A Close Look At Planned Changes To Tax Relief On Borrowing Costs

 

The July budget included an announcement that tax relief for borrowing costs would be restricted for landlords with ‘higher incomes’. The Finance Bill, including the new law that will come into force with effect from 5th April 2017, is making its way through Parliament so it can now be seen how the restriction will work.

It might be thought that a residential landlord who has interest costs and other expenses that bring his net profit within the basic rate band would not be affected. This is not the case, and the new legislation denies any deduction for interest costs in the first instance and then allows an amount to be deducted from the tax bill calculated without the loan interest deduction.

By way of an example: assume a landlord has income of £60k, repair and other costs £10k and loan interest costs of £30k. In 2015/16 this would result in a net profit of £20k and assuming a personal allowance of £11k a tax bill of £1,800 (£20,000-£11,000=£9,000*20%)

In 2020/21, once the new restriction is fully in place, the profit that will go into the tax computation will be £50k. Assuming the personal allowance is still £11k and the basic rate band say £34k the tax bill before the new tax reduction will be £9,800 (£50,000-£11,000=£39,000, £34,000 assessable at 20% and £5,000 assessable at 40%). The tax reduction amount will be £6,000 (£30k@20%) leaving the net liability under the new rules £2,800. On these figures the increase in tax payable is £1,000 (which is the £5,000 profit falling within the 40% band without deduction on loan interest as an expense at 20% -the difference between the basic and higher rate of tax).

In 2017/18, 75% of loan interest costs will be deducted in the normal way with the restriction applying only to 25% of the loan interest. The restriction will apply to 50% of loan interest in 2018/19, 75% in 2019/20 and 100% in 2020/21.

These changes do have the potential to have a very negative impact on landlords with highly geared residential property portfolios. It is possible for a landlord to have a tax liability even though the accounts for the business do not show a profit.

The changes affect only individual landlords and do not affect companies so they may prompt more landlords with larger interest cost to look at incorporation of their businesses.

For further information on this topic or any other tax and finance related issues please contact Mike Turner, Director and DonnellyBentley Chartered Accountants in Bolton. Email mike@donnellybentley.co.uk or call 01204 388675.

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