of this marked new change and need to start planning for their portfolios now. Whilst the additional 3% SDLT has created the most anxiety amongst buy-to-let investors, the restriction to interest relief may have been overlooked, but this is likely to have greater longer-term effect on after tax returns.”
HMRC have finally issued their guidance on these changes, which include some worked examples to illustrate how landlords will be affected.
Nimesh said: “HMRC say in their latest guidance that ‘all residential landlords with finance costs will be affected, but only some will pay more tax.’ The statement is quite misleading as the changes could have quite far reaching effect, which most buy-to-let landlords will not appreciate.
A number of individuals have picked up a buy-to-let property in recent years, whether that is an investment property to supplement earnings, a second home which is occasionally rented out or a property which they have inherited and decided to let out.
It is wrong for HMRC to say ‘only some will pay more tax’, as entitlement to child benefit, personal allowance and the pension annual allowance will all be affected indirectly through how this new measure operates in practice. It would also not be an unreasonable assumption to say that the majority of buy-to-let landlords will be higher or additional rate taxpayers and they will be affected without question. This change will capture a large proportion of the buy-to-let landlord population.”
When the announcement was made at the Summer Budget, the measure was described as restricting interest relief at the 20% basic rate. However, the actual mechanism of how the restriction works has wider impact.
Nimesh explained: “Currently, buy-to-let landlords can deduct all their interest cost to calculate rental profits. When the new measure takes full effect, the interest cost will be completely disallowed in computing rental profits and instead a tax credit equal to 20% of the interest will be given against the person’s income tax liability. Whilst this may sound like what the Government intended the measure to achieve, the fact the interest is completely disallowed means the individual will have higher overall taxable income.”
He added: “This could push an individual into a higher rate of income tax (40%/45%), start to reduce their personal allowance (if their income now starts to exceed £100,000), affect their entitlement to child benefit and restrict the amount on which they can claim tax relief for pensions.”