Deductions: interest: restriction for income tax purposes from 2017/18: apportionment
Apportionment on a just and reasonable basis
Where a property business consists of the letting of both a dwelling-house or dwelling-houses, and other letting, then it may be necessary to apportion interest and finance costs on any loan which has been taken out for the purposes of the whole letting business. The restrictions will apply only to the proportion of the interest and finance costs which relate to the dwelling-house letting.
The legislation does not stipulate how the apportionment is to be made, other than that it must be on a ‘just and reasonable basis’. The examples below show some possible ways in which an apportionment might be made.
Mushtak takes out a mortgage of £120,000 towards the purchase of a rental property which has a retail shop on the ground floor, with a separate residential flat on the first floor. At the time the mortgage is taken out, the mortgage provider values the shop premises at £50,000 and the flat at £150,000. Mushtak’s annual mortgage payments include interest of £4,800.
To decide how much of the mortgage interest is subject to the restrictions applying to a ‘dwelling-related loan’, Mushtak multiplies the interest cost of £4,800 by 0.75 (the value of the residential flat as a proportion of the value of the whole property). This gives a figure of £3,600 interest to which the finance cost restrictions apply. See PIM2058 for how the restriction calculations work.
Mushtak may deduct the balance of £1,200 mortgage interest from his property rental income as part of the calculation used to arrive at his taxable rental profit.
Andy owns a building which includes both residential and office accommodation. The central heating system throughout the building has been causing problems so Andy takes out a loan of £10,000 to have much of the pipework replaced. His annual loan payments include interest of £800.
To decide how much of the mortgage interest is subject to the restrictions applying to a ‘dwelling-related loan’, Andy compares the floor areas of the commercial and residential parts of the building. The residential parts make up 40% of the whole floor area of the building, so he applies that proportion to the annual interest costs to arrive at a figure of £320 to which the finance cost restrictions apply.
Andy may deduct the balance of £480 from his property rental income as part of the calculation to arrive at his taxable rental profit.
Amanda inherits a rental property which consists of several self-contained small office premises. The property is dilapidated and not generating as much income as she would like, so she decides to convert some of the office space into a one-bedroom rental flat while upgrading the remaining office premises. She borrows £80,000 to do the work. Of that, she uses £70,000 for the flat conversion work, and £10,000 to develop some of the office space into an open-plan co-working hub which she intends to let to young entrepreneurs. Her annual mortgage payments include interest of £3,000.
To decide how much of the mortgage interest is subject to the restrictions applying to a ‘dwelling-related loan’, Amanda multiplies the interest cost of £3,000 by 0.875 (the amount spent on the flat as a proportion of the whole loan). This gives a figure of £2,625 to which the finance cost restrictions apply. See below for how the restriction calculations work.
Amanda may deduct the balance of £375 mortgage interest from her property rental income as part of the calculation to arrive at her taxable rental profit.
Plush Properties LLP carries on a large property rental business with a substantial number of both residential and commercial properties. From time to time it takes out loans to acquire new properties or to fund specific work needed on particular properties. It calculates the finance cost restriction for those loans using one or other of the methods in Examples 1 to 3 above.
It also has a revolving overdraft facility with its bank, which it draws on from time to time to fund general working capital costs for the property business as a whole. To decide how much of the overdraft interest is subject to the ‘dwelling-related loan’ restrictions, Plush Properties LLP compares the rents received from the residential properties with the rents received from the commercial properties. 30% of the rent is from residential properties, so Plush applies that proportion to the overdraft interest for the year.
There may be other acceptable methods of apportioning finance costs where those costs have arisen from a loan or credit facility to provide general working capital for the business. For instance, it may be preferable in some cases to calculate the apportionment based on the amount of staff time devoted to each element of the business. We would expect that whatever method is adopted, a business would be able to justify that method by reference to its records, and would apply the method consistently unless there were good reason to change.