Finance Cost Restriction Unfair

In the summer budget 2015 the Chancellor announced he was to make the tax system fairer by restricting the tax relief available for landlords on their finance costs for residential property to the basic rate of tax, currently 20%. This will not apply to corporate residential landlords.

Initially many landlords may have dismissed this out of hand as they may be basic rate taxpayers and therefore assume this does not apply to them, this is a risky assumption.

The change is being phased in gradually from April 2017, during 2017/18 75% of the finance costs will be allowed tax relief in full under the existing rules, dropping to 50% in 2018/19, and 25% in 2019/20. The new tax relief will be phased in correspondingly. From 2020/21 onwards the new rules will be fully implemented.

The new rules mean that landlords will no longer be able to reduce their taxable property income using their finance costs, however their tax liability will, in most cases, be reduced by an amount of up to their finance costs multiplied by the basic rate of tax.

The following table shows the calculation of tax from 2016/17 to 2020/21:

As you can see the increase in tax from the current system to the new turns an economic profit into an economic loss in this scenario, a basic rate taxpayer is now paying an effective rate of 110% tax on their actual economic profit of £3,000. 

This result gets worse as your economic profit gets lower, the following example shows a higher rate taxpayer.

There are complex rules which may mean the basic rate relief is restricted, and the interaction with the High Income Child Benefit Charge must not be overlooked.

The rules will often change an economic profit into a loss after tax, reducing the return on investment on property income significantly.