Finance Bill : - Calculation of Income Tax Liability

Transcription

1 Finance Bill : - Calculation of Income Tax Liability September

2 About the NLA: The National Landlords Association (NLA) is the UK s leading organisation for privateresidential landlords. It works with 61,000 landlords, of which over 28,700 are paying members, ranging from full-time landlords with large property portfolios to those with just a single letting. NLA membership helps landlords make a success of their lettings business by providing a wide range of information, advice and services. The NLA campaigns for the legitimate interests of landlords by seeking to influence decision-makers at all levels of government and by making landlords collective voice heard in the media. It seeks to raise standards in the private-rented sector while aiming to ensure that landlords are aware of their statutory rights and responsibilities. Background: The private-rented sector (PRS) is the UK s second largest tenure, serving 19 per cent (4.4 million) 1 of households and comprising of property valued at close to 1 trillion 2 owned by an estimated 1.5 million private landlords. The sector is subject to relatively low gearing; with approximately 188 billion 3 of outstanding buy-to let finance and an indeterminate amount of commercial lending. Buy-to-let (BTL) mortgages, those specifically intended for the purchase, or re-financing, of residential property for the purpose of running a lettings business, account for approximately 14.4 per cent of all mortgage lending in the UK 4. Clause 24 of the Finance Bill aims to remove landlords ability to deduct from taxable income their finance costs related to residential property, replacing this relief with a tax reduction equivalent to the basic rate of Income Tax. In practice this will result in those landlords with an income exceeding the upper threshold of the basic rate will be taxed on a significant portion of their turnover, rather than profit. Impact: The NLA estimates that there are currently 301,283 landlords with BTL mortgages, providing homes for 828,526 rented households. Of those landlords relying on BTL finance approximately 135,089 operate their lettings businesses on a non-incorporated basis and have an income exceeding the threshold for higher rate Income Tax. Additionally, around 69,878 unincorporated landlords with earnings in excess of the threshold opt for alternative financial products. Assuming typical house prices, gearing and interest rates, this amounts to a loss of posttax income in excess of 858,199, per year from 2020 across the PRS. In the context of a typical rental property, this equates to a loss of around 840 per year or 8 per cent of the national average annual rent in the PRS. 1 English Housing Survey Headline Report , DCLG, February Savills, January Council of Mortgage Lenders, December Council of Mortgage Lenders, April

3 Of equal concern to the NLA is the matter of those landlords who rely on finance, but are not currently higher or additional rate taxpayers. According to the Office for National Statistics (ONS), in the most recent recorded year, there are 4,391,000 basic rate taxpayers who derive their largest income from either employment for investment who earn in excess of 30,000 without exceeding the threshold for the higher rate. We estimate that approximately 10 per cent own one or more rental property 5, of whom 31 per cent are likely to have BTL or equivalent finance in place to support their portfolio. This equates to 136,121 landlords potentially liable to an elevation in personal taxation band, disproportionate increase in Income Tax and loss of unrelated income dependent benefits as a direct result of this change. The Issue: The Treasury s objective is to ensure that higher earning landlords do not enjoy greater tax advantage by virtue of the deductibility of finance costs at the higher and additional rate of Income Tax. However, this fails to recognize that the majority of private landlords incomes fall within the basic rate and that a significant proportion will be pushed into a higher bracket by the change proposed to the calculation of income for tax purposes. Approximately 136,000 landlords currently have an income in excess of 30,000 and below the threshold for the higher rate ( 42,385 for the tax year 2015/16). Currently, their taxable liability (on profit) is calculated by means of variations on the following formula: Income Tax (due) = Rental Profit (rental income expenses incl. finance costs) x Prevailing Income Tax Rate This allows landlords to calculate their tax liability on profit made after deducting the costs of running their lettings business thereby providing appropriate tax relief and ensuring that turnover does not push income into a higher tax bracket. The proposed policy will result in the following: Income Tax (due) = Rental Income (rental Income expenses not incl. finance costs) x Prevailing Income Tax Rate Tax Reduction* Here tax liability is calculated without taking into account landlords finance expenses, resulting in the use of a higher income figure, including the full cost of servicing finance therefore potentially pushing an individual s income into a higher tax bracket. 5 BTL Market Report 2015, Mintel UK, March 2015 (6% of households earning 25-39k and 4% households earning 40-49k) 3

4 Once a landlord s tax liability has been ascertained using this formula a tax reduction (*) is applied equivalent to the basic rate of income tax, which is intended to provide relief not exceeding that available to basic rate taxpayers. For example a landlord earning a pre-salary of 35,000, with a gross rental income of 10,000 pa is currently a basic rate taxpayer as only their rental profit is considers for tax purposes. As a result of the Chancellor s changes the landlord will not be permitted to deduct the cost of interest on finance from their income. In the example below this means that their taxable income will increase by 6,000 pa, exceeding the higher rate threshold and therefore increasing the landlord s tax bill by 473 even after the reduction is applied. Example: INCOME Existing Calculation Proposed Calculation Earned Income (Salary etc.) 35, , Rental Income 10, , COSTS Revenue Expenses (excl. finance costs) Loan Interest & Finance Costs 6, , Other Deductible Expenses ALLOWANCES & RELIEFS Personal Allowance 10, , Deductible Loan Interest 6, Loan Interest 'Reduction' (post-2020) N/A 1,200 INCOME TAX Taxable Income 28, ,150 Basic Rate - Due 5, , Higher Rate - Due Additional Rate - Due Total Tax Bill 5, ,

5 Effect of Budget (additional tax paid) N/A 473 TAX BANDS (2015/16) For ease of comparison tax bands for the year 2015/16 are used in all examples. Personal Allowance 10, , Basic Rate Limit 31, , Higher Rate Threshold 42, , Additional Rate Threshold 150, , The NLA does not believe that this falls within the scope of the objective outlined by the Treasury in it s explanatory notes accompanying the Finance Bill: This clause will ensure that landlords with higher incomes no longer receive the most generous tax treatment. To give landlords time to adjust the clause introduces this change gradually from the tax year over 4 years. 6 In this instance, and in relation to the estimated more than 130,000 landlords whose income may be pushed over the higher rate threshold by virtue of their turnover rather than profit, the effected individual is not classified as having a higher income at the present time. However, they will be in great danger of being treated as such by this new methodology despite benefiting from no real increase in income. Proposal: The NLA remains opposed to the withdrawal of finance cost tax relief, believing the policy to be an unjust attack on landlords businesses. However, if the Government is committed to introducing such a policy it is our desire to ensure that they are able to achieve their policy objective while subjecting private landlords to the minimal amount of financial detriment. As such we believe that the following alternative method of calculating landlords tax liabilities would enable HM Treasury to restrict relief to 20 per cent, without increasing the tax burden on those landlords who are not currently subject to marginal rates of personal taxation. The NLA believes that by retaining the existing system of deduction, and applying a levy to individuals who are higher or additional rate taxpayer (operative in a similar, but inverse, way to the proposed tax reduction) higher earning landlords would lose the marginal relief currently enjoyed while lower income landlords would not be forced into higher tax brackets. 6 Finance Bill 2015 Explanatory Notes Clauses 1-50, HM Treasury, July

6 Example 1: With Tax Reduction INCOME Basic Rate (low) Basic Rate (marginal) Higher Rate Earned Income (Salary etc.) 25, , , Rental Income 10, ,000 10, COSTS Revenue Expenses (excl. finance costs) Loan Interest & Finance Costs 6, , , Other Deductible Expenses ALLOWANCES & RELIEFS Personal Allowance 10, ,600 10, Deductible Loan Interest 6, Loan Interest 'Reduction' (post-2020) 1,200 1,200 1,200 INCOME TAX Taxable Income 23, , , Basic Rate - Due 4,630 6, , Higher Rate - Due , Additional Rate - Due Total Tax Bill 3, , , Effect of Budget (additional tax paid) , TAX BANDS (2015/16) For ease of comparison tax bands for the year 2015/16 are used in all examples. Personal Allowance 10, , Basic Rate Limit 31, , Higher Rate Threshold 42, , Additional Rate Threshold 150, ,

7 Example 2: With Tax Levy INCOME Basic Rate (low) Basic Rate (marginal) Higher Rate Earned Income (Salary etc.) 25, , , Rental Income 10, , , COSTS Revenue Expenses (excl. finance costs) Loan Interest & Finance Costs 6, , , Other Deductible Expenses ALLOWANCES & RELIEFS Personal Allowance 10, , , Deductible Loan Interest 6, , , Loan Interest 'Reduction' (post-2020) N/A N/A N/A INCOME TAX Taxable Income 17, , , Basic Rate - Due 3, , , Higher Rate - Due , Additional Rate - Due Tax Levy - Due ,200 Total Tax Bill 3, , , Difference (tax paid) from Finance Bill Difference (tax paid) from current system 0 0 1,200 TAX BANDS (2015/16) For ease of comparison tax bands for the year 2015/16 are used in all examples. Personal Allowance 10, , Basic Rate Limit 31, , Higher Rate Threshold 42, , Additional Rate Threshold 150, ,

8 As the above illustrates, those landlords who have an income in excess of the higher rate threshold would continue to lose any perceived tax advantage by means of adopting the proposed levy methodology therefore achieving the Government s objective of removing alleged advantage. However, those currently below the threshold would not find their incomes artificially inflated, thereby pushed above the marginal rate threshold. The effect of this is to ensure that (a) Their incomes are not disproportionately taxed (b) In being pushed into a higher tax band these individuals, and their households, do not lose associated benefits for instance Child Benefit. Although, this would still result in the increased taxation of private landlords to a level the NLA does not believe fair or equitable, this simple change to the method of calculation would remove the perceived imbalance whilst safeguarding the income of landlords with lower incomes. 8