major changes to the taxation of residential property - eyfile/… · 4 maor changes to the...

Major changes to the taxation of residential property have been announced by the Government, some of which have been implemented from 1 April 2016. It is expected that these changes will have widespread repercussions on the taxation of residential property, with buy-to-let landlords set to be particularly affected.

Changes to the taxation of income from residential property include:

A restriction on the income tax relief available for finance costs incurred by an individual who is in receipt of rental income from residential property

The abolishment of the Wear and Tear Allowance, which is to be replaced by a tax relief on the replacement of items only

In addition, a 3% surcharge on the purchase of residential properties (other than the replacement of an individuals only or main residence or the first purchase by an individual) has also been introduced under both stamp duty land tax (SDLT) and land and buildings transaction tax (LBTT).

The capital gains tax (CGT) reporting regime in respect of residential properties is also being overhauled with payment of any CGT liability being due within 30 days of completion with effect from 5 April 2019.

Major changes to the taxation of residential property

Changes to tax relief on finance costs

Who will this affect?

The changes apply to individual landlords, trustees, partnerships and limited liability partnerships who incur finance costs in respect of UK and overseas residential property. This will include loans to partnerships which are used to acquire residential property. The changes will not affect landlords holding commercial property or properties which qualify as furnished holiday lettings. Importantly, the changes do not affect residential property owned through a company.

These changes will affect all buy-to-let owners and those affected are likely to see an increase in their tax liability. Landlords therefore need to consider how these changes will affect them.

2 | Major changes to the taxation of residential property

What are the new rules?

Individual landlords will no longer be able to claim finance costs, such as mortgage interest, as a deduction from rental income when calculating their taxable rental profit. It will be replaced with a basic rate tax reduction from the individuals income tax liability.

The changes will apply from 6 April 2017 but will be phased in over four tax years so that the full implications of the change will not apply until 6 April 2020. However, as the effect of these changes will result in an increase in the tax liability for many landlords, those affected should now start to consider the impact of these changes on the cash flow and profitability of their rental business. Some landllords may find that the effective rate of tax on their taxable rental income will increase. In some instances the effective rate of tax may increase to in excess of 100% of their net rental profit.

A reminder of the current rules

The full amount of finance costs, which are incurred wholly and exclusively for the purpose of the rental business, can be deducted from gross rental income to calculate taxable rental profits. This deduction therefore reduces the landlords rental income liable to income tax.

Under current rules, landlords may also claim other allowable deductions from rental income, such as rates, insurance, ground rents, repairs, renewals, management and professional fees and costs of services provided.

Further detail on the changes

The changes will be phased in over the course of four tax years, with the full impact from 6 April 2020.

The restriction will apply as follows:

2017/18 allowable deduction restricted to 75% of finance costs basic rate deduction on the remaining 25%



2020/21 no deduction for finance costs basic rate deduction on finance costs incurred

The restriction of tax relief will only apply to expenditure incurred on finance costs. Other expenditure incurred which qualifies for a deduction, for example on repairs, should not be affected. However, landlords should also be aware of the replacement of the wear and tear allowance and the CGT and SDLT changes.

Finance costs explained

The definition of finance costs is broader than interest incurred on a mortgage. In fact, the definition includes incidental costs incurred in obtaining loan-finance, such as arrangement fees, refinancing fees and legal costs. Costs incurred in attempting to obtain finance can also be claimed regardless of whether finance is actually obtained.

It should also be noted that finance costs for these purposes are not only restricted to costs incurred in relation to a mortgage or loan. They also include costs incurred in respect of loans used for the purpose of repairs and improvements.

Key implications for individual landlords

Generally these changes will give rise to higher income tax liabilities for affected landlords. As a result of the reduction of allowable expenditure, their taxable rental income will increase, resulting in an increase in their total taxable income.

The changes may result in a requirement for landlords to file a tax return whereas previously they have not been required to do so.

For basic rate taxpayers, the increased taxable rental income may move them into higher rates of tax.

An increase in taxable income could also affect other personal tax allowances and income assessed benefits, such as Child Benefit.

Landlords will therefore need to consider the effect of any increased tax liability on the cash flow and profitability of their rental business. Whilst the economic profit of the property may not change, when fully implemented the changes could mean that some landlords pay tax at a level that exceeds their net profit so that their rental business may not generate sufficient cash to meet their property liabilities. The illustration below provides examples of the potential cash flow effect of these changes for a landlord.

3Major changes to the taxation of residential property |

Illustration of potential implications on cash flow of the landlord

Tax year 2015/16 2020/21 2015/16 2020/21 2015/16 2020/21

Rate of tax 20% 20% 40% 40% 45% 45%

Gross rents 12,500 12,500 12,500 12,500 12,500 12,500

Interest paid (10,000) (10,000) (10,000) (10,000) (10,000) (10,000)

Income tax payable (500) (500) (1,000) (3,000) (1,125) (3,625)

Net cash flow 2,000 2,000 1,500 (500) 1,375 (1,125)

The first impact of any increased tax liabilities will not be seen until after 6 April 2017, and the full impact not until the year ended 5 April 2021. The timing therefore provides landlords with an opportunity to assess the implications of the changes and consider any action they may wish to take.

As a result of these changes landlords may consider transferring existing rental properties into a company or acquiring new property within a company. Before doing so, landlords will need to consider many other tax implications including:

Capital gains tax

Stamp duty land tax/land and buildings transaction tax

Inheritance tax

Corporation tax

Income tax

Value added tax

Annual Tax on Enveloped Dwellings

Depending on the specific circumstances, it may also be necessary to consider the current consultation on the tax deductibility of corporate interest expenses, which broadly proposes to cap the amount of tax relief for interest expenses incurred by companies at 30% of taxable earnings before interest, depreciation and amortisation (EBITDA). However, it is expected that these rules will be subject to an interest-expense de minimis of 2 million and therefore the majority of landlords considering a corporate structure are unlikely to be affected by these new rules, which are set to take effect from 1 April 2017.

This can be a particularly complicated area and we would therefore recommend seeking professional advice in order to fully understand all of the potential tax implications.

Changes to the Wear and Tear Allowance

A reminder of the current rules

The Wear and Tear Allowance is a claim for tax relief to reflect the cost of wear and tear on furnishings and is currently only available to landlords renting out fully furnished residential properties. It is calculated as 10% of the net rent received from fully furnished residential properties. A claim can be made each year without necessarily incurring any cost but the allowance is limited at 10% even when the landlord incurs higher costs. The allowance is solely dependent on the amount of rental income received.


From 5 April 2016 the 10% annual Wear and Tear Allowance will no longer be available to landlords (including corporate landlords) of residential properties on an annual basis. It is being replaced with a relief that can only be claimed by landlords of residential properties as a deduction in the year that they actually incur costs on replacing furnishings in the property.


The relief applies to the replacement of furniture, furnishings, appliances and kitchenware so that the initial cost of furnishing a property or acquiring new furnishings will not be allowable. The relief applies to furnished, part furnished and unfurnished properties. Moreover, tax relief will only be available on a like-for-like replacement basis. Therefore, if there is any element of enhancement, the tax relief will be partially restricted. Incidental costs of disposal should also qualify for relief, whilst any proceeds received from disposal will be taxable.

Changes to stamp duty land tax and land and buildings transaction tax

A reminder of the old rules

SDLT is charged on transactions relating to land or property in England, Wales and Northern Ireland. LBTT applies to land and property transactions in Scotland. The SDLT or LBTT liability is determined by the amount of the chargeable consideration given for the purchase of the property. Whilst SDLT is levied in increasing increments on property transfers over 125,000, LBTT applies from 145,000. Even where no tax is payable, a return is still required for transactions that are above 40,000.


A new higher rate of SDLT and LBTT has been introduced for purchases of additional residential properties (such as buy-to-let properties and second homes) which complete on or after 1 April 2016. The higher rates for SDLT will not apply where the contract has been exchanged and substantially performed on or before 26 November 2015, but not completed by 1 April 2016. Similarly, for LBTT, the higher rates will not apply if the contract was entered into before 28 January 2016 even if completion takes place on or after 1 April 2016. The higher rate is three percent above the

SDLT Bands Pre-April 2016/main residence SDLT rate

Additional SDLT Rate

Up to 125,000 0% 3% (except for properties where the chargeable consideration is less than 40,000)

Over 125,000, up to 250,000

2% 5%

Over 250,000, up to 925,000

5% 8%

Over 925,000 up to 1,500,000

10% 13%

Over 1,500,000 12% 15%

LBTT Bands Pre-April 2016/main residence LBTT rate

Additional LBTT Rate

Up to 145,000 0% 3% (except for properties where the chargeable consideration is less than 40,000)

Over 145,000, up to 250,000

2% 5%

Over 250,000, up to 325,000

5% 8%

Over 325,000 up to 750,000

10% 13%

Over 750,000 12% 15%

SDLT and LBTT rates previously applicable to all purchases of residential property, as shown in the tables below:


The higher rates will apply if at the end of the day on which the transaction takes place an individual owns two or more residential properties and has not replaced their main residence. If there is a period of overlap on ownership of a main residence (for example, if an individual has completed on the purchase of their new home, but not yet been able to sell their old home and therefore has strictly acquired an additional property), then the higher rate will be payable on the new home but purchasers will be able to claim a refund for the additional SDLT (or LBTT) incurred provided their previous property is sold within 36 months (or 18 months in the case of LBTT) from the date of acquisition of the new property.

If there is a gap where the old main residence has been sold and a new main residence is purchased which is regarded as an additional property, then provided the new main residence is regarded as a replacement of the previous main residence and this occurs within 36 months (or 18 months for the purposes of LBTT) the higher rates should not apply.

Purchases by non-natural persons such as companies and trustees will also be subject to the higher rates, which will apply to even the first purchase of a residential property. It has been confirmed that there will be no exemption from the higher rates for large-scale investors. However, for SDLT, if six or more dwellings are acquired as part of a single transaction the dwellings are treated as not being residential property and the non-residential SDLT rates and bands would apply to the transaction. As regards LBTT, the same rule applies; however, a claim must be made in the land transaction return to apply the non-residential LBTT rates and bands.

For SDLT, the higher rates will not apply to purchases for under 40,000, caravans, mobile homes and houseboats. There are also exemptions for leases granted for less than seven years and freehold or leasehold interests that are reversionary on leases with more than 21 years to run at the date of acquisition. Additionally, small shares in recently inherited properties will not be considered in the three-year period beginning with the date of inheritance when determining if the higher rates apply subject to specific conditions being satisfied.

Effect on Multiple Dwelling Relief

Multiple Dwelling Relief is a relief for transactions where there is an acquisition of more than one dwelling in the same transaction or as part of a linked transaction. The relief must be claimed in a land transaction return. Where the relief is claimed, the rates of SDLT (or LBTT, as appropriate) are based on the average consideration for the number of dwellings, rather than on the total consideration of the combined transaction(s). The additional 3% SDLT rates outlined above will also apply to transactions where a claim for Multiple Dwelling Relief is made. Therefore, the minimum SDLT rate (or LBTT rate) under the new rules will be 3% if the acquisition comprises residential properties.

This relief may be of particular relevance to individuals or companies who are buying more than one property as part of a single transaction or series of transactions. Where six or more properties are being acquired as part of a single transaction, claiming Multiple Dwelling Relief should be balanced against the commercial SDLT (or LBTT) rates that would otherwise apply. However, this can be a complicated area and we would therefore recommend seeking professional advice in order to fully understand all of the potential tax implications.


Changes to Capital Gains Tax

Rates and payment of CGT

A reduction in the CGT rates was introduced with effect from 6 April 2016. The rate of CGT was reduced from 18% to 10% for basic rate taxpayers and from 28% to 20% for higher and additional rate taxpayers. However this reduction does not apply to chargeable gains arising from the disposal of a residential property interest (which therefore still remain taxable at 18% and 28%).

Furthermore, from 5 April 2019, it has been proposed that CGT will be payable within 30 days for individuals who sell a residential property interest, instead of the potential timeframe of up to 21 months that individuals currently have to pay. This change will only affect individual taxpayers (not corporates) who dispose of additional residential property such as buy-to-let properties and second homes.

Capital gains tax for non-UK residents disposing of UK residential property

Rules were introduced in 2015 which meant that CGT would potentially be payable by non-UK residents on the disposal of UK residential property. Prior to this, non-residents were generally outside the scope of a charge to tax on any capital gains arising to them, although the Annual Tax on Enveloped Dwellings (ATED) regime was potentially applicable.

However, due to nuances in the rules certain non-residents were potentially exposed to a double tax charge. As announced in the 2015 Autumn Statement, the Government has amended the CGT computations required by non-residents on the disposal of UK residential property, removing the double tax charge that occurs in some circumstances (specifically, where a non-UK company disposing of UK residential property has also been subject to UK tax under the ATED provisions).

The Government has also prescribed (with retrospective effect from 6 April 2015) two specific circumstances in which a tax return is not required. Furthermore, they will give the Treasury powers to add, amend or remove these circumstances and make consequential provision. The Government will also add CGT to the list of taxes that it may collect on a provisional basis.

How we can help

Although the new rules for financing relief will not apply until 6 April 2017, those affected should begin considering the changes now to understand the impact of any increased tax liability and consider any actions or changes to their investment strategy that they may wish to take. In addition, tax payers should seek advice to ensure they fully understand the potential implications of the SDLT, Wear and Tear Allowance and CGT changes that came into effect in April 2016.

We can provide advice on the:

Impact of the new rules specific to an individuals circumstances. This will assist landlords in identifying where there may be a future cash flow issue to consider

Possible effect of the changes for landlords not previously required to file a tax return which results in a requirement for self-assessment

Options available to landlords in respect of restructuring, growing and/or refinancing their existing portfolio structures

Implications of transferring properties to spouses or other family members taking into account the CGT and other tax implications that may arise

Tax implications of transferring property into a company or acquiring a property using a company

Changes as part of a strategy for succession planning. This can include advice on exposure to inheritance tax, and the use of Family Investment Companies or Family Limited Partnerships

Implications arising from the changes in the Wear and Tear Allowance and SDLT

Compliance obligations associated with the holding and/or disposal of property interests, including advice on the income tax and CGT reporting requirements


Further information

For further information, please contact one of the following or your usual EY contact:

Martin Portnoy T: + 44 161 333 3275 E: [email protected]

David Richardson T: + 44 191 247 2748 E: [email protected]

Elaine Shiels T: + 44 121 535 2110 E: [email protected]

Natalie Parry T: + 44 161 333 2664 E: [email protected]

Jo Hamilton T: +44 161 333 2795 E: [email protected]

Jamie Richards T: + 44 161 234 0583 E: [email protected]

Karl Russen T: + 44 191 247 2617 E: [email protected]

Claire Morton T: + 44 191 247 2710 E: [email protected]

Sarah Traill T: + 44 191 247 2813 E: [email protected]

About EYEY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities.

EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com.

Ernst & Young LLPThe UK firm Ernst & Young LLP is a limited liability partnership registered in England and Wales with registered number OC300001 and is a member firm of Ernst & Young Global Limited.

Ernst & Young LLP, 1 More London Place, London, SE1 2AF.

2016 Ernst & Young LLP. Published in the UK. All Rights Reserved.

ED None

1466171.indd (UK) 06/16. Artwork by Creative Services Group Design.

Information in this publication is intended to provide only a general outline of the subjects covered. It should neither be regarded as comprehensive nor sufficient for making decisions, nor should it be used in place of professional advice. Ernst & Young LLP accepts no responsibility for any loss arising from any action taken or not taken by anyone using this material.

ey.com/uk

EY | Assurance | Tax | Transactions | Advisory

major changes to the taxation of residential property - eyfile/… · 4 maor changes to the...

Documents