Restriction of tax relief on mortgage interest – section 24

Background

In his budget on 8th July 2015, the then chancellor George Osbourne, announced a measure to restrict the tax relief on finance costs (including mortgage interest and bank charges) to 20%, for individuals. Incorporated into Section 24 of the Finance (no. 2) Act 2015, the measure has had a major impact on landlords and new investors alike.

As a result, one of the most common questions we get asked is, can I still claim mortgage interest? The answer is :-

• if you are a basic rate taxpayer, you still get full tax relief, provided that your total income before deducting any finance costs does not take you into the higher rate of tax.
• If you are a higher rate or top rate taxpayer, you still get tax relief but this is restricted to 20% of the interest and is given as a tax credit.

So how does the measure work?

Example:

£15,000 rental income

£5,000 mortgage interest costs

£2,000 other costs

= £8,000 profit

The taxable profit is £13,000 (£15,000 rental income less other costs £2,000). This profit is then taxed at your marginal rate of tax. The £5,000 finance costs are then deducted from the tax liability at 20% (£5,000 at 20% = £1,000)

So the tax liability in each case is…

Basic rate taxpayer:

20% tax on £13,000 profit = £2,600

Minus £1,000 finance cost deduction 

= £1,600 tax to pay (which is 20% of the net profit of £8,000, so the same as if the finance costs had been allowed in full)

Higher rate taxpayer:

40% tax on £13,000 profit = £5,200

Minus £1,000 finance cost deduction

= £4,200 tax to pay (which is 52.5% of the net profit of £8,000, so 12.5% more than if the finance costs had been allowed in full)

Additional rate taxpayer:

45% tax on £13,000 profit = £5,850

Minus £1,000 finance cost deduction

= £4,850 tax to pay (which is 60.625% of the net profit of £8,000, so 15.625% more than if the finance costs had been allowed in full)

You will notice that the basic rate taxpayer is not affected but Section 24. The higher rate taxpayer, however, ends up paying £1,000 more and the top rate taxpayer £1250 more than if the interest had been allowed in full.

But this doesn’t mean that the basic rate taxpayer is necessarily unaffected. Because the deduction is applied after calculating the taxable profit, everyone’s “profit” has actually increased — from £8,000 to £13,000. So, people whose income (from property plus employment and any other sources) is currently below the higher rate threshold may end up getting pulled into the higher rate band as a result of their higher property “profits”.

What can you do about it? 

The starting point should always be to work out the effect that the change has had on your tax position. In many cases, the effect is actually quite small and does not warrant any further action especially when taking into consideration factors such as the one off costs of a restructure.

Following on from this you could look at the following :-

1. Do nothing. If the changes result in only a minor increase in costs, the chances are that it will not be worthwhile doing anything.

2. Sell some or all of your properties and re-invest the proceeds into a limited company property structure. You will need to consider any capital gains tax as a result.

3. If you are married or in a civil partnership and one of you is a lower rate taxpayer, consider a transfer of the beneficial ownership into the name of the lower rate partner.

4. Consider a transfer of the properties into a limited company or an LLP (Limited Liability Partnership). There has been much written about this. The important things to bear in mind are that you need to consider the following:-

Finance costs

What are the re-finance costs of transferring ownership to a limited company.

Apart from the costs of refinancing such as arrangement fees and higher interest rates, this is a topic which generates a lot of discussion. Mostly, this is centred around the use of a declaration of trust to transfer the beneficial ownership to the limited company.

We strongly advise that if you are contemplating this that you speak to any lender/mortgage provider in situ first and seek clearance from them to the extent that they are happy to accept such a transfer, and not just the word of any so called expert/ tax adviser.

If you have signed terms and conditions with a lender any variation should be with the agreement of the lender. Do NOT be persuaded by anyone who tells you that there is no need to involve the lender.

Our advice, if this is what you have been told, is to ask the adviser to get clearance in any case. After all if there is no problem with what they are proposing, surely the lender will not object! It is your name on the mortgage offer so you need to be confident that you are not breaking the terms, don’t you?

Capital gains tax

Any transfer from yourself to a limited company will need to be looked at from a capital gains tax perspective. A transfer from you to a limited company, even one that is owned entirely by you, is regarded as a sale at market value.

Stamp duty land tax

A transfer from yourself to a limited company will attract SDLT payable by the limited company.

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