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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| Less: capital withdrawn | (25,000) | |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| Less: capital withdrawn | (35,000) | |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
22:54 PM, 29th October 2017, About 7 years ago
Reply to the comment left by Alison King at 29/10/2017 - 22:51
Not easy to do if somebody is intentionally creating confusion.
Your understanding is sound.
Alison King
23:10 PM, 29th October 2017, About 7 years ago
Thanks Mark.
Thinking it through, the original legislation is completely logical. If we think of the deposit and any mortgage repayments as effectively a business loan, it makes sense that this should be able to be withdrawn for any purpose once the business has accrued enough capital to allow that. It also makes sense that any additional capital gain should be taxed unless reinvested in the business. The guidelines just need to revert to what they were to make this clear.
Mark Alexander - Founder of Property118
0:55 AM, 30th October 2017, About 7 years ago
Reply to the comment left by Alison King at 29/10/2017 - 23:10
Thankfully, I've found a clear explanation is this HMRC manual https://www.gov.uk/guidance/income-tax-when-you-rent-out-a-property-case-studies
To quote ....
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.
Expenses incurred wholly and exclusively for the property rental business
You can sometimes offset any costs - or ‘expenses’ - of keeping your rental property against the rental income, which could mean that your taxable rental income is less.
However, the expense should be incurred wholly and exclusively for the purposes of your property rental business. This means that if an expense was not incurred for the purpose of your property rental business, in any way at all, then you can’t offset the cost against the rental income.
Mark Hunt
8:10 AM, 30th October 2017, About 7 years ago
Reply to the comment left by Mark Alexander at 30/10/2017 - 00:55
Mark,
I’m not sure why you are accusing me of trying to cause confusion here. Isn’t your last post pretty much in line with what I said?
I.e. you cannot claim income relief on interest related to mortgage debt over and above the ORIGINAL market value of your properties therefore you cannot have a total mortgage value greater than the original property values across your whole portfolio AND that you cannot claim relief on interest incurred on expenses not related to your property business. Therefore, surely, you CANNOT spend the money on whatever you like? How is, for example, paying for a holiday using withdrawn funds related to the running of your property business?
Do you interpret the above differently? I’m really not trying to confuse anyone here. I just want to establish what members views of the situation are.
Junaid Safiullah
17:17 PM, 14th November 2017, About 7 years ago
Reply to the comment left by Mark Alexander at 24/10/2017 - 11:14
Hi Mark,
My portfolio is now within a Hybrid LLP.
I bulk of my letting income goes into a CT return.
Are there any adverse tax implications for me at all?
Junaid
Mark Alexander - Founder of Property118
18:19 PM, 14th November 2017, About 7 years ago
Dear Junaid
Please see the link below.
https://www.property118.com/tax/worried-seriously-worried-heres/
Stephen Jones
23:11 PM, 19th November 2017, About 7 years ago
I'm confused now. Either we can remortgage and spend it on a car or not. Which is it??
Alison King
5:02 AM, 20th November 2017, About 7 years ago
Reply to the comment left by Stephen Jones at 19/11/2017 - 23:11
I am confused too.I think the situation is this :The rules were and I think still are that If for example when you purchased the property, you put in 30k and had a 70k mortgage, you could later remortgage and use the 30k to buy a car because you are re using your own savings. If at a later date you remortgage again, you have to use the money released to invest in more property or lose the tax relief on the interest payments. That's because you are now dipping into the capital gain. This has not changed but the wording in the hmrc guidelines has and that is what is causing the confusion. Someone should ring them and tell them to sort it out.
Mark Alexander - Founder of Property118
8:21 AM, 20th November 2017, About 7 years ago
Reply to the comment left by Alison King at 20/11/2017 - 05:02
I agree with you on all points.
HMRC are aware.