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8:42 AM, 24th October 2017, About 6 years ago 39
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The following article is credited to Ross Martin, a firm which provides “practical tax resources for accountants and advisers” and has been copied verbatim from their website.
HMRC appears to have changed its long held views on the availability of tax relief on interest charged on new borrowings by property business owners who remortgage their property to withdraw capital from their business.
If this is a genuine change it may well impact on thousands of buy-to-let owners.
It is unclear is this is a policy change or an accidental error during the re-write of their Property Income manual (PIM) following the April 2017 Restrictions on Mortgage Interest Relief.
Historically, the rules, and examples, have regarded withdrawal of capital as being for the purposes of the trade since rental income became subject to the same accounting principles as trading businesses (2005/06). This was covered by the trade press in 2005. ICAEW guidance still reflects the position as it was understood prior to HMRC’s changes
HMRC’s old PIM guidance
HMRC’s previous PIM guidance to landlords who wish to remortgage their letting property was as follows:
HMRC guidance @ 31/12/2016 (it is unclear when this was changed)
|
Using HMRC’s old guidance, and assuming that you always withdrew all your rental profits as drawings, the balance sheet would be as follows:
| 3 years ago
£ |
Today
£ |
|
| Property original cost | 120,000 | |
| Property revalued | 150,000 | |
| Mortgage | (90,000) | |
| Mortgage | (115,000) | |
| Net assets | 30,000 | 35,000 |
| Represented by: | ||
| Owners’ capital account B/f | 30,000 | 30,000 |
| Revaluation reserve | 30,000 | |
| Less: capital withdrawn | (25,000) | |
| Total | 30,000 | 35,000 |
If you increased the mortgage to £125,000, your balance sheet would be:
| 3 years ago
£ |
Today
£ |
|
| Property original cost | 120,000 | |
| Property revalued | 150,000 | |
| Mortgage | (90,000) | |
| Mortgage | (125,000) | |
| Net assets | 30,000 | 25,000 |
| Represented by: | ||
| Owners’ capital account b/f | 30,000 | 30,000 |
| Revaluation reserve | 30,000 | |
| Less: capital withdrawn | (35,000) | |
| Total | 30,000 | 25,000 |
HMRC’s New Property Income guidance
| HMRC Property income @ ? 2017
If you increase your mortgage loan on your buy-to-let property you may be able to treat interest on the additional loan as a revenue expense, as long as the additional loan is wholly and exclusively for the purposes of the letting business. Interest on any additional borrowing above the capital value of the property when it was brought into your letting business isn’t tax deductible. |
If we take the old example and combine it with the new guidance, the additional interest charged on the increased borrowing of £35,000 would only be tax deductible if the funds from the new loan are used wholly and exclusively for the purposes of the letting business.
When and why?
HMRC appears to have changed its views as part of the re-write of its Property income manuals following the Restriction in Mortgage Interest Relief (subscriber version) rules that apply from 6 April 2017.
The updates section of the Property Income Manual fails to note when the changes were made.
There are no changes to tax relief for companies, loan interest relief for corporates remains is via the Loan Relationship Rules.
Confusingly, HMRC’s Business Income Manual (para BIM45700) provides a slightly different version of the rules.
| HMRC BIM45700 example 2 (18/10/2017)
A proprietor of a business may withdraw the profits of the business and the capital they have introduced to the business, even though substitute funding then has to be provided by interest bearing loans. The interest payable on the loans is an allowable deduction. This is on the basis that the purpose of the additional borrowing is to provide working capital for the business. There will, though, be an interest restriction if the proprietor’s capital account becomes overdrawn. Example 2 Mr A owns a flat in central London, which he bought ten years ago for £125,000. He has a mortgage of £80,000 on the property. He has been offered a job in Holland and is moving there to live and work. He intends to come back to the UK at some time. He decides to keep his flat and rent it out while he is away. His London flat now has a market value of £375,000. He renegotiates his mortgage on the flat to convert it to a buy to let mortgage and borrows a further £125,000. He withdraws the £125,000, which he then uses to buy a flat in Rotterdam. Although he has withdrawn capital from the business, the interest on the mortgage loan is allowable in full because it is funding the transfer of the property to the business at its open market value at the time the business started. The capital account is not overdrawn. The opening balance sheet of his rental business shows:
The balance sheet at the end of Year 1 shows:
|
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What does the legislation say?
Tax relief for business interest is given by s34 ITTOIA 2005, the rules apply for letting business, however since April 6 2017, there is a restriction in relief for higher earners.
S34 Expenses not wholly and exclusively for trade and unconnected losses
(1) In calculating the profits of a trade, no deduction is allowed for—
(a) expenses not incurred wholly and exclusively for the purposes of the trade, or
(b) losses not connected with or arising out of the trade.
(2) If an expense is incurred for more than one purpose, this section does not prohibit a deduction for any identifiable part or identifiable proportion of the expense which is incurred wholly and exclusively for the purposes of the trade.
Business income example v old property income example
The BIM example illustrates the withdrawal of capital before the rental business commences.
The old PIM example showed withdrawal of capital whilst the rental business was continuing.
EDITORS NOTE
It is very naughty that they have changed the wording of their internal manuals without any corresponding change in legislation, particularly as they have not dated the change. I have put the text highlighting the ambiguity in regards to the change in bold, red italics below.
HMRC Property income @ ? 2017
If you increase your mortgage loan on your buy-to-let property you may be able to treat interest on the additional loan as a revenue expense, as long as the additional loan is wholly and exclusively for the purposes of the letting business.
Interest on any additional borrowing above the capital value of the property when it was brought into your letting business isn’t tax deductible.
The question now is; what does “as long as the additional loan is wholly and exclusively for the purposes of the letting business”.
Show Book a Tax Planning ConsultationIt appears the latest update to HMRC’s manual which has caused confusion is indeed mistake and will hopefully be rectified in due course. HMRC also have Guidance Notes HERE which includes a section which reads as follows:
If you increase your mortgage loan on your buy-to-let property you may be able to treat interest on the additional loan as a revenue expense, as long as the additional loan is wholly and exclusively for the purposes of the letting business.
Interest on any additional borrowing above the capital value of the property when it was brought into your letting business isn’t tax deductible.
If the mortgage is for a residential property then the restrictions on interest from April 2017 will apply.
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Richard U
11:12 AM, 24th October 2017, About 6 years ago
This is interesting, thanks for highlighting the incongruous actions of the HMRC - do you believe this impacts people outside a limited company?
Mark Alexander - Founder of Property118
11:14 AM, 24th October 2017, About 6 years ago
Reply to the comment left by Richard U at 24/10/2017 - 11:12
It ONLY impacts people who are unincorporated
Puzzler
17:28 PM, 24th October 2017, About 6 years ago
I am not an expert but I believe this is just clarification, further borrowing was always only tax deductible if used to propagate the lettings business and not for any other. I looked into it a while back.
Mark Alexander - Founder of Property118
17:30 PM, 24th October 2017, About 6 years ago
Reply to the comment left by Puzzler at 24/10/2017 - 17:28
No that's not the case. It has always been further borrowing over and above base cost previously, as explained in the main article
Alison King
0:00 AM, 25th October 2017, About 6 years ago
So what about remortgaging property held as an individual in order to provide a directors loan to set up a property related company? Or what if you remortgage with the intention of buying and then can't find anything? Or invest it in a peer lending property scheme? It's vet confusing.
Mark Alexander - Founder of Property118
7:40 AM, 25th October 2017, About 6 years ago
Reply to the comment left by Alison King at 25/10/2017 - 00:00
We can but hope the ambiguity will be corrected.
Puzzler
13:04 PM, 26th October 2017, About 6 years ago
Reply to the comment left by Mark Alexander at 24/10/2017 - 17:30
Hi Mark, are we at cross purposes? Advice I received a couple of years ago was that if you borrow further than the original purchase price that amount wasn't tax deductible UNLESS it was used in the purchase of another property.
Mark Alexander - Founder of Property118
13:31 PM, 26th October 2017, About 6 years ago
Reply to the comment left by Puzzler at 26/10/2017 - 13:04
In that case we are saying the same thing.
HMRC has amended its manuals to suggest otherwise but it's legislation that really matters. Either HMRC's manuals or legislation need to be amended.
John walker
11:34 AM, 27th October 2017, About 6 years ago
I currently trade as a firm with none of the properties mortgaged. If I now wish to mortgage one property and use the capital released to form a limited company which will use the capital transferred to purchase further properties, may I then have the firm recharge the Ltd. Co. sufficient interest on the loan to cover the mortgage?
Mark Alexander - Founder of Property118
12:13 PM, 27th October 2017, About 6 years ago
Reply to the comment left by John Walker at 27/10/2017 - 11:34
Legislation says yes, HMRC's manuals are now ambiguous.
However, there is a much better structure for landlords in your position. Please see the Case Sudies on our main tax page.