Buy-to-let Tax Changes. A detailed look at how they affect you and how you can mitigate the problems

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1 Buy-to-let Tax Changes A detailed look at how they affect you and how you can mitigate the problems

2 Summary of buy-to-let tax changes Furnished lettings - wear and tear allowance Previously, a wear and tear allowance was given at 10% of the net rents received in respect of fully furnished let properties. This has been abolished with effect from 6 April In its place all landlords of residential property (whether fully furnished or not but excluding furnished holiday lettings) will only be able to claim the actual cost of replacing furnishings, appliances and white goods. Additional Stamp Duty Land Tax (SDLT) and Land and Buildings Transfer Tax (LBTT) from 2016 Higher rates of SDLT (LBTT in Scotland) are charged on purchases of additional residential properties (above 40,000), such as buy to let properties and second homes, this was introduced on 1 April The higher rates will be 3 percentage points above the current SDLT/LBTT rates. These rules impact individuals, trustees and corporate purchases of residential property. Recent years have seen the introduction of a number of changes to the way that let residential property is taxed. These punitive changes will have a significant impact for landlords moving forward. A summary of the changes, some of which are already in operation, are detailed below. To better demonstrate how the changes in legislation will affect your own circumstances, we have set out an example on pages 2 and 3. Relief for mortgage/loan interest for Buy to Let investors In the past, individual landlords received tax relief at their highest rate of income tax on all of the interest they paid to finance their letting business. From April 2017 the amount of interest that is eligible for tax relief at the higher and additional rate (40% and 45%) has been restricted to the following: 75% of the interest paid in 2017/18 50% of the interest paid in 2018/19 25% of the interest paid in 2019/20 The balance of the interest will be eligible for 20% tax relief in each case. From 6 April 2020, only basic rate tax relief will be available for interest paid by higher or additional rate tax payers. A critical point is that these rules apply only to private landlords and do not apply to limited companies. Furnished holiday lettings are unaffected. 1

3 Restriction of interest deductibility Impact of new rules In this example Adam has built up a fairly substantial rental property portfolio. He has other income of 50,000 from his main employment. Assuming income tax rates and personal allowances don t change between now and 2020/21, Adam s liabilities on his rents compare as aside: Even though nothing has changed in Adam s personal circumstances, he will, as a result of the changes in legislation, end up paying an additional 14,400 in income tax per annum. *Adam also loses his personal allowance since his total income exceeds 122,000 Previous rules 2016/17 Future rules 2020/21 Gross Rents 125, ,000 Expenses (excluding interest) (25,000) (25,000) 100, ,000 Mortgage interest (50,000) Net rental profits 50, ,000 Total tax for Adam (at 40%) 20,000 44,400* Less: Interest relief (20% x 50,000) (10,000) Total tax payable on rents 20,000 34,400 Total tax increase for Adam as a result of the new rules 14,400 2

4 Impact of Incorporation As discussed on page 2, the new rules restricting interest deductibility do not apply to limited companies. Using the same example as above, the overall position if Adam were to operate his business through a company is detailed in the following pages. As the changes to the interest deductibility rules do not impact limited companies, the net rental profits will be 50,000. We have considered two of the many possible options for Adam. One where the company pays the net income after corporation tax to Adam as a dividend, and another in which the money is retained in the company in order to more quickly repay any borrowing on the properties. Company net profits paid as dividend Company net profits retained Company position Net rental profits (as above) 50,000 50,000 Corporation Tax payable (9,500) (9,500) Company profit after tax 40,500 40,500 Adam s position Dividends received 40,500 Nil Income tax payable (12,513) Net retained dividend 27,987 Total tax payable 22,013 9,500 Tax saving vs 34,400 under future income tax rules (above) 12,387 24,900 3

5 As demonstrated by the examples on pages 2 and 3, a company will pay significantly less tax on profits from a rental property portfolio. However, there are a number of potential pitfalls that must be considered on incorporation. Capital Gains Tax (CGT) The transfer of residential let properties into a limited company will give rise to a charge to CGT on any increase in value since the properties were originally purchased, unless incorporation relief is available. Incorporation relief is available where a sole trader or partnership transfers their business into a limited company in return for shares in that company. In order to qualify for the relief the property letting activity must be sufficient to amount to a business. The scale of activities required to represent a business is a complex area however there is useful guidance in the tax case of Ramsey v HMRC (2013). If incorporation relief is available the properties receive a tax free uplift in base cost for CGT within the company, making the relief potentially very valuable. 4

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7 Stamp Duty Land Tax (SDLT) When moving properties into a limited company the company will have to pay SDLT based on the market value of those properties. In addition the company will be liable for the 3% surcharge applying to the purchase of residential let properties. Therefore SDLT on transfer of the properties could be very costly and must be considered in detail. There are potential SDLT reliefs and consideration needs to be given on a case by case basis as to whether these are of benefit. Where a number of properties are transferred there is the potential to claim multiple dwellings relief, or the company can opt to pay non-residential rates if buying six or more dwellings. There may also be the opportunity in exceptional circumstances and where the properties are held in partnership, to claim incorporation relief under FA 2003 section 15 paragraph 18. Business activity levels need to be high to justify this and the business must be sufficiently organised to prove that there is a genuine partnership. For instance a formal partnership agreement and preparation of partnership Tax Returns would normally be required. The relief available for partnership incorporations is up to 100% and is therefore a very valuable relief, however this only applies to genuine partnership incorporations and HMRC are likely to challenge any contrived or artificial arrangements. 6

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9 Refinancing of Loans A significant potential issue in an incorporation is that the lenders will normally require that the borrower terminates personal mortgages and re-finances in the name of the company. This can cause complications for the borrower and additional costs, so it is essential to check with mortgage providers before an incorporation is contemplated. Additional Compliance Costs The company will need to prepare and file annual accounts and returns to Companies House and HMRC. There may also be a requirement to file returns under the Annual Tax on Enveloped Dwellings ( ATED ) rules, although no ATED levy should apply if the properties are let to unconnected parties. Costs for annual accounts, tax returns, ATED and other required filings are likely to cost at least 2,000-3,000 per annum so must be considered and budgeted for. Summary The impact of the new rules for landlords will have a significant impact over the coming years with many landlords struggling to generate sufficient profit after tax. As the changes to loan interest relief will apply only to individuals and not to limited companies, many individuals will consider incorporating their property letting businesses. However, there are a number of issues that need consideration and professional advice should be taken in advance. 8

10 If you wish to discuss any element of the changes and how we can help you minimise the impact, please visit our website to find your nearest Duncan & Toplis office duntop.co.uk Alternatively, please Antony Voakes, Tax Director: or call duntop.co.uk trust, strength, direction and value Duncan & Toplis is the trading name of Duncan & Toplis Limited, registered in England and Wales, company number Registered Office: 3 Castlegate, Grantham, Lincolnshire, NG31 6SF. Registered to carry on audit work in the UK and regulated for a range of investment business activities by the Institute of Chartered Accountants in England and Wales. October 2018.