Restriction for finance costs on residential properties (except, furnished holiday letting and company) to the basic rate of Income Tax. (Finance costs include mortgage interest, interest on loans to buy furnishings and fees incurred). This was introduced gradually from 6 April 2017 to 5 April 2020. The only part of the loan interest eligible for relief is allowable as a deduction from income when calculating taxable property income in respect of residential properties.

Amount of interest allowable as a deduction in previous three years:

2017/18                        75%

2018/19                        50%

2019/20                        25%

2020/21                        0%

From 2020/21 no relief for loan interest will be given as a deduction from income in respect of residential property. Instead, interest is only eligible for basic rate tax relief.

Relief at basic rate (20%) is available on lower of:

1. the eligible interest
2. the property income for the year less property losses brought forward; or
3. adjusted total income (which is, net income less savings and dividend income less the personal allowance / alternatively, non-saving income less personal allowance).

If any amount of eligible interest has not received relief, is carried forward to the next year and is added to the amount of interest for that year.

Effect on taxpayer:

Basic rate taxpayer:

• This finance cost restriction can lead to increase in taxable rental profits can lead to an increase in your total income for tax purpose.
• If anyone was basic rate taxpayer and remain in basic rate taxpayer in 2020-21 and future year /onwards, no effect.
• This finance cost restriction can lead to basic rate taxpayers to becoming higher rate taxpayers which means to pay 40% tax on some of these profits and get relief only 20%. (Because the finance costs are disallowed which will increase profit).
• Tax liability depends on individual’s other income (salary, bonus, dividend etc.) and the amount of finance costs.
• if the landlord or partner claims child benefit and increases income above £50,000 then, Higher Income Child Benefit Charge will apply.

Higher or Additional rate taxpayer:

• This finance cost restriction can also lead to increase in taxable rental profits and increase the amount of profit falls in HR /AR.
• Some situation, Higher rate or additional rate taxpayer may end up paying tax more than their ‘real’ profit, it is possible that the overall tax rate on real profit could be more than 100%!!

It is possible that the overall effective rate of tax on the ‘real’ profit from the letting could be more than 100%, when the full amount of eligible loan interest only obtains relief at the basic rate.

For example:

Mr X is a 40% (higher rate) taxpayer, he has a two-bedroom rental property in London. He received rent £15,000 per year. In 2020-21 he paid repairs and other allowable expenses £2,000 and mortgage interest paid £10,000.

So, Mr X’s Real profit from the property is £3,000 (£15,000-£2,000-£10,000).

For tax purpose, he makes a rental profit in 2020/21 of £13,000 (£15000-£2000).

Tax: 13,000 @40%                                          £5,200

Less: Relief on finance cost 10,000 @20%         £2,000

Tax                                                                  £3,200

Mr X’s tax bill will be £3,200, which is higher than the real profit of £3,000. Which means Mr X ends up paying tax £200 from his own pocket NOT from the profit. So, (in some cases) an effective rate of tax (3200/3000)100% = 106.6%!

( https://www.gov.uk/guidance/changes-to-tax-relief-for-residential-landlords-how-its-worked-out-including-case-studies )

NAZALI TAX & LEGAL

info@nazali.com

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