Buy-to-let landlords are being pushed over tax cliff edges, as their taxable income is increased by restrictions on the amount of interest they can deduct from their rents.
Back in 2015 I warned that individual landlords would face huge tax bills, as the tax relief on interest and finance charges connected with letting residential was gradually reduced, from a 25% restriction in 2017/2018 to 100% block from 6 April 2020. This restriction does not apply to corporate landlords, or those letting furnished holiday lettings or commercial property.
The higher income tax bill is partially softened by a tax credit equivalent to 20% of the blocked interest, but it is the amount of taxable income which determines eligibility for many allowances, and has a knock-on effect for other taxes.
The Low Income Tax Reform Group (LITRG) has identified over a dozen unintended consequences of the restriction on interest deductions, which I’ve categorised below.
Where taxable income exceeds the basic rate band (£50,000 in 2019/20, £43,430 for Scottish taxpayers) the marriage allowance is withdrawn. This is the transferable part of the personal allowance which can only be utilised if the recipient doesn’t pay tax at rates higher than the basic rate, or the intermediate rate (21%) in Scotland. Thus just £1 of income in the higher rate band means all of the marriage allowance is lost, worth £250 for 2019/20.
The personal allowance is tapered away by £1 for every £2 of taxable income over £100,000, producing a marginal tax rate of 60%, or 61.5% for Scottish taxpayers.
The pensions annual allowance is reduced by £1 for every £2 until it reaches a minimum of £10,000, where net adjusted income exceeds £150,000. If pension contributions are paid in excess of the annual allowance, taking account of any unused allowance brought forward, the taxpayer will be subject to a pensions annual allowance charge at their highest marginal tax rate.
Where one or both parents has taxable income over £100,000, they are not eligible to have a tax-free childcare account. Breaching this income threshold will also mean the family loses entitlement to 30 hours free childcare. The family can also be hit by the high income child benefit charge (HICBC) which will claw back child benefit paid to the family by 1% for every £100 of the higher earner’s taxable income over £50,000.
In both cases the income of the higher earning partner effects the entitlements of the whole family.
Parents who are liable to pay child maintenance will find they have to pay larger amounts based on their taxable income.
Individuals who have outstanding undergraduate student loans have to pay 9% of their taxable income above these thresholds:
- £18,935 for plan 1 loans
- £28,725 for plan 2 loans
Those who have also taken out a postgraduate loan must pay an additional 6% of their taxable income above £21,000 from 6 April 2019. The interest restriction could easily push a landlord over these thresholds from 2017/18 onwards.
Taxpayers who have significant savings income may enjoy their interest tax-free where it is covered by their personal savings allowance (PSA), or the starting rate for savings (0% on up to £5000).
The PSA is set at £1,000 for basic rate taxpayers and £500 for higher rate taxpayers, but is withdrawn for those in the additional rate band. The restriction on interest deductions may thus reduce the savings allowance to £500 or nil, and eliminate the band available for the zero rate on savings.
Where a landlord has savings income, but also has property related loans on which the interest deduction is restricted, it would make sense to use those savings to reduce debt in the property business.
An increase in taxable income will have a greater effect for Scottish taxpayers as there are more tax bands and higher income tax rates in Scotland. The tax credit for Scottish landlords is still 20%, although the intermediate rate in Scotland is 21%.
The rate of CGT payable is dependent on the level of the taxpayer’s taxable income. The interest restriction could result in the taxpayer paying CGT at 20% rather than at 10%, or at 28% on residential property gains rather than at 18%.
As dividends are taxed as the highest slice of income, the interest restriction could push the dividend income into a higher tax band, attracting tax at 32.5% or 38.1% rather than at 7.5%.
Advise your clients
The knock-on effects of the interest restriction in 2017/18 will have been relatively minor as only 25% of interest was blocked. You will see a far greater impact in the 2018/19 tax returns, and this should be projected forward for 2019/20 and 2020/21 to take action before it’s too late.