NLA 2016 Autumn Statement Submission October 2016 About the NLA The National Landlords Association (NLA) is the UK s leading organisation for private-residential landlords. We work with 70,000 landlords (including over 31,000 paying members), ranging from full-time landlords with large portfolios to those with just a single letting. NLA membership helps landlords achieve business success 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 giving a collective voice to landlords in the media. We seek to raise standards in the private-rented sector (PRS) while aiming to ensure that landlords are aware of their statutory rights and responsibilities.
Background The PRS is the UK s second-largest tenure, serving 19 per cent (4.4 million) 1[ of households and comprising property valued at 1.3 trillion (up 55 per cent in five years) 2[2] owned by an estimated 2 million private landlords. The sector is subject to relatively low gearing, with approximately 188 billion 3] of outstanding buy-to-let (BTL) finance by the end of 2014 and an indeterminate amount of commercial lending. BTL mortgages, those specifically intended for the purchase, or refinancing, of residential property for the purpose of running a lettings business, account for approximately 15 per cent of all mortgage lending in the UK. 4[ Summary Our Autumn Statement submission concerns: Finance cost relief (section 24 of the Finance (No. 2) Act 2015 ) Stamp Duty Land Tax levy. We will express our views on the impact of these policies and put forward possible mitigation strategies for any unintended consequences. There is an increasing body of evidence to suggest that these policies will: increase tenants rents increase the likelihood of tenants falling into arrears increase the number of evictions reduce the number of affordable rental properties available to tenants. As a consequence of these changes, we have already seen landlords increase rents and serve notice on tenants because they intend to sell their properties. We do not 1 English Housing Survey Headline Report 2014 15, Department for Communities and Local Government, February 2016 2 Savills, January 2016 3 Council of Mortgage Lenders, December 2014 4 Council of Mortgage Lenders, April 2015
believe this was the original intention of these policies, which are effectively a Tenant Tax, and we call for a rethink. Finance cost relief (section 24 of the Finance (No. 2) Act) Section 24 of the Finance (No. 2) Act 2015 aims to remove landlords ability to deduct from taxable income their finance costs related to residential property and replace this relief with a tax reduction equivalent to the basic rate of Income Tax. In practice, this will result in landlords whose income exceeds the upper threshold of the basic rate being taxed on a significant portion of their turnover, rather than on their profit. When the full details of this change emerged, many landlords realised that if they were to remain in business, they would be paying an effective tax rate of over 200 per cent. We cite some examples below. In the cases of Sarah and Ian, these are effective tax rates of 109 and 265 per cent, respectively. The Department for Communities and Local Government is currently chairing a working group entitled Affordability and Security within the PRS. Everyone in this group, including Shelter and Generation Rent, who originally backed the proposals, increasingly accept that the overwhelming body of evidence proves that these changes will see an increased risk of some or all of the following: higher rents tenant arrears
evictions lack of supply. The issue The Treasury s objective is to ensure that higher-earning landlords do not enjoy greater tax advantage from reduced finance costs at the higher and additional rate of Income Tax. However, this fails to recognise that most private landlords have an income within the basic rate, but a significant proportion would be pushed into a higher tax bracket by the proposed change to the income calculation. Approximately 136,000 landlords currently have an income in excess of 30,000 but 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. This provides appropriate tax relief and ensures that turnover does not push income into a higher tax bracket. The proposed policy will result in the following formula: 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. Using this higher income figure (which includes the full cost of servicing finance) potentially pushes a landlord s income into a higher tax bracket. Once a landlord s tax liability has been ascertained using this formula, a tax reduction (*) is applied. This is equivalent to the basic rate of Income Tax and is intended to provide relief not exceeding that available to basic rate taxpayers. Example
A landlord earning a pre-salary of 35,000 and with a gross rental income of 10,000 per year is currently a basic rate taxpayer as only their rental profit is considered for tax purposes. As a result of the proposed changes, the landlord will not be permitted to deduct the cost of interest on finance from their income. This means that their taxable income will increase by 6,000 per year, exceeding the higher rate threshold and increasing the landlord s tax bill by 473 even after the tax reduction is applied. 5 We do not believe that this falls within the scope of the objective outlined by the Treasury in its explanatory notes accompanying the Finance Act: 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 2017 18 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. Recommendations 1. Remove section 24 from the Finance (No. 2) Act 2015 Ideally, we would like to see the complete removal of section 24 from the Finance Act on the basis that it will lead to increased housing costs during an affordability crisis. Mortgage interest and associated costs are legitimate revenue expenses that should be deducted from income prior to calculating tax liability. This is the case in other areas of business and there is no credible justification for removing this ability from private landlords. To remove tax relief from private landlords in this manner will jeopardise their businesses and put the affordability of housing at risk in many parts of the UK. 5 For a full briefing and full workings please go to: www.landlords.org.uk/sites/default/files/finance%20bill%202015-16%20%20- %20%20Calculating%20Income%20Tax%20-%20Sept%202015_1.pdf 6 Finance Act 2015, explanatory notes, clauses 1 50, HM Treasury, July 2015
We remain vehemently opposed to the withdrawal of finance cost tax relief and believe the policy to be an unjust attack on landlords businesses. However, in the event that the government is still committed to this policy (against all the advice and weight of evidence from the industry and key stakeholders), then we strongly urge the Chancellor of the Exchequer to consider an amendment to ensure that the government is able to achieve its policy objective while subjecting private landlords to the minimal amount of financial detriment. We believe that by retaining the existing system of deduction and applying a levy to individuals who are higher or additional rate taxpayers (operative in a similar, but inverse, way to the proposed tax reduction), higher-earning landlords would lose the marginal relief they currently enjoy, while lower-income landlords would not be forced into higher tax brackets. We believe that the following alternative method of calculating landlords tax liabilities would enable the 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. Example 1: With tax reduction Basic rate (low) Basic rate (marginal) Higher rate Income Earned income (salary etc.) 25,000 35,000 50,000 Rental income 10,000 10,000 10,000 Costs Revenue expenses (excl. finance costs) 750 750 750 Loan interest and finance costs 6000 6000 6000 Other deductible expenses 500 500 500 Allowances and reliefs Personal allowance 10,600 10,600 10,600 Deductible loan interest 6000 0 0 Loan interest reduction (post-2020) 1200 1200 1200 Income Tax Taxable income 23,150 33,150 48,150
Basic rate due 4630 6357 6375 Higher rate due 0 546 6546 Additional rate due 0 0 0 Total tax bill 3430 5703 11,721 Effect of budget (additional tax paid) 0 273 1200 Tax bands (2015/16) For ease of comparison, tax bands for the year 2015/16 are used in all examples Personal allowance 10,600 10,600 Basic rate limit 31,785 31,785 Higher rate threshold 42,385 42,385 Additional rate threshold 150,000 150,000 Example 2: With tax levy Income Basic rate (low) Basic rate (marginal) Higher rate Earned income (salary etc.) 25,000 35,000 50,000 Rental income 10,000 10,000 10,000 Costs Revenue expenses (excl. finance costs) 750 750 750 Loan interest and finance costs 6000 6000 6000 Other deductible expenses 500 500 500 Allowances and reliefs Personal allowance 10,600 10,600 10,600 Deductible loan interest 6000 6000 6000 Loan interest reduction (post-2020) N/A N/A N/A Income Tax Taxable income 17,150 28,150 42,150 Basic rate due 3430 5630 6375 Higher rate due 0 0 4146 Additional rate due 0 0 0 Tax levy due 0 0 1200 Total tax bill 3430 5630 11,721
Difference (tax paid) from Finance Bill 0-73 0 Difference (tax paid) from current system 0 0 1200 Tax bands (2015/16) For ease of comparison, tax bands for the year 2015/16 are used in all examples Personal allowance 10,600 10,600 Basic rate limit 31,785 31,785 Higher rate threshold 42,385 42,385 Additional rate threshold 150,000 150,000 This proposed levy method would mean that landlords whose income exceeds the higher rate threshold would continue to lose any perceived tax advantage. This would meet the government s objective of removing alleged advantage. At the same time, landlords currently below the threshold would not find their incomes artificially inflated and pushed above the marginal rate threshold. This would ensure that: their incomes are not disproportionately taxed they do not lose associated benefits, such as Child Benefit. Although this would still result in the increased taxation of private landlords to a level that we do not believe to be fair or equitable, this simple change to the method of calculation would remove the perceived imbalance while safeguarding the income of landlords with lower incomes. 2. Amend section 24 to apply only to finance written after April 2017 Landlords, and financial institutions with an interest in rental property, plan their involvement in the PRS based on an informed assessment of their likely returns. Section 24 will significantly alter the possible returns available to landlords reliant on secured finance. Likewise, lenders assess the viability of applications for finance (primarily BTL mortgages) on the basis of minimum rental cover. Typically, a landlord will be required to demonstrate that the achievable rent will exceed 125 per cent of a nominal interest rate applied to the principle. It is very likely that the reaction of the majority of lenders in this marketplace will be to increase the minimum rental cover
requirements considerably. This would restrict lending in lower-yield areas and those where rent levels are less robust. If government were to restrict the scope of this policy to new finance, applied for after its implementation, alleged competition between future owner-occupiers and landlords would be reduced without causing financial detriment to landlords or lenders already committed to particular investments or assets. 3. Provide a tax-efficient means for landlords to restructure their portfolios The government can also mitigate the impact of section 24 by providing a taxefficient means for landlords to restructure their portfolios, thereby reducing the effect the policy is likely to have on housing costs. If landlords ability to deduct from taxable income their finance costs related to residential property is restricted in the manner described by section 24 of Finance (No. 2) Act 2015, it is likely that: a small but significant proportion of landlords will find their business plans are no longer viable, precipitating a need to dispose of some or all of their portfolio a larger proportion of landlords will need to restructure their portfolios to account for the reduced tax efficiency of private residential property in relation to lettings previously unincorporated but committed landlords will seek to professionalise their business by transferring assets into a limited company. However, it is quite likely that some landlords will find themselves unable to dispose of property efficiently, or in manner that is sufficiently cost-effective to enable their business to remain viable. We, therefore, propose several measures that would facilitate the restructuring of private portfolios and ease the transfer of stock between tenures, without substantially reducing the Exchequer s income. Residential Estate Investment Trusts (REITs) The government should explore ways in which it can both incentivise and promote the benefits of REITs to private landlords as a method of allowing them to invest in private residential housing in a tax-efficient way, while leaving the management of the properties to professionals. Capital Gains Tax (CGT) taper
Introducing a CGT taper would facilitate the disposal of poorly performing property. When surveyed, 10 per cent of our members suggested they would sell their properties and leave the PRS. However, in a later survey of 977 private landlords, 35 per cent said they had delayed selling property because of the implications of CGT and 29 per cent added that they feel unable to retire because of the CGT they will have to pay. 7 We believe that this situation benefits no one: property is retained by landlords who would rather release the equity they have built up, and the wider economy suffers because this money cannot be spent. Furthermore, as the effect of this proposal becomes apparent, landlords who would otherwise prefer to sell will have fewer available funds to invest in existing property, thereby increasing the risk of cumulative disrepair and falling standards in the PRS. During the last 25 years of investment in the PRS, during which time the sector has grown from around 8 to 19 per cent of households, there has been significant house price growth and some landlords have experienced substantial gains. Using the figures collated by the Nationwide Building Society 8 it is evident that landlords who have held residential property for a number of years are likely to have a significant CGT liability. Of those landlords with finance whose income currently exceeds the basic rate threshold, we estimate that approximately 20,497 will seek to dispose of their portfolios directly as a result of this policy. Assuming a typical portfolio containing 5.2 mortgaged properties, we estimate: - gains of approximately 239,292 - a CGT bill of 63,894 (after deduction of the annual tax free allowance and assuming a 28 per cent rate of CGT). Across all 20,497 landlords seeking disposal, this equals 1,309,631,628. The manner in which CGT is currently applied fails to recognise the difference between landlords long-term holding of property as a business asset and short-term speculative trading. Throughout the lifetime of a property investment, a landlord will 7 NLA Q2 2015 Landlord Panel 8 Nationwide House Price Index, Nationwide Building Society, Q1 2015
contribute significantly to the Exchequer, and even more so following the restriction of this relief. This differentiates their activity from that of short-term trading. We, therefore, believe that a taper should be introduced, proportionate to the time a property has been held. This would avert the potential issues related to landlords unable to sell. The taper would only apply to property held for at least five years and would increase in generosity to a minimum CGT liability of 50 per cent for property held for at least 10 years. Time property held Proposed taper 10 years 50% 9 years 40% 8 years 30% 7 years 20% 6 years 10% 5 years 5% <5 years 0% This means that a landlord selling a property bought three years ago would pay CGT on 100 per cent of any gains made (after deductions), whereas a landlord selling a similar property after nine years would pay 60 per cent of the relevant gain. Additionally, when the increased revenue derived from restriction of finance costs relief and the Stamp Duty Land Tax (SDLT) income from purchasers, such a taper would not represent a significant shortfall for the Exchequer. If the 20,497 landlords were motivated to sell, around 106,583 properties would be released to the market, valued at approximately 17,053,266,432 (assuming typical property values and portfolio holdings). Approximating the split between newly acquired and property held for a longer period (see appendix 2 for breakdown), this would release an estimated gain of 4,904,772,275, resulting in a post-taper tax revenue in the region of 765,698,969.
These properties would be free to be purchased by other landlords looking to expand their portfolios, and taking into account the new fiscal environment, or by owneroccupiers purchasing a new home. This would generate upwards of 74,608,041 of SDLT revenue. From 2020, we estimate that the restriction of finance cost relief will generate an additional 858,199,985 per year in Income Tax revenue. Motivating 10 per cent of landlords to sell would reduce this by a potential 85,819,996 to 772,379,987. Nonetheless, even after the reduction created by introducing a taper is taken into account, the Exchequer will stand to increase revenue by 765,698,969. Summary of CGT taper in numbers CGT revenue: 765,698,969 SDLT revenue: 74,608,041 Reduction in Income Tax from exiting landlords: 85,819,996 Stimulated revenue (excluding added benefits of increased economic activity): 754,487,015 4. Extend business asset rollover relief to allow restructuring of portfolios A landlord whose portfolio is leveraged is likely to maintain relatively high gearing in order to maximise their Income Tax efficiency. However, the changes encapsulated in section 24 greatly reduce this efficiency and may necessitate the restructuring of their portfolio to reduce its size, thereby reinvesting equity in remaining stock. This will reduce the landlord s gearing and subsequently their exposure to this change. Unfortunately, the existing CGT mechanism discourages landlords from selling property in order to reinvest. Unlike many other businesses, landlords are unable to take advantage of the business asset rollover relief. Rollover relief is explained by the Taxation of Chargeable Gains Act 1992: If the consideration which a person carrying on a trade obtains for the disposal of, or of his interest in, assets ( the old assets ) used, and used only, for the purposes of the trade throughout the period of ownership is applied by him in acquiring other assets, or an interest in other assets ( the new assets ) which on the acquisition are taken into use, and used only, for the purposes of the trade, and the old assets and new assets are within the classes of assets listed in section 155, then the person carrying on the trade shall, on making a
claim as respects the consideration which has been so applied, be treated for the purposes of this Act (a) as if the consideration for the disposal of, or of the interest in, the old assets were (if otherwise of a greater amount or value) of such amount as would secure that on the disposal neither a gain nor a loss accrues to him, and (b) as if the amount or value of the consideration for the acquisition of, or of the interest in, the new assets were reduced by the excess of the amount or value of the actual consideration for the disposal of, or of the interest in, the old assets over the amount of the consideration which he is treated as receiving under paragraph (a) above, but neither paragraph (a) nor paragraph (b) above shall affect the treatment for the purposes of this Act of the other party to the transaction involving the old assets, or of the other party to the transaction involving the new assets. 9 As rental income is considered to be unearned, and consequently not by means of trading activity (defined by the Income Tax Act 2007), landlords may not defer their CGT liability when disposing of assets to invest in new or existing rental property. We believe that extending business asset rollover relief to the sale of residential property, used exclusively for the purposes of a lettings business, would: - facilitate the sale of property and greater mobility between tenures - allow landlords to reduce the gearing of their portfolios, thereby protecting against market shocks and improving stability - mitigate the impact of the policies outlines in section 24Finance (No. 2) Act 2015, thereby reducing the inflationary impact on rent levels. 9 Taxation of Chargeable Gains Act 1992, section 152
5. Remove barriers to incorporation Some private landlords operate their lettings in a fashion closely aligned to investment activity, delegating management responsibility to a professional third party and spending little time actively managing their lettings portfolios. However, a significant proportion of private landlords run a lettings business as either their sole or secondary occupation. It is, therefore, inappropriate that the income derived from this activity be considered unearned and thereby excluded from various provisions aimed at facilitating business stability and growth. Until recently, a large proportion of portfolio landlords have opted not to incorporate their businesses for tax-efficiency purposes. It is likely that section 24 will alter the balance of costs and benefits for many landlords, incentivising the incorporation of their businesses. The incorporation of a larger volume of lettings businesses would appear beneficial to the government s objective of improving the professionalism and visibility of private landlords, as well as fuelling the growth of small business. However, the transition of a portfolio from privately held to enveloped in a limited company has many financial barriers and a distinct lack of statutory certainty. In order to remove the financial barriers to incorporation, statute should provide certainty for landlords with a pre-existing portfolio that incorporation relief will be available provided that certain appropriate trading criteria are met. As the contradictory tribunal cases of Ramsay v HMRC (2012) and (2013) demonstrate, there is little clarity concerning this matter, primarily because no statutory definition of business exists for CGT purposes. We believe that defining what level of activity constitutes a business for this purpose could: remove uncertainty from the market make a clear distinction between investment and letting by way of business better motivate landlords to assume appropriate tax structures. Stamp Duty Land Tax levy The SDLT levy on the purchase of additional properties was introduced against a backdrop of restricting landlords, and second home purchasers, from competing with
owner-occupiers when acquiring property. As such, it was intended as a lever to facilitate increased owner-occupation. However, it failed to take into account the impact that significantly reducing investors ability to purchase property has on the wider housing market and affordability therein. Reducing the ability of private landlords and larger investors to make new acquisitions of land or property inhibits the construction of additional stock. On a small scale, this equates to removing long-lead investment from new sites as the need to commit off-plan more than six months before expected completion prevents owner-occupiers from purchasing initial releases at most sites. It is only the willingness and ability of private landlords and investors to effectively underwrite initial construction that enables many small to medium developments to break ground. This in turn reduces supply in the wider marketplace and drives up prices for potential purchasers. Further downstream, the SDLT levy, combined with the Income Tax relief changes and the Prudential Regulation Authority s recent confirmation of its intention to tighten underwriting standards in BTL, will mean that landlords are far less able to finance and therefore invest in additional property. This will further limit supply relative to demand. We would like to see the SDLT levy suspended while a comprehensive review of the impact of the policy is conducted. Conclusion In conclusion, the tax changes introduced by the previous chancellor in 2015 threaten to seriously destabilise the private rented sector in a way that was not foreseen at the time. Such diverse groups such as Shelter, Generation Rent, RICS and Landlords are all in agreement that unless changes are made, tenants will most likely feel the brunt of these changes.