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Written evidence submitted by Barry Fitzpatrick (FB 77)
Submission to the Public Committee on Clause 24 of the Finance Bill: regarding ‘Restricting Deductions for Finance Costs related to Residential Property’ announced in the Summer Budget.
1. My background:
I have been a L andlord for 8 years and have built up a small portfolio consisting of HMO Student let’s. I chose to do this as an alternative source of income in my retirement so as not to be dependent upon the State, where returns on traditional pension savings where dwindling rapidly, and threat to the burgeoning cost to the Government of providing the State pension becoming less & less sustainable .
My ability to have an independent income in retirement and not be a burden upon the State is now in jeopardy.
2. Summary of this submission :
This submission will demonstrate how this proposal :
a. fails to meet the Treasury Committee ’s own “Principles for Taxation Policy ” ,
b. is fundamentally unfair,
c. fails to “level the playing field”,
d. errors in the HMRC impact assessment,
e. fails to target accurately wealthy Landlords, and
f. could precipitate the destabilisation of the economy that the Bank of England has warned against
The ramifications of this proposed change will have a direct impact on a far greater number of Tenants as the type of Landlord so affected will own a disproportionately higher number of properties. The consequences on Tenants will be substantial rises in rent, and in some cases eviction. Worsening the already escalating homelessness figures.
3. The Treasury Committee produced a report “Principles of Taxation Policy” 2010-11 after considerable consultation and concluded the following principles that would form the framework for the determination of future taxation policy:
1. be fair.
2. support growth and encourage competition.
3. provide certainty.
Certainty about tax requires
i. legal clarity.
4. provide stability.
5. be practical
6. be coherent
3.1 The proposed tax change is fundamentally unfair as it introduces a horizontal inequity within the community of Landlords. Affected Landlords will be deemed Higher or Additional Rate taxpayers (and tax accordingly); and will be deemed on support profits which are not actually realised. The tax payable in many cases exceeding the actual profits made.
3.2 Many private Landlords have already put on hold their future plans which have previously stimulated builders into developing new homes, and severally disadvantages private Landlords versus the incorporated competitors who are unaffected by the proposed measures.
3.3 Private Landlords entered the rental business based upon the certainty that normal taxation of business principles would be applied i.e. tax would be based upon the actual profit made after full allowance has been for the expenses of generating that income (profit =revenue – all expenses including finance costs). Property being an illiquid asset and the rental business being a long term business is even more dependent on certainty than many other businesses. The tax changes is supposedly targeting at wealthy Landlords however, many wealthy Landlords do not have mortgages on their properties and therefore will be unaffected. However, many middle income Landlords currently only Basic Rate taxpayers will be deemed to be Higher Rate taxpayers and face effective rates of tax 70%+ and in a number of case s 100%+ despite still only having an income below the Higher Rate threshold. The effective rate of tax increases exponentially with any increases in interest rates (and therefore finance charges).
3.4 The Bank of England has warned about the threat to economic stability from the BTL sector. Whilst there will always be an interest rate above which a business with borrowings becomes unviable (which is the case for any business with borrowings ) increasing the tax burden will only lower the threshold at which a business become unviable, and if it falls within the realistic range that rates might rise to ; could precipitate the very instability that the Bank of England wants to avoid.
3.5 The proposed tax change lacks coherence, for centuries the core principle of tax of businesses has been the equation profit = revenues less expenses. The change exacerbates the inequality that private landlords with substantial incomes already pay tax at 40% or 45% on their profit versus incorporated Landlords who only pay 20% on the same profit. The automatic consequence of this inequality is that any additional expenses whether it is finance cost or any other cost reduces the tax payable by 40% or 45%. It is this fundamental inequality/incoherence that gives rise to the anomaly that this proposed measure seeks to address. If the income from private residential lettings where taxed at the same rate as incorporated Landlords then this inequality would not exist and there would be no grounds for this measure.
3.6 Michael Devereux, professor of taxation at Oxford University, has also commented that: ‘If you are trying to tax profit you have to give relief for the cost of earning it’. The Institute for Fiscal Studies, IFS, have stated that this proposal is “plain wrong”. There is a consensus among experts that the decision is wrong in principle
4. This proposed measure is fundamentally unfair because it taxes non-existent profits. It is retrospective in that it fundamentally change s the premise upon which Landlords entered in to the lettings business often several decades ago, and it results in effective rates of tax that not even millionaires have to pay and can result that tax is payable even though no profit or even a loss has been made.
4.1 For example a retiree has gross pension income of £10,600, gross rental revenue of £100,000 non finance expenses of £20,000 and mortgage interest of £60,000 his rental income is £20,000 which under current rules would be taxable at 20% resulting in a tax bill of £4,000, under the new rules (assuming all other things being equal), The ‘deemed’ profit would be £80,000 resulting in a tax bill of £13,643 – an increase of 341% and effective rate of tax on actual profit of 68%.
4.2 Furthermore a rise of just £5,000 interest charges to £65,000 would increase the effective rate of tax to 84% on a lower level of profit, and a rise in interest charges to £75,000 (resulting in an actual profit of £5,000) would be liable to £10,643 tax or an effective rate of 213%!
5. The measure is intended to “level the playing field” with first time buyer s /owner occupiers. The Institute for Fiscal Studies, IFS, has already stated that “rental property is taxed more heavily than owner occupied property”. Owner occupiers do not have to pay Capital Gains Tax, CGT, on sale of the property, couples can get up to £1 million relief from Inheritance Tax, IHT, have Help To Buy scheme assistance when buying, Help To Buy ISAs, and if taking in a lodger receive the first £7,000 of income tax free, and do not have to comply with the many laws relating to rental properties . The think tank, the Policy Exchange, confirmed this view noting that: ‘ In truth, the tax system massively favours home ownership ’. Institute of Economic Affairs said that the decision ” didn’t address the problems of supply and planning restrictions and that the reasoning behind the decision didn’t make sense.”
6. The impact assessment made by HMRC states that there will be no impact on Tenants, yet a survey by the Residential Landlords Association performed after the Budget announcement indicates that approximately 60% of Landlords intend to increase rent in order to fund this tax increase, and a significant number of Landlords will be selling up (and thereby evicting the Tenants) in order to sell with vacant possession. A Freedom of Information Request to HMRC said that that they didn’t know how many properties held by affected Landlords (and therefore Tenants and their families) would be impacted by these measures. HMRC estimated 330,000 Landlords will be affected by the proposal. On a pro-rata basis this would equate to about 1 million properties and about 2 million people. Most will face steeply rising rents starting immediately as Landlords spread the increase over the next 6 years, and a proportion will face eviction where local market condition s preclude significant rent rises forcing Landlords to sell up or in the case of Tenants on Housing Benefit to find Tenants able to afford the higher rents caused by the increase costs that Landlords will face.
7. The measure is purported to target only wealthy Landlords which is determined to be those Landlords who pay Higher Rate or Additional Rate Income Tax. However, the proposal first of all misses any Landlords who do not have a mortgaged rental property even though they may be Higher Rate/Additional Rate taxpayers, and secondly, it actually targets Basic Rate taxpayers which by excluding the finance costs in the determination of profit (even though it is still incurred) thereby inflating the rental profit and dragging the Basic Rate taxpayers in to the Higher Rate or even the Additional Rate tax bands. The measure does not affect Landlords where the properties are owned via a limited company even if the profits are far in excess of Higher/Additional Rates of Income Tax.
8. The Governor of the Bank of England, Mark Carney, has warned that the overheating in the BTL sector could pose a threat to economic stability. The most likely cause to precipitate this would be a mass sell off by Landlord’s which would only be likely due to a large and rapid increase in interest rates. As Lenders for many years have stress tested Landlords ability to pay the finance costs at rates of 6% or 7%, and require that the rent, at these interest rates, exceeds such repayments by 25%.
However, the imposition of a large increase tax cost substantially lowers the threshold at which a property becomes economically unviable, and therefore potentially could therefore precipitate the very destabilisation of the economy that the Governor has warned about.
8.1 the purchase of properties by BTL Landlords may well continue but through a limited company vehicle to avoid this tax, and will therefore only marginally slow the BTL sector and not help first time buyers.
8.2 the much talked about restrictions on the maximum LTV for BTL Landlords will have the same effect on the industry but without the ramifications Tenants.
The lack of consultation with the industry is blatantly apparent by the unfairness, the poor targeting, the lack of proper impact assessment, the creation of uncertainty and the threat to economic stability.
Whilst it is appreciated that the Government wishes solve the UK’s housing crisis, and to raise revenue for the Treasury . The proposal as it stands will have many unintended consequences which will have significant social and economic costs.
9.1 I would therefore urge the Committee to have this proposal put to wide- spread industry consultation so that it will be fair, properly targeted, maintain certainty, not risk economic stability and minimise unintended impacts on Tenants.
9.2 I would propose therefore that the Committee considers the following amendments :
9.2.1 restriction on tax relief would be applied only to new BTL property purchases ;
This would Avoid the unintended consequences detailed above, provide certainty for existing Landlords , and “cool” the BTL sector ;
9.2.2 assess if a Landlords income under current rules makes him a Basic Rate taxpayer and if that is the case not apply the restrict ion the tax relief on finance costs.
This would better target the wealthy Landlord’s as the Chancellor stated, and not unfairly target basic rate taxpayer Landlords.
9.2.2 consider a more general tax on profits of residential property rental irrespective of the ownership structure.
This would, potentially, generate more revenue for the Treasury, reduce the widening horizontal inequity in the tax system, and thereby reduce the opportunity for tax avoidance.
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