What now for buy-to-let landlords? by Mark McLaughlin

Mark McLaughlin looks at the prospects for buy-to-let residential landlords following the recent High Court refusal of a judicial review application by a group of landlords in respect of the impending tax relief provisions for finance costs.

Tax changes are often unpleasant for those affected, and are sometimes even controversial.

There are probably few tax changes in recent times as controversial as the introduction (in Finance (No. 2) Act 2015, as amended in Finance Act 2016) of a restriction in the deduction of finance costs (e.g. loan interest) related to residential property to the basic rate of income tax, which is being phased in over a four-year period commencing from 6 April 2017. The new legislation can be found in ITTOIA 2005, ss 272A-272B, ss 274A-274C; see also ITA 2007, ss 399A-399B for property partnerships).

Unsuccessful legal challenge

Such was the outrage and protest by many landlords potentially disadvantaged by the new measures that a number of them recently attempted to legally challenge the introduction of the provisions. A group of around 700 landlords sought judicial review of the tax changes, represented by a legal team which included Cherie Blair QC. However, this attempt failed at the High Court earlier this month.

The Financial Times reported Mr Justice Dingemans, in dismissing the case, as commenting: “It would be a miserable spectacle to watch a case bound to fail – fail”. The finance cost restrictions do not apply to companies, and it was argued that corporate landlords would therefore have a competitive advantage over individual landlords, such that the new rules effectively represented the grant of state aid to the former group but not the latter one. However, this argument was unsuccessful according to the Financial Times, on the grounds that the tax system has always treated individuals and companies differently.

Any further campaigning by landlord bodies such as Axe the Tenant Tax (www.tenanttax.co.uk) is arguably unlikely to prevent the finance cost restriction being introduced, so individual landlords will need to consider the likely effect of the changes, and possibly their options, before the rules take effect next April.

What are the implications?

The effect of the relief restriction for finance costs related to residential property businesses is broadly that the normal deduction for affected interest costs, etc. is disallowed for income tax purposes, but a basic rate (20% for 2016/17) reduction is allowed instead, albeit that the full 20% relief will not always be immediately available.

Individual landlords who are presently basic rate taxpayers, and who will remain as such despite the finance costs disallowance and relief restriction, can perhaps count themselves fortunate, although such landlords will probably be relatively small in number. The most worrying consequence of the provisions for many other landlords will be that it pushes them into a higher income tax bracket.

However, that is not necessarily the end of their tax troubles. For example, some landlords may suffer a restriction or complete loss of the personal allowance as the result of increased rental profits. The personal allowance is reduced at the rate of £1 for every £2 of ‘adjusted net income’ in excess of £100,000 (ITA 2007, s 35(2)). Similarly, at a lower level, landlords (or their ‘partners’) in receipt of child benefit may be subject to a potential clawback of benefit, to the extent that their ‘adjusted net income’ exceeds £50,000, subject to the complete loss of child benefit when adjusted net income reaches £60,000 (ITEPA 2003, ss 681B–681H).

The possible implications for (among other things) tax credits entitlement and student loan repayment purposes also need to be considered, where appropriate.

What can be done?

Individual landlords who are worried about the adverse effect of the finance cost relief provisions should consider their options before the new rules start to bite.

However, it should be remembered that the rules only apply to the extent that finance costs such as mortgage interest are incurred. Thus (for example), landlords with existing residential properties without mortgage finance, and/or landlords who can buy residential property without the need for loan finance, will be largely unconcerned about the changes. Those landlords fortunate enough to be in a position to repay outstanding borrowings before the changes take effect might wish to consider doing so.

In addition, the new provisions apply to finance costs related to residential property businesses; they do not apply to commercial properties such as industrial units. Nor do they apply to qualifying furnished holiday lettings businesses. Diversifying the property business may therefore be another option to consider.

Sole proprietor landlords and partnerships of individuals may wish to consider incorporating their rental property business, so that their company can claim unrestricted relief for such costs, albeit at a corporation tax rate of 19% from 1 April 2017, reducing to 17% from 1 April 2020. However, aside from any non-tax (e.g. refinancing) issues, it is important to consider any implications for other tax purposes, such as capital gains tax and stamp duty land tax (or land and buildings transaction tax in Scotland).

Other options to consider include introducing family members into the business (e.g. if those family members have unused personal allowances, and/or are basic rate taxpayers), advancing interest payments into the tax year 2016/17 (if possible and practical to do so), and (if appropriate) paying additional pension contributions and/or gift aid contributions to extend the basic rate income tax band.

Of course, some landlords will simply seek to increase rents. Alternatively, the ‘nuclear’ option would be for landlords to sell their buy-to-let residential properties, although this may trigger potentially large capital gains tax liabilities, and in some cases there may be insufficient equity in the properties to meet the tax on their disposal.

All in all, there are interesting times ahead for many buy-to-let landlords.

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The mechanics of the new provisions is beyond the scope of this short article, but entire chapters with detailed commentary on the finance costs relief legislation and the incorporation of a buy-to-let property rental business are included in the Buy-To-Let Property Tax Handbook by Bloomsbury Professional (www.bloomsburyprofessional.com/uk/buy-to-let-property-tax-handbook-9781784510541/).

 

mark-mclaughlin-7285Mark McLaughlin CTA (Fellow) ATT (Fellow) TEP is a consultant to professional firms with Mark McLaughlin Associates Ltd (www.markmclaughlin.co.uk). Mark is also Managing Editor of TaxationWeb (www.taxationweb.co.uk). He can also be contacted via Twitter https://twitter.com/charteredtax and LinkedIn http://www.linkedin.com/pub/mark-mclaughlin/11/811/12.

Written by Ellie MacKenzie

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