The amount of income tax relief landlords can get on residential property finance costs will be restricted to the basic rate of income tax. Landlords will no longer be able to deduct all of their finance costs from their property income. They will instead receive a basic rate reduction from their income tax liability for their finance costs.
The restriction in the relief will be phased in as follows:
- in 2017/18, the deduction from property income will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate tax reduction;
- in 2018/19, 50% finance costs deduction and 50% given as a basic rate tax reduction;
- in 2019/20, 25% finance costs deduction and 75% given as a basic rate tax reduction;
- from 2020/21, all financing costs incurred by a landlord will be given as a basic rate tax reduction.
These rules do not apply in relation to calculating the profits of a property business for the purposes of charging a company to income tax on so much of those profits as accrue to it otherwise than in a fiduciary or representative capacity.
The restriction applies to 'the costs of a dwelling-related loan', namely the amount borrowed for purposes of the business that is referable, on a just and reasonable basis, to a business carried on for the purpose of generating income from land consisting of a dwelling-house or part, or an estate, interest or right in or over land which is a dwelling-house. This includes building the relevant property but does not apply to furnished holiday lettings.
Costs include interest or any economic equivalent or incidental costs of obtaining finance by means of the loan.
Basic rate relief
If, for a tax year, an individual has a relievable amount in respect of a property business, or two or more relievable amounts each in respect of a different property business, they are entitled to relief. An individual has such an amount if, for that year, the individual has a current-year amount, a current-year estate amount and/or a brought-forward amount.
An individual's relievable amount for a tax year in respect of a property business is the total of:
- the individual's current-year amount (if any) for that year in respect of that business;
- the individual's current-year estate amounts (if any) for that year in respect of that business; and
- the individual's brought-forward amount (if any) for that year in respect of that business.
An individual has a current-year amount for a tax year in respect of a property business if an amount (A) would be deductible in calculating the profits for income tax purposes of that business for that year but for the new rules, the individual is liable to income tax on a percentage of those profits and that liability is not under Chapter 6 Part 5 ITTOIA 2005 (estate income). (new s274A ITTOIA 2005)
An individual has a current-year estate amount for a tax year ('the current year') in respect of a property business and a particular deceased person's estate if:
- an amount (A) would be deductible in calculating the profits for income tax purposes of that business for that year but for the new rules, whether that year is the current year or an earlier tax year:
- the personal representatives of the deceased person are liable to income tax on a percentage of those profits (N%);
- the individual is liable for income tax on estate income treated under Chapter 6 Part 5 ITTOIA 2005 as arising in the current year from an interest in the estate, and
- the basic amount of that estate income consists of, or includes, an amount representative of E% of the personal representatives' N% of the profits of the business for the profits year;
in which event the individual's current-year estate amount for the current tax year, in respect of that business and estate and the profits year, is equal to E% of N% of A.
Where a relievable amount is greater than the actual amount on which relief for the year is to be given in respect of the relievable amount, the difference is the individual's brought-forward amount for the following tax year in respect of the property business concerned (new s274AA(4) ITTOIA 2005).
Reduction for individuals - calculation
In respect of a relievable amount, the actual amount on which relief for the year is to be given is 'L', L being the lower of:
- the relievable amount; and
- the total of:
- the profits for income tax purposes of the property business concerned for the year after any deduction for property losses brought forward ('the adjusted profits') or, if less, the share of the adjusted profits on which the individual is liable to income tax other than under Chapter 6 Part 5 ITTOIA 2005; and
- so much of the relievable amount that consists of current-year estate amounts. new s274AA(2) ITTOIA 2005
If S is greater than the individual's adjusted total income for the year (ATI), the actual amount on which relief for the year is to be given in respect of a relievable amount is ATI/S x L where S is the total obtained by identifying the amount that is L for each relievable amount and then finding the total of the amounts identified and L has the same meaning as above.
'Adjusted total income' for a tax year is identified as follows:
Step 1 - identify the individual's net income for the year (per Step 2 s23 ITA 2007);
Step 2 - exclude from that net income so much of it as is within s18(3) or (4) ITA 2007 (income from savings) or is dividend income;
Step 3 - reduce the remainder by the amount of any allowances deducted for the year in the individual's case at Step 3 s23 ITA 2007. The result is the individual's adjusted total income for the year.
Reduction for accumulated or discretionary trust income - entitlement
Similar rules apply to the trustees where the property business profits are classed as accumulated or discretionary income per s480 ITA 2007.
Clearly, these changes are significant and will affect a number of clients, so it is worth making sure that they are fully aware of the changes as soon as possible. To help you communicate these changes to your clients, we have prepared a client letter. For more details, visit our website.