The gradual restriction of higher rate income tax relief for finance costs
The restriction of income tax relief will apply to:
- Individuals
- Who let residential property in the UK or elsewhere, and
- Who are claiming a deduction for financing costs (see below for list of costs included) from April 2017, and
- Who pay income tax on their property income at the higher (40%) or additional (45%) rates.
It will not apply to:
- Financing costs for purchase of furnished holiday let property,
- Property businesses subject to corporation tax - owned by companies, or
- Individuals who pay tax on their property income at basic rate only.
The new measure will gradually restrict landlords' tax relief, for finance costs to purchase residential properties, to the basic rate of income tax. From 6 April 2020 landlords affected will no longer be able to deduct their finance costs from their property income. Instead they will receive a basic rate deduction from their income tax liability.
Between now and the 6 April 2020 relief will be tapered as follows:
| 2017-18 | The deduction of allowable finance costs will be restricted to 75%, with 25% being available as a basic rate income tax deduction. | | 2018-19 | The deduction of allowable finance costs will be restricted to 50%, with 50% being available as a basic rate income tax deduction. | | 2019-20 | The deduction of allowable finance costs will be restricted to 25%, with 75% being available as a basic rate income tax deduction. |
A worked example: consider the case of Linda, who has a buy to let with an annual mortgage interest charge of £10,000. Up to April 2017 she will be able to deduct the full amount, £10,000, from her property income before she pays tax. Obviously, the higher her rate of income tax the more tax relief she will currently receive.
The table below sets out the effective loss of tax relief if Linda is a higher rate or additional rate taxpayer. If Linda only pays tax at the basic rate there is no change in her income tax position.
| 2016-17 | 2017-18 | 2018-19 | 2019-20 | 2020-21 | | Finance cost allowed | 10,000 | 7,500 | 5,000 | 2,500 | 0 | | If additional rate taxpayer: | | Additional rate 45% relief | 4,500 | 3,375 | 2,250 | 1,125 | 0 | | Basic rate deduction | 0 | 500 | 1,000 | 1,875 | 2,500 | | Total tax relief | 4,500 | 3,875 | 3,250 | 3,000 | 2,500 | | Net finance costs paid | 5,500 | 6,125 | 6,750 | 7,000 | 7,500 | | If higher rate taxpayer: | | Additional rate 40% relief | 4,000 | 3,000 | 2,000 | 1,000 | 0 | | Basic rate deduction | 0 | 500 | 1,000 | 1,875 | 2,500 | | Total tax relief | 4,000 | 3,500 | 3,000 | 2,875 | 2,500 | | Net finance costs paid | 6,000 | 6,500 | 7,000 | 7,125 | 7,500 |
Because the amount of tax relief is gradually reduced, from April 2017 to April 2020, the cash flow impact is progressively negative for higher rate or additional rate tax payers. In our example, if Linda is a higher rate taxpayer her net finance costs (after deduction of tax relief) increase from £6,000 in 2016-17, to £7,500 in 2020-21.
A further consequence of this change to a basic rate deduction is that the rental income for tax purposes increases with no increase in rents: the finance costs are added back. In some circumstances this may mean that basic rate taxpayers become higher rate tax payers. |
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