Why Osborne’s Buy to Let Tax Grab is Flawed

by Dr Rosalind Beck

11:42 AM, 26th October 2015
About 3 years ago

Why Osborne’s Buy to Let Tax Grab is Flawed

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Why Osborne’s Buy to Let Tax Grab is Flawed

Written evidence submitted by Dr Rosalind Beck (FB 06) Why Osborne's Buy to Let Tax Grab is Flawed

This submission specifically challenges the theoretical premises behind the decision on ‘restricting deductions for finance costs related to residential property’ announced in the Summer Budget.

1. My background:

My expertise and special interest in the provisions of the Finance Bill with regard to the ‘tax relief restriction’ for landlords is that I have been a landlord for just under 20 years and jointly own a large portfolio of properties. The decision to no longer allow me to offset the finance costs of running my business will have a catastrophic effect. As a professional, portfolio landlord, a 2-3% increase in interest rates at any point in the future would currently affect my profits but not the viability of my business. Under the new, proposed tax regime, the same increase in interest rates (which is bound to happen sooner or later) is likely to throw me into bankruptcy (see the separate submission by John McKay to see the appalling implications for professional landlords, who rely entirely on their portfolios for their income).

2. Summary of this submission:

This submission will demonstrate how the theoretical/philosophical premise behind the measure to restrict ‘tax relief’ for landlords is inherently flawed. Evidence from experts calls into question the logic of the Chancellor’s justification for the measure, that is, his stated aim to create a ‘level playing field’ between owner-occupiers and landlords. In fact, the measure will exacerbate inequalities within the tax system. As the assumptions behind the measure are wrong, I urge that the decision be reversed before it becomes law.

3. The stated reason for the above measure was based on the Chancellor’s view that:

‘The ability to deduct these costs puts investing in a rental property at an advantage. Tax relief for finance costs is particularly beneficial for wealthier landlords with larger incomes, as every £1 of finance cost they incur allows them to pay 40p or 45p less tax.’ HMRC’s accompanying Policy Paper suggests the proposal will: ‘make the system fairer… This will ensure that landlords with higher incomes no longer receive the most generous tax treatment.’ This is wrong. In fact, the measure will not affect landlords with the highest incomes, as landlords with the greatest wealth do not need finance. It is rather portfolio landlords with high interest costs who will in many cases be ruined by the measure (the assumption by the Chancellor and HMRC that landlords with the highest interest costs to pay are the ‘wealthiest’ is bizarre). The basic principle that tax be based on ability to pay will be abolished with this measure.

4. Several chief economists in the UK have explained why the decision is wrong, and their arguments stand in stark contrast to those of the Chancellor and HMRC. Notably, on the 9th of July, Paul Johnson, Director of the impartial Institute for Fiscal Studies said: ‘At present if you own a property which you let out to tenants you can set any mortgage interest costs against tax due on rent received. The Budget red book states that this means that ‘the current tax system supports landlords over and above ordinary homeowners,’ and that it ‘puts investing in a rental property at an advantage.’ This line of argument is plain wrong. Rental property is taxed more heavily than owner occupied property.’ He also said that the measure implies a refusal to recognise that mortgage interest is a cost of running landlords’ businesses and should be offsettable. He said that the solution to the housing shortage is simple: to build more houses. (Source: http://www.ifs.org.uk/uploads/publications/budgets/Budgets%202015/Summer/opening_remarks.pdf.)

5. The think tank, the Policy Exchange, confirmed this view noting that: ‘In truth, the tax system massively favours home ownership – for one thing home owners do not have to pay capital gains tax on their principal residence, whereas buy to let landlords do on the rental properties they sell. Rental income is also taxed (and even more now). (Source: http://www.policyexchange.org.uk/media-centre/blogs/category/item/additional-policy-exchange-analysis-of-summer-budget-2015 ).

6. Professor Philip Booth of the Institute of Economic Affairs, reporting to the Treasury Select Committee on the Summer Budget, 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.’ (see Annexe 1, where Professor Booth outlines the implications). It should be noted that this policy was most recently advocated by the Green Party, which made no study of the potential impacts on landlords, tenants, first time buyers, owner-occupiers, businesses which depend on the BTL sector, house prices and the economy in general. There is also no evidence that the Government has made any such study. Indeed, the Treasury asked the rather small organisation, the Residential Landlords Association, to come up with an impact study, after the measure was announced.

7. Professor of taxation at Oxford University, Michael Devereux, has also pointed out that: ‘If you are trying to tax profit you have to give relief for the cost of earning it’ (Daily Mail, 1st of August 2015). There is, thus, consensus among experts that the decision is wrong in principle.

8. In addition, the Chancellor in the more general observations in his Budget speech spoke of harmonising financial policies between the G7 countries. As these other countries allow landlords to offset the finance costs of running their businesses, this decision will only serve to ‘de-harmonise’ the policies. It will set the UK apart as a country with an anti-landlord, anti-business ethos (see Annexe 2).

9. The tax would be retrospectively applied, which is grossly unfair. The Chancellor acknowledged the injustice of retrospective tax changes in the Summer Budget within the context of car taxes, saying how it would be unfair for new taxes to be applied to cars that people already own. Surely the same principle must be valid for houses already owned, which are a far greater financial commitment? If landlords had known that a central pillar of tax law would be abolished, they would not have heavily invested their own money in providing the essential housing that fills the gap left by governments’ sale of public housing and by the failure to build sufficient housing year upon year.

10. Other pertinent arguments include the fact that owner-occupiers will also enjoy improved inheritance tax thresholds, following the Budget, thus favouring owner-occupied property even more in comparison with rented property. This will deter older owner-occupiers from downsizing and limit the number of existing large houses being freed up for families. There are 25 million empty bedrooms in the UK and it should be an aim of Government to get these rooms utilised. Private landlords should be incentivised, for example through being encouraged to provide high-quality HMOs, which are environmentally-friendly and an excellent use of space in cities and student areas in particular.

11. Furthermore, with regard to the importance of ‘fairness’ in the tax system – a key justification for introducing the measure – the evidence is that the decision actually makes for a less level playing field than before in the following contexts:

• Within the private rented sector, it singles out private landlords’ businesses; landlords operating under the auspices of limited companies will still be allowed to offset all their finance costs as part of running their business. No explanation has been given for the discriminatory treatment of private landlords compared to incorporated landlords running an identical business model.

• Within the context of business in general, all other businesses in the UK, whether involved in property or not also continue to operate under the established tax norm of profit = income – costs.

• Within the context of the Chancellor’s statement of levelling the playing field between owner-occupiers and landlords, the decision will mean that owner occupiers’ favourable tax regime will become even more favourable, with the converse true for landlords.

• Tenants, despite being a key affected group, are almost invisible in the HMRC impact statement. However, when one compares the position of tenants with owner-occupiers (a comparison not mentioned by the Government) the evidence is that rents, evictions and homelessness will all rise as a direct consequence of this decision. Four surveys of landlord intentions have shown that a majority of landlords will increase rents to combat the new massive tax bills that will become payable (the Residential Landlords Association found 65% of landlords will increase rents; for Rentify the figure was 56%; and the National Landlord Association has estimated £70 per month will be added to rents; a recent Scottish Association of Landlords survey estimated the average rent rise expected as a direct result of the measure to be 12%). The number of landlords expecting to increase rents will rise as the anecdotal evidence is that most landlords have not yet realised what the measure means (largely because of the misleading way it was presented in the Budget and by HMRC and continues to be presented as though it will only affect wealthy landlords). The massive new tax burden placed on landlords is likely to lead to a decline in maintenance standards. This move is thus detrimental to the interests of a large number of tenants in the private sector.

• Within Europe, UK landlords will also be strangely and unfairly singled out. It is already the case that taxation in the UK is more heavily biased in favour of home-ownership and against landlords than in any other country in Europe. Also, no other country in Europe disallows landlords from offsetting finance costs to calculate profit The Chancellor’s argument about creating a level playing field therefore makes no sense in the European context.
12. HMRC states that 1.6 million BTL mortgages are held in the UK and recent research by the NLA found that an average of 28% of landlords’ rental income goes on mortgage payments. The Government has not explained how it believes only 1 in 5 landlords would be affected (which would still involve an enormous number of landlords). In addition, the moot point is the number of houses and households it will affect, not the number of landlords; as portfolio landlords will be most affected, the number of homes (and tenants) will be huge. The Government has also not stated if the 1 in 5 includes the landlords who will move from paying tax at 20% to 40% because of the way ‘profit’ will now be calculated. It has also not demonstrated the impact the proposal will have on portfolio landlords whose only source of income is their rental business. The Government has not acknowledged that viable businesses will become unsustainable as a result of the Budget proposals, nor has the Government recognised that the proposed change will lead to the bankruptcy of many portfolio landlords.

13. The separate submission by John McKay shows how the business of buy-to-let for landlords who hold mortgages will be quickly rendered unviable and portfolio landlords especially are already working on strategies to deal with the consequences of the proposed measure. For many, this will involve raising rents and others will give tenants notice in order to prepare houses for sale; other landlords may incorporate property into limited companies which will result in capital gains tax and SDLT; these costs will lead to no positive benefit for landlords or tenants. In extreme cases, landlords are considering leaving the country to avoid financial ruin.

14. No statistics have been presented regarding the number of first time buyers who are actively seeking to purchase a home and in a financial position to do so, or indeed how many starter homes may be freed up from rental stock by landlords offloading their portfolios (and evicting tenants to do so). There will also be considerable regional and local variation in supply and demand. There is often a considerable discrepancy between the kinds of houses rented out and those which potential owner-occupiers would wish to purchase. For those that are bought by first time buyers, these properties will be lost to the rental market and an unspecified number of tenants are likely to be made homeless. In this respect, the decision discriminates against renters and favours potential owner-occupiers; hardly a ‘level playing field.’

15. Whilst some landlords may suggest amendments to the policy, I cannot suggest an amendment to something that, to quote the Director of the IFS again, is ‘plain wrong.’ Rather than there being an amendment there needs to be a thorough examination of what the problems are in the housing sector, followed by solutions to those problems. Better use of existing housing and building new homes is the obvious solution; damaging the private rental sector is not a solution to the country’s housing problems; neither is destroying long-established property rental businesses. Indeed, private landlords should be among those incentivised to provide this housing, rather than forcing landlords to sell or have their properties repossessed because of this punitive tax on turnover which will merely change the ownership of these extant properties and in no way guarantees that currently tenanted properties are re-occupied by owner-occupiers (a very dubious aim of Government policy in any case).

16. According to HMRC’s policy paper, the measure is expected to raise £225M in 2018/19, £415M in 2019/2020 and £665M in 2020/21. However, these figures do not take into account lost revenue from existing landlords who will exit the private rented sector, or downsize the scale of their portfolios or go bankrupt as a direct result of the measure. The long term impact for the Treasury could be a net reduction in tax, not an increase as suggested by the impact statement. Whilst the Government might obtain CGT and SDLT windfalls as a result of landlords disposing of properties, this is likely to be a short term windfall and has not been quantified by the Government. In any case, landlords will take tax planning advice and seek to minimise the CGT and SDLT paid. Local councils’ Bed and Breakfast bills for homeless people are likely to soar in less desirable areas where landlords give tenants notice in order to prepare the properties for sale and then wait some time before a buyer is found. If the buyer is an owner-occupier that area loses a rental property. The Treasury needs a far more comprehensive analysis of the costs of this policy.

17. Conclusion: The decision creates problems; it doesn’t solve problems and it exacerbates the inequitable and heavy tax burden already existing for private landlords in the UK compared to other advanced nations. It will lead to financial ruin for many landlords with a range of nefarious knock-on effects for other groups and individuals. In addition it sets a dangerous precedent as it destroys the fundamental principle of business taxation that:
Business profit = income – costs.

It will cause lasting damage to the private rental sector and it will create no new housing. It will make buy-to-let so unattractive that future investment from private landlords dependent on finance will be significantly reduced at a time when demand for private rented sector housing is growing (why would anyone still invest when the investment could bring a negative return?). At the same time the Government is providing guaranteed loans to encourage institutional investment. The Government’s plans are contradictory. On the one hand, the Government is encouraging investment in the sector (for companies and institutions); on the other, it is discouraging investment by individuals. This makes no sense. In fact, the evidence is that private landlords provide better quality housing than institutions and that the majority of private tenants are satisfied with both their housing and their landlord in the private rented sector (according to the Rugg Report, 2008, on the private rented sector: ‘three-quarters of tenants are either fairly or very satisfied with their landlords’). This policy must be reversed.

August 2015

Annexe 1:
1. This is an extract from an article by Professor Philip Booth, from February 2015 regarding the Green Party’s (uncosted) proposal to abolish “tax relief” on interest for private landlords.
‘Private landlords generally take out loans, add some of their own equity capital, buy houses and let them out – that is how any small business works. They receive income (rent) and they deduct costs (wear and tear, alterations, depreciation and the interest on the loans they take out). On income less costs they pay tax (corporation tax if they incorporate; income tax if they do not). Being able to deduct interest from the rental income is not a “relief”, it is recognition of a cost of doing business… This is absolutely the correct way to tax returns for buy-to-let landlords, though believing that the tax deductibility of interest is a “concession” is an easy mistake to make – George Osborne flirted with abolishing it for corporations before the 2010 general election.

‘What will be the result of the Green policy? Any combination of the following could occur:
• There might be a replacement of debt capital by equity capital to fund buy-to-let properties. But this can only be a partial replacement because few will have access to sufficient equity capital. Institutions may take over some of the slack in this market but this is unlikely given that it is still regarded as a political football (it was repeated political interventions that led to the wholesale withdrawal of institutions from this market in the first place). There will be no gain to the Exchequer because the gain from the Green policy comes from the fact that interest is taxed twice (both the landlord who will pay the interest and whoever funds the loan will have to pay tax). If buy-to-let is only financed by equity capital, the returns will only be taxed once.

• Houses for let will be sold and we will see a decline of the rental market again. Here, there will be no gain to the Exchequer because owner-occupied property is not taxed at all (indeed, there will be a loss to the Exchequer).

• Rents will rise to restore the investors’ return on equity – in this case by nearly 15 per cent.

5. It should be borne in mind that the response to various forms of double taxation that are imposed on investors is normally the development of complex tax avoidance mechanisms. In fact, the most likely outcome of the Green policy is that there will be no new revenue for socialised housebuilding and a lot of revenue for bankers designing tax efficient funding products.’
(reference: http://www.iea.org.uk/blog/the-green-interview-%E2%80%93-failed-on-style-what-about-the-substance)

Annexe 2.

The other G7 countries’ and/or European countries’ policies on ‘finance costs’ for private landlords:

1. USA:

In the USA, interest is fully deductible as an expense; indeed the tax regime is considerably more favourable to private landlords than the UK system is; landlords can claim for depreciation, for example.
(ref: http://www.irs.gov/pub/irs-pdf/p527.pdf – see page 3)

2. Canada:

In Canada, interest is fully deductible, as are many additional costs of landlords’ businesses.
(reference: http://www.cra-arc.gc.ca/tx/bsnss/tpcs/rntl/bt/rprt/xpns/ln8710-eng.html )
3. Japan:

Deductible expenses for real estate income purposes include interest, depreciation, maintenance or improvements to property. (ref: http://japantax.org/)
4. All countries in Europe, including the G7 countries of France, Germany and Italy, allow mortgage interest as a deduction in calculating tax (except for the Netherlands where real figures for rent and costs are not used). (reference: http://www.treanor.co.uk/books/HousingPoliciesinEurope.pdf – p16)
In addition, all other countries in Europe also allow finance costs as an offsettable expense and indeed, generally have a more favourable tax regime for landlords than the UK (even before the Budget decision to restrict this ‘relief).



Comments

Guy Bradley

21:33 PM, 26th October 2015
About 3 years ago

Very detailed and we'll researched article which I think accurately sums up the iniquitous 'logic' behind this i.e. it is just a weak, knee jerk response to current press comments against landlords (all slum don'cha know!) Keep the pressure up. Good work.

Dr Rosalind Beck

22:31 PM, 14th November 2015
About 3 years ago

Reply to the comment left by "Guy Bradley" at "26/10/2015 - 21:33":

Thanks Guy.
I didn't realise my submission was here on the site.
I did try my best with the submission to expose the complete lack of logic and absence of any justification for this astonishing and outrageous attack on us.

Dr Rosalind Beck

23:42 PM, 14th November 2015
About 3 years ago

Also, I was very pleased to see today that some of these issues were covered in the Telegraph - where they covered the issue of landlords in the UK being treated like sh*te, basically, compared to other countries where not only are they still allowed to offset their finance costs, but also for example, after a period of ownership do not have to pay CGT or pay a lower amount. We are standing alone as the country which demonises landlords and which is currently trying to drive landlords out of business and many of their tenants out of their homes.

Richard York

23:50 PM, 15th November 2015
About 3 years ago

Might be worth pointing out that:

The US, Japan and Spain allows full interest reduction for OO (up to a certain allowance) - so you can't really compare these. The "playing field" between OOs and owner occupiers is the same.

Italy only allows financing relief up to 30% of the EBITDA of a business, restricting leverage significantly.

France has a wealth tax that is levied on the rental value of the land and building. It is payable by the owner, and there is a seperate tax on habitation that roughly is half the cost. France doesn't allow "no fault" evictions either.

Germany has rent controls and nothing like S21.

All I'm saying with the above is - be careful what you wish for. Comparing the UK with other countries is a complex and difficult affair, because the circumstances in each country is unique.

Dr Rosalind Beck

9:39 AM, 16th November 2015
About 3 years ago

Reply to the comment left by "Richard York" at "15/11/2015 - 23:50":

Hi Richard.
Yes, it is complex to compare all of the economies in the world and their policies towards the taxation of property and landlords specifically. And lots of arguments are put forward.
For example, one thing I hear now and then is how rents are cheaper in Germany than here and as you say they don't have S21s, but I also believe people are more-or-less given a shell and have to supply their own kitchens and bathrooms, are responsible for a lot of the day-to-day maintenance and so on, so landlords' costs would be far lower - no wonder they can charge cheaper rents - especially if they are then not taxed on the finance costs of purchasing the buildings in the first place. Naturally, it would be unjust to then give tenants two months' notice to leave. Hopefully they pay their rent... and fulfill their side of the bargain.
In Spain it is nigh on impossible to evict tenants and because of this there are hundreds of thousands if not millions of empty second homes - owners don't dare rent them out, because it is so difficult to regain possession. Unless this has changed (I'm not up-to-date) it was the case there that if a tenant stayed for 12 months and one day, the landlord could not regain possession for 5 years and could only increase rent in line with inflation. This caused a lot of difficulties for landlords who maybe wanted to sell and/or whose tenants were badly behaved and/or didn't pay the rent.
Our set-up has been far better in recent decades and encouraged a thriving rental market and better use of empty properties. This will now all change with this unjust and retrogressive step.
Finally, in terms of saying we can't compare the UK with countries which allow owner-occupiers 'relief' I don't follow the logic. We only need to compare landlords in those countries and landlords in the UK.


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