The first stage in the restriction of tax relief for residential landlords on interest paid came into force at the start of the current tax year.
From 6th April 2017, 25% of mortgage interest will be restricted to relief at basic rate. This restriction will extend to 50% from 5th April 2018 and to 75% from 5th April 2019. From 5th April 2020 all interest will only receive tax relief at basic rate.
However, the change is even more significant. Until the start of the current tax year tax relief on interest was given by reducing the rental income received by the amount of interest paid. However, from this year the interest paid is ignored when determining tax liability. This tax liability is then reduced by a tax deduction given on the interest.
For instance, let us look at the position in both the last tax year and the current tax year of Fred. In both tax years Fred has earned £45,000 from employment, and has received £6,000 in rental profits before deducting interest on the rented property of £4,000.
This year, the whole of Fred’s rental profits are taxable at higher rate (40%), ie £2,400 but this tax is reduced by the tax deduction on the interest paid. Of the £4,000 interest that has been paid, £3,000 will give rise to a tax deduction at 40% (£1,200) and the remaining £1,000 will give rise to a tax deduction at 20%, ie £200. Therefore, the net tax payable on the rental income will be £1,000, calculated as £2,400 less the total tax deductions of £1,200 plus £200. Last tax year Fred would have paid 40% tax on the net rental income after deducting interest payable, ie £2,000, resulting in tax payable of £800. Therefore, tax payable has increased by £200, and this is what most people would expect.
However, that is not the end of the story. There are a number of measures that refer to “Net Income For Tax Purposes”. Last tax year, Fred’s Net Income For Tax Purposes would be his employment income of £45,000 plus the net rental income after interest of £2,000, resulting in a total of £47,000. However, in the current tax year interest is not deducted from Net Income For Tax Purposes, meaning that this has now increased to £51,000.
One measure that refers to this is Child Benefit, which is restricted by 1% for every £100 by which Net Income For Tax Purposes exceeds £50,000. Therefore, with the same level of income in each tax year, Fred would have received the full amount of Child Benefit last year, but will need to repay 10% of Child Benefit in the current year. This could result in a significant difference for some people.
For more information about our tax services for landlords check out our company tax section.