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8:42 AM, 24th October 2017, About 7 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| Less: capital withdrawn | (25,000) | |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| Less: capital withdrawn | (35,000) | |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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Mark Alexander - Founder of Property118
14:22 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Mark Hunt at 29/10/2017 - 14:15
Yes I agree with your latest point. Do you now agree that in this scenario that the interest on the full £250,000 can be offset against rental income (save for s24 restrictions)?
Mark Hunt
17:02 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Mark Alexander at 29/10/2017 - 14:22
Yes, I think we are in agreement on this issue...
I guess the point I was making is that unrealised equity growth can be used as a security against loans from a bank. The interest from loans made against unrealised equity growth can be offset against income, only provided they are used to purchase new BTL property.
What unrealised equity cannot be used for is adding directly to the capital account. There never has been any way to convert unrealised equity gains into capital without realising the gain (i.e. selling the asset). Which means if you withdraw funds and use them on anything other than the purchase of additional BTL property then the interest associated with those loans cannot be offset against income. This will include improvements to your BTL properties as this is a capital gains benefit and will be accounted for when the property is sold and the gain realised.
But I believe this has always been the case Mark - so I'm a bit confused as to why this is suddenly a surprise? It is certainly how I have always seen it?
I'm pretty sure most landlords out there will not be withdrawing equity and spending it on lifestyle choices, and then still trying to offset the interest against the rental profits.....surely!! Do you think many have?
Alison King
19:08 PM, 29th October 2017, About 7 years ago
I'm sorry I thought I understood this but I am completely confused now. Here is a hypothetical example. I buy a property for 60k with 20K deposit on a repayment mortgage. Five years later it is worth 80k and the mortgage is 30k. I remortgage it to a 60k mortgage and release 30k.
My understanding is that I can use the 30K released for whatever I like and still get tax relief on the loan. Only if I release more than that does it get complicated. Is that not correct?
Mark Alexander - Founder of Property118
20:12 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Mark Hunt at 29/10/2017 - 17:02
I think you have misunderstood the main article Mark. I suggest that you read that again to understand the point being made.
Mark Alexander - Founder of Property118
20:13 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Alison King at 29/10/2017 - 19:08
That is what the legislation says.
The manual has been amended (without any change to legislation) to imply that is no longer the case. That is who whole point of this particular article.
Mark Hunt
20:17 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Alison King at 29/10/2017 - 19:08
Hi Alison,
You can spend the money from a re-mortgage on whatever you like. But, you can only continue to offset the mortgage interest for the part that you have spent on the purchase on new BTL property.
For example, if you re-mortgaged to release £30k and you then spent the whole £30k as a deposit on a new BTL property you can offset 100% of the additional interest associated with the additional £30k of mortgage on your first property.
If, however, you spent £15k on a car and £15k on the deposit for a new property you can only offset 50% of the additional interest against rental income.
If you spent the whole £30k on, for example, a car purchase then NONE of the additional interest associated with additional £30k mortgage can be offset against rental income.
Think about it, if HMRC allowed you to spend the money on whatever you like and still offset it against rental income, then the tax man would effectively be subsidising your car purchase (or holiday etc..) - I know BTL has been kind to us, but that would be taking the p***
Mark Alexander - Founder of Property118
20:27 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Mark Hunt at 29/10/2017 - 20:17
Hello Mark
I have reason to believe you have joined this forum with the sole intention of causing confusion. Your comments are written to suggest you are an authority on the subject matter but clearly you are not. The only other explanation is that you may know a reasonable amount about the subject but you also have a sick agenda. This is because every comment you have posted includes at least one form of misdirection. This is a practice known as trolling. Two regular members have emailed me privately to say the same thing.
Please call me during office hours on 01603 489 118.
If I do not hear from you within two days I will remove your comments and all interaction you have had with other members of this forum and ban you from further commenting.
Alison King
22:20 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Mark Hunt at 29/10/2017 - 20:17
That makes no sense. I would be being taxed on some of the money twice. Once as rental income and again on the bit used to repay the mortgage.
Also when does the money get taxed? When it gets spent on a fancy car or whilst it is sitting in my deposit account waiting to be spent on a good deal? I am unclear how this could possibly be policed in any case.
Mark Alexander - Founder of Property118
22:23 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Alison King at 29/10/2017 - 22:20
Please see my comment above yours.
I suspect all discussion with Mark Hunt will have to be deleted, including your own.
Alison King
22:51 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Mark Alexander at 29/10/2017 - 22:23
Thanks for trying to get to the bottom of all this Mark.