New UK tax measures will target rental profits, putting the brakes on the ‘buy to let’ market
United Kingdom tax legislation is becoming ever more complex. Property ownership as an investment has been the focus of several recent legislative changes in an effort to cool the housing market, and most of these are designed to discourage buy-to-let investment. For landlords living outside the UK, such as in Hong Kong, the new measures mean they could likely owe more tax on their rental profits.
A restriction on the relief for mortgage interest and other finance costs against rental income is being phased in from April. In 2017 to 2018, only 75 per cent of such costs will be permitted as a deduction against the rents received and this will be reduced by 25 per cent each subsequent year.
The remaining unrelieved finance costs will be given limited relief by way of a credit against a person’s tax liability at 20 per cent of the costs. By 2020 to 2021, relief will only be given by way of the credit, known as a “tax reducer”. This will slash the relief obtained by higher rate tax payers resulting in quite material increases in their tax liabilities, and potentially, the net cash flows becoming negative.
At present, companies that let property can continue to offset finance costs in full.
The “Wear and Tear” allowance for furnished rental properties was abolished on April 6, 2016. This relief provided a notional tax deduction at roughly 10 per cent of the gross rents received to attempt to reflect the ongoing average cost of continually furnishing a property. In its place, individuals are now entitled to tax relief on the cost of replacing furniture, which in most cases is likely to be less generous.
Since April 2016, when acquiring a new rental property or second home, a 3 per cent surcharge on the Stamp Duty Land Tax (SDLT) rate payable is applied. Unfortunately, there is limited relief from this and there are a host of pitfalls. For example, if you buy a new home but have not managed to sell your original home by that time, you suffer the higher rate. You can claim back if you sell the original home within 36 months – but this is a cash flow pinch at a time when you may be able to least afford it.
The Capital Gains Tax (CGT) rate reductions to 10 per cent to 20 per cent from 18 per cent to 28 per cent introduced by the 2016 budget do not apply to residential property. So the gains realised on properties not covered by Principal Private Residence relief or lettings relief will be subject to the old higher rates. There is some planning that can be considered to work around this, but it requires investment in certain tax advantaged shares, which themselves carry commercial risks.
For non-UK residents investing in UK real estate, the government is looking to close any existing loopholes. The additional SDLT of 3 per cent will also apply to Hongkongers who already own homes (regardless of where the home is located) when they purchase property in the UK.
It is also common for Hongkongers to own UK residential property through BVI companies to shelter the property from UK inheritance tax. Going forward this will not work and the property will be subject to UK inheritance tax upon death of the owner. It is recommended that advice on “de-enveloping” the structure is taken.
New rules will be introduced in April this year to bring all UK residential property into the UK inheritance tax net, regardless of how it is held. This is most relevant for non-UK “non-doms” and relevant offshore trusts where a residential property is held through a company. The company shares will no longer be ignored for inheritance tax purposes.
For those of you who currently pay the annual charge on such properties, it is important that you review the position carefully because it may be beneficial to unwind the company to remove the Annual Tax on Enveloped Dwellings (ATED) liability, but this will be judged on the potential SDLT and ATED related CGT charge that could arise. In some instances, the structure may continue to be the most appropriate vehicle or, perhaps, the best of a set of bad options.
Ishali Patel is senior manager of expatriate tax services at Buzzacott