Say "No" To George

Landlords are set to be hit by the Treasury in 3 different ways. Firstly the insurance premium tax has just been increased from 6% to 9.5% - an increase of over 58%, which will of course directly impact on all our insurances to run our businesses.

Secondly, the 10% Wear & Tear allowance is to be removed and replaced with the system of offsetting cost of replacement furnishings against income. Most Landlords would probably agree this is actually very fair, except that you cannot offset the original cost of buying them. We think this is grossly wrong as in any other business you could, even in a start-up. If say, you furnished your office then the complete cost of doing so could be offset against your business income. Why is it different for providing someone with decent furniture? The change will most likely lead to more cheap or second-hand furniture being used initially in setting-up a property before letting it.

However, the most notable impact will be from the Chancellor’s proposed change to tax on mortgage interest relief and will undoubtedly have some serious consequences as interest rate rise.

What is the proposal and when was it announced?
The proposal was announced in the Chancellor’s Summer Budget on 8 July 2015 and it will restrict relief for finance costs on residential properties owned by individual landlords to the basic rate of income tax. Finance costs include mortgage interest and interest on loans. Property Companies and Institutions who hold residential properties are not affected by the proposal.

In plain English, what does this mean?
Landlords are currently able to offset all their finance interest against their rental income, before calculating their rent profits and therefore their tax bill. This is quite normal in business as the general taxation principle is that tax is applied on profit.

The Government proposes to break this normal taxation practice and require landlords to pay tax on part of their costs. By the year 2021, it will still be possible to get a deduction for finance interest, but the amount will be capped at 20%. This is a big change because in most cases, finance costs will be the landlord’s largest cost. No other business is taxed in this way. No other business is taxed on interest on loans taken out to buy assets that generate taxable income. We believe that individual landlords who provide valuable housing across the UK are being unfairly discriminated against by the Government.

What is the Government’s policy objective?
In its latest Financial Stability report the Bank of England commented that the buy to let market could pose a risk to financial stability, especially if interest rates go up. The theory is that this could cause landlords to fall into negative cashflow, where their rental payments no longer cover the cost of mortgage payments. This could force them to sell in a hurry, potentially destabilising the housing market. It was following these comments that George Osborne decided he needed to exert some control over buy to let but we think the Bank of England and the Chancellor have overlooked something extremely simple in their thinking. That is that the lenders already allow for this risk of an interest rate rise in their calculations when they work out mortgage payments on their ‘Standard Variable Rate’ and the rent to mortgage multiple of 1.25.

The Government say that their policy objective is to make the tax system fairer. The Chancellor has said that landlords are taxed more favourably than home owners. However, both the Institute for Fiscal Studies and the Conservative’s favourite think tank, Policy Exchange, have warned that this is not correct. Unlike home owners, landlords are taxed on rental income and capital gains.
We believe that the Government’s proposal to tax landlords debt goes too far and will destabilise the housing market, which is what the Bank of England wants to avoid.

When will the measure be introduced?
The measure will be introduced gradually from 6 April 2017 and is ‘tapered’ over 4 years. By 2021, the full impact of the change will bite. Although the implementation of the proposal is to be phased, it is already causing uncertainty for landlords and tenants.

Who is likely to be affected?
The Government say that individuals that receive rental income on residential property in the UK and elsewhere who incur finance costs will be affected. We believe that the proposal will not just affect landlords because there will be many unintended social and economic consequences of this ill thought out proposal. Many other people will suffer too, including tenants, tradespeople, the financial industry, house-builders and the economy as a whole.

How might landlords be affected?
Landlords will fall into 1 of 3 categories, in terms of how the tax change affects them:
1) Landlords remains basic tax payer = no change
2) Change pushes basic rate tax payer into Higher Rate Band = more tax paid
3) Existing Higher Rate Tax payer = more tax paid

Many thousands of landlords will pay more tax as a result of the proposal. For some, the additional tax will not impact on the viability of their businesses. However, for thousands of landlords who have borrowed substantially to invest in their property business, the consequences will be serious. Some landlords will even lose their personal tax allowance because of the unfair way that the Government will calculate taxable income; in many cases, landlords will pay more in tax in connection with their property business than they make in net profit and in many cases landlords who make a loss from their property business will still be faced with huge tax bills. We cannot understand how the Chancellor considers his changes will result in a fairer tax system.

The implications for some landlords are such that they will need to sell properties to reduce the tax they pay on their finance costs. There is concern that many landlords will be declared bankrupt as their tax bills will exceed their taxable income and they will be left with property businesses that are no longer sustainable. The situation will get worse when interest rates increase. The Governor of the Bank of England has publicly stated that he expects interest rates to increase before the end of 2015. If Landlords are subjected to this extra tax burden it will initially be passed on to the tenants, but if they have to sell their properties or face having them repossessed, then the tenants will be without a home.

Can you show some examples of the impact on landlords?

Example 1 : Joe is an architect and earns £ 45,000. He is what has become known as an ‘accidental landlord’. He has only one buy to let property. This used to be his home but he let it out when he moved in with his partner Monica. Joe is a 40% taxpayer. His rental income is £7,200 per annum; his mortgage costs are £2,500; and his repairs and other tax deductible costs are £1,000. Under the current tax system, Joe would pay £1,480 tax on his property income. Under the proposed tax system, Joe would pay £1,980 tax on his property, an increase of £500. For Joe, the new tax system still results in him making a ‘real profit’ but his effective rate of tax on ‘real profit’ increases from 40% to 53.5%.

Example 2: Dave and Margaret are a married couple. They consider themselves to be entrepreneurs and operate a sizable buy to let business. They have invested in property to provide a livelihood for themselves and to provide a pension when they retire. They have some tenants who are employed but most of their tenants are in receipt of housing benefit. Their only source of income is from their rental business. Their property rental assets are jointly owned and they split the rental income 50/50. Properties have been acquired over a period of nearly three decades. They have recently fixed their interest rate at 4.99% for 10 years to protect their business from risks associated with rises in interest rates. That seemed to be the sensible thing to do at the time. Their rental income is £600,000; their mortgage costs are £350,000; and their repair and other tax deductible costs are £200,000. Their net rental profit is £50,000. They are currently basic rate taxpayers. Their taxable income, after deduction of their personal allowance, is £28,000. Under the current tax system, Dave and Margaret each pay £5,600 tax. Their effective tax rate over personal allowance is currently 20%.
Under the proposed tax system, because Dave and Margaret will not be able to offset any of their mortgage costs against their rental income, they will become higher rate tax payers and their individual taxable income will increase to a staggering £200,000 each, the same as their rental profit because they lose their personal allowance at £121,000 each. The actual tax they would each pay would be £38,900, making £77,800 in total. This is £27,800 more than they actually make in profit from their rental business.
Their effective tax rate on their real profit is now 155.6% as the amount of tax paid exceeds their income. Dave and Margaret are now higher rate tax payers. For Dave and Margaret, the Government’s proposal is catastrophic as their business is no longer sustainable as the tax they pay exceeds their ‘real profit’. Dave and Margaret are now very worried and feel trapped. Their once profitable business is no longer viable. If they were to look at selling their properties they would incur early repayment charges, incur selling costs, be required to pay a significant sum in Capital Gains Tax and repay their outstanding mortgage balances in full, the sum total of which would be greater that the proceeds of sale. They are responsible landlords and are concerned about what will happen to their 187 tenants if their properties are repossessed, especially those tenants in receipt of benefits. They are scared to share their concerns with their tenants as they fear that their tenants may give notice to quit and look for a tenancy that is more secure.

Example 3 : Emily is a civil servant and has non-property income of £40,000. She started to invest in property to create an additional income stream to fund her children through university. Her rental profit is £25,000 and she pays £35,000 in mortgage interest on her rental properties giving her a total income of £65,000. Her total tax bill under the current tax system would be £15,200, of which £9,400 arises from her rental income. This would increase to £22,200 under the new tax regime of which £16,400 would arise from her rental income. Emily’s effective tax rate on her real profit of £25,000 would increase from 37.6% to 65.6%. Emily is now concerned that her tax bill has increased by £7,000 and that her profit from her property rental business has been substantially eroded. She is becoming increasingly concerned about risk, especially knowing that if interest rates go up, her margins will be further eroded. This was not what she had in mind when she used all her savings to invest in property to fund her children’s further education. She assumed that the long established principle of income – expenses = profit would remain and that tax payable would be based on profit made. The Government’s proposal fundamentally changes that formula.

EVERY OTHER BUSINESS IN THE LAND IS ALLOWED TO OFFSET THEIR TOTAL COSTS AGAINST THEIR INCOME BEFORE BEING TAXED (ON THEIR PROFIT). IF YOU BELIEVE THAT YOUR PROPERTY INVESTMENT IS TO BE TAXED UNFAIRLY THEN PLEASE WRITE TO YOUR LOCAL MP TO ASK HIM/HER TO SUPPORT YOU!