HMRC change landlord tax manuals without notice or legislation change

by Mark Alexander

4 weeks ago

HMRC change landlord tax manuals without notice or legislation change

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HMRC change landlord tax manuals without notice or legislation change

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.

  • A business owner may claim tax relief on the interest costs of loans made to refinance a business.
  • Refinancing may allow the owner to withdraw capital (see the examples below).
  • HMRC appears to have rewritten its guidance on this subject for property owners and the effect is that there will be no tax relief for extra costs of interest on a remortgaged property.

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)

  • You purchased a buy-to-let property for £120,000 with a mortgage of £90,000 and let it to a tenant straight away.
  • Three years later the property is valued at £150,000 and you increase your mortgage on the property to £115,000. All of the interest on the mortgage can still be claimed as a revenue expense as the loan doesn’t exceed the initial £120,000 value of the property when it was introduced to your letting business.
  • If you increased the mortgage to £125,000, the interest payable on the additional £5,000 is not tax deductible and cannot be claimed as a revenue expense.

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:

Mortgage £80,000 Property at market value £375,000
Capital account £295,000

 

The balance sheet at the end of Year 1 shows:

Mortgage £205,000 Property at market value £375,000
Capital account B/F £295,000
Less Drawings £125,000
C/F £170,000

 

 

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”.

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EDITORS UPDATE 30th OCTOBER 2017

It 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:

Increasing a mortgage

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.

 

Comments

Richard U

4 weeks 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

4 weeks ago

Reply to the comment left by Richard U at 24/10/2017 - 11:12
It ONLY impacts people who are unincorporated

Puzzler

4 weeks 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

4 weeks 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

4 weeks 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

4 weeks 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

4 weeks 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

4 weeks 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

4 weeks 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

4 weeks 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.

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