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HMRC altered guidance to deny interest relief

23rd Oct 2017
Tax Writer Taxwriter Ltd
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HMRC has apparently changed its stance regarding remortgaged let property, denying interest relief on the additional borrowings where the capital is withdrawn.

Historical position

Individual clients with property lettings businesses often ask “can I remortgage the let properties and extract the money for my own use?” For many years the answer to this query has been: “yes”, as deductions for a lettings business are treated just like deductions for any other business.

From 6 April 2017, where the let property is residential, the deductions for interest and finance charges are subject to a 25% restriction, but that rule is not relevant to this story.

The property owner can remortgage and extract capital from their lettings business as long as their capital account doesn’t become overdrawn. All the mortgage interest, include the extra payable on the additional loan, is eligible to be deducted from the rental income.

If the owner extracts no more than the capital he introduced to the business (the value of the properties when first let), there is no effect on the tax position. The fact that a greater proportion of the capital in the business is now supported by a mortgage, is irrelevant.

This position is clearly set out in the HMRC Business Income Manual at para BIM45700, which includes the example of Mr A who acquired a flat for £125,000 with a mortgage of £80,000. He lets it when it is valued at £375,000 and remortgages so the total debt is £205,000, and extracts £125,000 of capital to spend on a private asset. The HMRC example concludes:

“Although he has withdrawn capital from the business, the interest on the mortgage loan is allowable in full because it is funding the transfer of the property to the business at its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.”

Amended guidance

If you client falls squarely in the position of Mr A in the HMRC manual, you would not expect HMRC to challenge the deduction of interest. However, this is what happened to a client of one West Midlands firm.

The HMRC officer who enquired into their client’s tax return insisted that the additional mortgage should be used to provide working capital for the business, and not be extracted to use for private purposes. The officer was not looking at the helpful example in para BIM47500, but instead referred to guidance on Income Tax when you let property, under the heading “increasing your mortgage”, where it says:

“If you increase your mortgage loan on your buy-to-let property you may be able to treat the interest on the additional loan as a revenue expense, so long as the additional loan is wholly and exclusively for the purpose of the letting business”

A similar passage is included on this page: Income tax when you rent out a property: case studies, under expenses wholly and exclusively incurred.

These passages impose the wholly and exclusively rule on the mortgage interest deduction as set out in ITTOIA 2005, s 34, but totally ignore the original capital introduced to the business argument. What’s more, this guidance was altered in the course of the enquiry into the taxpayer’s affairs.

Legitimate expectations  

The accountancy firm hit back with Business Brief 60/09 in which HMRC state:

We will normally be bound by our previous guidance where the taxpayer can demonstrate that he or she:

  • reasonably acted in reliance on the previous guidance, and
  • would suffer detriment from the correct application of the statute.”

Their client had relied on the HMRC guidance in the Business Income Manual para BIM45700, which had been in place for at least 12 years.

HMRC won't back down

The accountancy firm gently suggested to HMRC that changing their online guidance in the course of the tax enquiry was an abuse of power, and if they did not allow the guidance in para BIM47500 to apply, they would consider taking the point to judicial review.

HMRC are still not backing down. Sam Hart, of Cleaver Cook LLP, the tax advisers involved in this case, said: HMRC have not seen sense and we are currently awaiting a date for an FTT hearing.”


HMRC’s manuals are not the law; the guidance they contain is merely guidance which can and will be ignored by the courts if it does not agree with the tax law. However, if you are relying on a section of HMRC guidance to defend a client’s tax position, always print a dated copy of the page, as it can be changed without notice.

Check when the relevant section of the HMRC manual was last updated. All the recent updates should be listed on a separate page for each manual – click on: ”See all updates” in the header banner of the particular manual.

The pages are even less reliable than the HMRC manuals. The guidance there has often been simplified to suit the publishing guidelines so may miss vital points of detail.

If in doubt read the tax law, not the HMRC manuals. 


Replies (22)

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By alltaxedout
23rd Oct 2017 11:08

I would argue that the additional loan is wholly and exclusively for the purposes of the letting business as it is effectively refinancing the capital account.

Looking at it another way, what if I received a loan from my brother (interest free) to fund the original purchase and I then remortgaged property, using the excess to pay him back? Would that be wholly and exclusively for the purposes of the rental business? I would say yes.

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By John R
23rd Oct 2017 11:09

Readers may also be interested in this very recent First Tier Tribunal decision where the FTT appear to agree with HMRC - see paragraphs 103 et seq in the decision of TC06123: REBECCA LOUISE VOWLES [2017] UKFTT 704 (TC). Decision is here

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Replying to John R:
By alltaxedout
23rd Oct 2017 11:20

Again John, that makes no reference to the capital account. It is not in dispute that if the new mortgage goes over and above the value of property when first applied to the letting business, that the interest is not allowable.

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Replying to John R:
By Ruddles
08th Nov 2017 16:36

But the taxpayer in that case shot herself in the foot by expressly stating that the purpose of the new loan, as far as she was aware, was to release funds for a non-qualifying purpose. Would the outcome have been different had she claimed that the purpose of the new loan was to provide working capital for the business? Who knows.

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By cfield
23rd Oct 2017 11:12

I've got a case like this going on right now where we need to increase the interest claimed in line with the capital account, so a highly pertinent article.

It sounds to me more like untrained HMRC staff getting it wrong than any official change of policy. Happens all the time these days. They probably don't even understand the concept of a capital account.

Trouble is, once they adopt a position, they dig their heels in and refute all arguments to the contrary. You just have to be very persistent. Will be interesting to see if they let it go to Tribunal.

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By mydoghasfleas
23rd Oct 2017 11:18

There is some logic to HMRC's argument about the funding but legitimate expectation should prevail here.

If this was a company with loans from shareholders and those loans were repaid from refinancing, there would be no argument that you cannot repay more than the original shareholder loan. I know it's not he same but it ilustrates a mindset.

What happens if there is a fall in property prices leading to an overdrawn capital account? If BIM47500 applies in reverse the relief reduces. If the guidance applies, the entire loan interest is relieved because it was only ever for property purchase.

I wonder if this is an effect of interest no longer being a business expense but a relief against profits. If it is not an allowable expense, does the relief face a tougher test?

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Replying to mydoghasfleas:
By ireallyshouldknowthisbut
23rd Oct 2017 11:58

You don't revalue the properties, so current market value is irrelevant. Its what you paid.

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By tedbuck
23rd Oct 2017 11:18

I have long thought that HMRC were wrong about allowing relief on such loans so this doesn't come as a surprise.

I do think that they should stand by their published guidance as it is grossly unfair to expect people to second guess published and authoritative guidance. It simply emphasises that HMRC do not know what they are doing and don't understand what they are saying.

I suppose it stems from HMG who continually fail to perceive the consequences of what they are legislating for. They just look at the next soundbite. Osborne was about the worst for that and has made the biggest mess of tax law since Income Tax was introduced.

Heaven help us!

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Replying to tedbuck:
Hallerud at Easter
23rd Oct 2017 11:43

tedbuck wrote:

Osborne was about the worst for that and has made the biggest mess of tax law since Income Tax was introduced.

Heaven help us!

And to think that Income Tax was likely considered a "safe pair of hands" after taxing tea had proved such a disaster for Freddy North.

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By Ian McTernan CTA
23rd Oct 2017 11:47

I'd point the HMRC officer to their own manuals, which have more authority than the dumbed down guidance on their website.

Then ask him why he/she feels that the website should have more authority then their own manuals.

Then ask them to state clearly on which provisions they are relying on to go against basic accounting principles.

Then ask them to submit the case for internal review- I've dealt with a numbers of cases like this where the first officer is adamant no relief is due only to have them have their mind changed by someone higher up the food chain that understands basic accounting rather than HMRC dogma.

It may be that someone has released some internal guidance badly written on the subject and it's been misinterpreted by both those that write the website and the HMRC officer involved.

As one of those that contributed heavily to getting that change made all those years ago I'm very much interested in how the case goes. I no longer have the correspondence and notes we made in those discussions with HMRC otherwise I'd be sending them over!

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By ireallyshouldknowthisbut
23rd Oct 2017 11:56

I have taken HMRC on when they have made a similar statements to a (formally) unrepresented client.

We won by going through both HMRC's manuals and the legislation very slowly with them. It took a while for them to understand what was going on, but persistence paid off. I had to go right down to basics of balance sheets with them.

This was the let property campaign team so they ought to have known what they were doing quite frankly.

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By maasrw
23rd Oct 2017 13:15

You could of course point out that HMRC manuals are not the law. You could then produce for the Officer an opening balance sheet for the property letting business, which would show capital introduced equal to the value of the property. You could then point out that fi a person wishes to borrow to finance his business rather than finance the cost himself, that does not mean that the interest he pays on the borrowing is not wholly and exclusively for the purpose of his business. If a person were required to provide the whole of the finance for his business mortgage interest could never be allowed.
I doubt this is actually a change of HMRC policy. it seems to be an individual Officer taking an idiosyncratic view. I would be surprised if that view was upheld on review.

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By Justin Bryant
23rd Oct 2017 17:41

This HMRC policy change was mentioned last month here:

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By Vaughan Blake1
24th Oct 2017 09:16

This issue seems to stem from the time Sch A was scrapped and Sch D rules were applied to the concept of a 'property income business'.

With a 'Sch D' business, loan interest is generally allowable provided the proprietor's capital account is not overdrawn. I have successfully argued that even if it is overdrawn, the interest is allowable if we can effectively clear the O/D capital account by adding back accumulated depreciation as a non cash movement.

So why should it be any different for the 'property business'? I think the problem is that HMRC are not differentiating between the proprietor and the business. The business is using the funds to provide working capital, it is the proprietor who is using his drawings for non business expenditure. Therefore, as far as the business is concerned the interest is incurred 'wholly and exclusively'.

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By JCresswellTax
24th Oct 2017 09:35

Would love an any answers answered or Tax Tv discussion on this - Tim and Giles if you are listening...

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By raycad
24th Oct 2017 10:49

I am an avid follower of Rebecca Cave's articles but there are two stand-out things I would take issue with here. Firstly, the heading: "HMRC altered guidance to deny interest relief". No they didn't! BIM45700 is still there; as has been mentioned it's the dumbed-down GOV.UK guidance which is inadequate (although not actually wrong, I would argue).

Secondly, there is a paragraph headed "HMRC Backs Down" followed by these words: "HMRC are still not backing down." Say that again??

I think at the heart of the issue is the fact that the majority of trading businesses (even quite small ones) have a balance sheet and the proprietors capital account is therefore visible. However, in my experience the vast majority of rental businesses do not have a balance sheet; and even if they do, this is not captured in the Land and Property pages and so is not visible. This is a recipe for confusion and misunderstanding, even if you are dealing with a competent, well-trained HMRC Officer which, sadly, these days is a rarity.

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Replying to raycad:
By Rebecca Cave
24th Oct 2017 11:38

The point is that HMRC altered the guidance in the course of the tax enquiry, not thier manual BIM45700. However the HMRC officer handling the case refuses to pay attention to the BIM para and will only read the guidance.
The sub-heading is incorrect. I had understood that HMRC did back down, but I check the facts with the adviser concerned and the case is continuing to FTT. I will amend the sub-heading.

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Replying to Rebecca Cave:
By raycad
24th Oct 2017 12:27

Comments noted, Rebecca. However, I'm still not convinced that HMRC has "altered" its guidance in any meaningful way. I think the GOV.UK "Idiots guide" was merely updated to reflect the restriction to basic rate relief from April 2017. Yes, there's a reference to wholly and exclusively in there but that has ever been thus for a trading concern, which is how the rental profits have to be calculated; so, for my part, I can see nothing new there.

As I see it, it's simply a case of an ill-informed/trained Revenue officer who has made the classic mistake of taking the Idiots Guide as Gospel. And having painted him/herself into a corner doesn't have the good grace to concede. Sad to say, this happens all the time and with increasing regularity as all the properly trained Revenue staff reach retirement age. Lord help us when MTD comes in!

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By starbanana
26th Oct 2017 12:53

As as already been alluded to by several posters, unless the new loan exceeds the capital introduced to the letting business at the start then surely the loan must be wholly and exclusively for the business. Effectively it's substituting a loan from the owner (of the difference between the market value at introduction and the original mortgage) with a 3rd party loan.
The only way I could see any contention would be over the market value at introduction.

I don't really see any inconsistency between the wording of the BIM or the page. The difference of interpretation seems to come from whether the original loan, or market value is the threshold for whether the additional loan is w&a for the business. Example 2 seems to provide clarity on that.

I wonder what would happen in the case the owner paid down the principal by £x thousands but then a couple of years later increased the loan again.

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By sammerchant
31st Oct 2017 16:46

The problem stems from the fact that most HMRC staff have little or no knowledge of accountancy/bookkeeping.

I remember a wasted afternoon trying to explain to the 'VAT man' why the purchases and sales figures in the accounts did not tally with the corresponding VAT Returns.

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By Swedish Chef
25th Oct 2018 11:50

Rebecca - is there any update on this? Did this case ever go to FTT?

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By Mister E
25th Feb 2019 10:09

Any news on this.
Seems it has been left up in the air and I read conflicting advice on this. Some say drawing capital still fine and others say it is not.
BIM45700 includes the example of a property re mortgaged for personal reasons and allowed, so my view is it is all fine to claim, albeit HMRC may have an issue with doing so it does not make it wrong.

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