26 October 2017
Unexpected changes have occurred to HMRC’s Property Income Manual (PIM) and it’s not obvious whether or not these were meant.
HMRC has re-written parts of the PIM to reflect the restriction of interest relief for landlords who are higher rate tax payers. The revision seems to have reached parts of the manual that other revisions have not reached, much to the surprise of the tax advisory community.
Previously, the PIM indicated that a landlord could refinance a property business and replace capital with borrowings and still claim a deduction for interest paid on the new borrowings. The amended manual appears to prohibit what was previously permitted. Let’s look at an example to explain how the position has changed.
A number of years ago a landlord bought a property to let for £100,000, borrowing £60,000 to finance the purchase. If a balance sheet had been drawn up at that time it would have shown an asset of £100,000 financed by a loan of £60,000 and owner’s capital of £40,000. Five years later the value of the house had risen to £150,000. The landlord then re-financed and took a loan of £100,000 secured on the property, repaying the original £60,000 loan and withdrawing £40,000 of capital.
HMRC guidance previously was that loan interest on the new loan would be deductible against rental as long as the new borrowing did not exceed the original value of the property.
The updated guidance says that interest paid on the new loan can only be claimed as a deduction to the extent that the loan is used wholly and exclusively for the letting business. It’s hard to characterise a proprietor’s withdrawal of capital as being wholly and exclusively for the purpose of the letting business and most owners’ motivations for withdrawing capital usually have at least some personal element.
It’s not clear precisely when the change took place and from when HMRC expects it to be effective. It would certainly be anomalous if HMRC started to restrict deduction of interest in respect of re-financing loans on which interest had previously been allowed as a deduction.
To add to the confusion HMRC’s Business Income Manual (BIM) has a slightly different reading of the rules and BIM 45700 says, ‘A proprietor of a business may withdraw the profits of the business and the capital they have introduced to the business, even though substitute funding then has to be provided by interest bearing loans. The interest payable on the loans is an allowable deduction. This is on the basis that the purpose of the additional borrowing is to provide working capital for the business.’ It could be that the last sentence has something of the flavour of wholly and exclusively about it, but it’s probably more arguable than wholly and exclusively.
Property businesses are supposed to be taxed on the same lines as trading businesses when it comes to computing taxable profits, subject to such specific provisions such as the higher rate loan interest restriction. The potential difference between the new PIM and BIM guidance causes real uncertainty for taxpayers.
Private landlords have been under the tax cosh recently with the interest relief restrictions and the higher rates of CGT payable on gains relating to second properties. They can do without further restrictions on the deduction of interest payable, whether this is by design or not.
If you’re a private landlord and want help to navigate the new tax rules, please contact your usual UHY adviser or use our contact form here.