Beta This part of GOV.UK is being rebuilt – find out what this means

HMRC internal manual

Property Income Manual

From
HM Revenue & Customs
Updated
, see all updates

Deductions: Interest: Restriction of relief for income tax purposes from 2017-2018

 

 

Sections 272A, 272B, 274A, 274AA, 274B and 274C ITTOIA 2005

Sections 399A and 399B ITA 2007

These sections, introduced by s.24 Finance (No. 2) Act 2015 and s.26 Finance Act 2016, collectively have the effect of limiting relief for relevant interest and finance costs to the basic rate of relief.  The changes take full effect over several years between 2017/18 and 2020/21.

 

Calculation of the restriction

Relevant finance costs

The restrictions apply in respect of:

  • Income tax charged in relation to property businesses carried on by individuals (whether alone or in partnership), trustees and personal representatives of deceased estates and individuals who as beneficiaries of estates are chargeable to income tax under Chapter 6 of Part 5 of ITTOIA (see TSEM7453).  Companies carrying on property business are not affected.
  • Interest and other finance costs on loans taken out for a property business which involves the letting of residential properties.  Loans which are wholly for commercial properties, or for properties which are used for a furnished holiday letting business (see PIM4100) are not affected
  • Any payments which, although not described as interest, are made in connection with a relevant loan and are economically equivalent to interest in the hands of the recipient.  This would include amounts chargeable under Chapter 2A, Part 4 of ITTOIA.
  • Any incidental costs incurred in obtaining the loan.  This includes items such as fees or commission payments, but would exclude, for instance, exchange rate losses on a loan taken out in a currency other than sterling.

 

Relevant residential property lets

The restrictions apply to what the legislation terms a ‘dwelling-related loan’.  This means any amount borrowed for the purposes of a property business, to the extent to which both of the following apply:

  • the business consists of receiving rental income from a dwelling-house, and
  • the loan amount is used for that part of the business.

“Dwelling-house” has its normal dictionary meaning in this context, and can include part of a dwelling-house as well as the land and gardens attached to the house.  However furnished holiday accommodation which is let commercially (see PIM4100), is specifically excluded from the definition of “dwelling-house”.

A loan will be regarded as being for the purposes of a relevant property business if it is for the acquisition, construction or adaptation of the dwelling-house in question.

 

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.

 

Example 1

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 below 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.

 

Example 2

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.

 

Example 3

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.

 

Example 4

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. Note: 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.

 

Calculation of the restriction

The restriction to the amounts of ‘dwelling-related loan” costs which may be deducted in arriving at taxable profit is being phased in over several years, beginning in 2017/18.  The restriction applies as follows:

  • 2017/18           75% of finance costs may be deducted from rental income
  • 2018/19           50% of finance costs may be deducted from rental income
  • 2019/20           25% of finance costs may be deducted from rental income
  • Thereafter        0% of finance costs may be deducted from rental income

 

Individual beneficiary subject to income tax on estate income including property income

The finance cost restriction also applies to personal representatives carrying on a property business as part of a deceased person’s estate, to the extent that the property business includes income from the letting of a dwelling-house or part of a dwelling-house.

Under Chapter 5 of Part 6 ITTOIA an individual is charged to income tax on income treated as arising from an interest in the residue of an estate (see TSEM7453).  If any such estate income includes income from a property business which has had finance costs restricted as a result of section 272A, then the individual is entitled to a reduction at the basic rate in respect of his “relievable amount” relating to that property business.

 

Calculation of the basic rate tax reducer

Individuals

s274A, s274AA – C ITTOIA 2005

For individuals (including partners in a property rental partnership) the balance of finance costs which would otherwise qualify for relief but which because of the restriction has not been deducted in arriving at taxable rental profits, may be relieved at the basic rate of tax and deducted from tax liability for the tax year in question

To arrive at the actual amount of relief to be deducted, the individual may need to carry out calculations in several stages.  This is particularly the case if he or she is involved in more than one property business or receives income from property in more than one capacity. For this purpose, the individual will be involved in more than one property business if he or she lets property both in the UK and overseas. And any UK or overseas property business carried out by a partnership in which the individual is a partner, must be looked at separately from a property business which the individual carries on alone (see PIM1020). Income received by an individual from a deceased estate in administration should be regarded as arising from a separate property business from any carried on by the individual either alone or in partnership.

 

Step 1 – calculate “relievable amount” for each property business

For each relevant property business in which the individual is involved, do the following:

  • Identify the interest and finance costs which would be deductible in arriving at taxable profit for that property business, were it not for the restriction imposed by section 272A.
    • If the property business in question is one operated by a partnership of which the individual is a member, the relevant amount is the amount which (without section 272A) would have been deductible by the partnership in arriving at its profits, multiplied by the individual partner’s percentage profit entitlement.
    • If the property business in question is one operated by the executors of a deceased person’s estate, the relevant amount is the beneficiary’s share of the amount which (without section 272A) would have been deductible by the executors in arriving at the profits.
  • Add any as yet unrelieved amount relating to that business (or the individual’s share of that business) brought forward from earlier years – see below.

The total of these figures gives the individual’s “relievable amount” in respect of that property business.

 

Step 2 – calculate adjusted profits for the business

For each relevant property business in which the individual is involved, do the following:

  • Calculate the profits for the property business in question and deduct any loss brought forward under section 118 ITA 2007. Where the property business in question is carried on in partnership, the figure needed is the individual’s share of the profits, less any loss brought forward under section 118. Where the property business in question is carried on by the executors of a deceased person’s estate, the figure needed is the amount paid to the individual by the estate to the extent that figure is attributable to

 

Step 3 – Find “L” – lower of the results of Steps 1 and 2

For each relevant property business in which the individual is involved, do the following:

  • Compare the results of Steps 1 and 2 above
  • Take the lower figure - this is “L”.

 

Step 4 – Calculate Adjusted Total income

  • Identify the individual’s net income for the year from all sources (see Step 2 of the calculation in section 23 ITA)
  • Deduct savings income (sections 18(3) and (4) ITA)
  • Deduct the allowances listed in Step 3 of section 23 ITA (personal allowances, blind person’s allowance)

The result is “adjusted net income” or “ATI”.

 

Step 5 – Calculate amount of relief at basic rate

  • Identify all the individual’s “L”s for the year (Step 3 above) and add these together – this sum of “L”s is “S”.
  • Compare S with adjusted net income (Step 4 above)

 

  • If S is less than adjusted total income, apply the basic rate of tax for the tax year to the relievable amount (Step 1 above).  The resulting total amount is deducted at Step 6 of the calculation in section 23 ITA.

 

  • If S is greater than adjusted total income, then apply the basic rate of tax to the number obtained by carrying out the calculation according to the formula below.  The resulting amount is deducted at Step 6 of the calculation in section 23 ITA.

  ATI

_____    X     L

   S

Any balance of the unrelieved amount which is still unrelieved may be carried forward to future years and taken into account in Step 1 above..

 

Example

Jonny has income from two property businesses. He’s a member of a property partnership with an entitlement to 30% of the profits, and he has a separate property business which he runs alone.  He also has other self-employed profits totalling £4,000.

The example assumes that the tax year is 2020/21 or later, and Jonny has a personal allowance of £11,000 a year.

 

Property business A – partnership

Rental income                                                             £54,000Finance costs (£21,000)                                             nil deduction

Other allowable expenses                                           £15,000

Property business A profits                                         £39,000

Jonny’s share of the profits                                         £13,000

 

“Relievable amount” = £7,000, being the £21,000 unrelieved finance costs x 30% (Jonny’s partnership share)

“Adjusted profits” in this case are £13,000.“L” = £7,000, being the lower of the relievable amount and Jonny’s 30% share of the net profits

 

Property business B – Jonny’s own business

Rental income                                                               £5,000

Finance costs (£1,500)                                                nil deduction

Other allowable expenses                                             £7,000

Property business C loss                                             -£2,000

 

“Relievable amount” = £1,500

“Adjusted profits” = £0

“L” is £0, being the lower of the relievable amount and the net profit

 

The sum S of all Jonny’s L amounts is £7,000.

 

“Adjusted total income” calculation

Jonny’s total net income, consisting of his property profits of £13,000 and his other self-employed income of £4,000, is £17,000. He has no dividend or savings income, so his adjusted net income according to s274A(6) is (£17,000 less personal allowances of £11,000) = £6,000.

S (£7,000) is greater than ATI (£6,000) in this case, so the amount which will actually be relievable in respect of each relievable amount is determined by the formula at Step 5 above.

 

Property business A   Basic Rate relief

 

6,000

_____    X     7,000  = 6,000 x Basic Rate

   7,000

 

The unrelieved “relievable amount” of £1,000 (£7,000 - £6,000) may be carried forward to  the next tax year.

 

 

 

Property business B Basic Rate relief

£0

Jonny’s unrelieved “relievable amount” of £1,500 from his own property business, may be carried forward to the next tax year.

 

 

Restriction of relief for interest on loan used to invest in a property partnership, and basic rate tax reducer

Sections 399A and 399B ITA 2007

Individuals may claim relief against taxable income for interest on loans taken out to invest in a partnership (section 383(1) and section 398 ITA).  That relief is also subject to restriction, where the partnership in question carries on a property business which includes the letting of a dwelling-house or part of a dwelling house.

The restriction applies to the proportion of interest paid which can (on a just and reasonable basis) be attributed to the dwelling-house letting element of the partnership’s whole business.

 

The restriction is being phased in over several years, beginning in 2017/18.  The restriction applies as follows:

  • 2017/18           75% of the interest which would otherwise be relieved under s383(1)
  • 2018/19           50% of the interest
  • 2019/20           25% of the interest
  • Thereafter        0% of the interest

 

Basic rate tax reducer

The individual is entitled to deduct from his tax liability, the proportion of the interest which would by relievable under s383(1) were it not for the restriction imposed by section 399A, multiplied by the basic rate of tax.

 

Example

In the tax year 2020/21, Jo pays loan interest of £10,000 on a loan which she has taken out to invest in a property-letting partnership.  The partnership owns a block of residential flats which are let to tenants, and its whole property business relates to those lettings.

Under section 383(1) and section 398 Jo would be entitled to deduct the £10,000 from her income, before calculating her income tax liability for the year.

Section 399A prevents the relief from being deducted from Jo’s income.  Instead, the basic rate of tax is applied to the £10,000, and the resulting sum is deducted from Jo’s tax liability.

 

Calculation of the basic rate tax reducer for trustees of an accumulated or discretionary trust

Section 274B ITTOIA 2005

The restriction also applies to the trustees of accumulated or discretionary trusts which are carrying on property business.  (For more information about these types of trusts, see TSEM1565).

The restriction is calculated as for individuals as described above.  Similarly, the trustees of the settlement are entitled to relief at the basic rate.

The amount of the basic rate reduction to which the trustees are entitled is calculated as below:

 

Step 1 – calculate “relievable amount” for each property business

For each relevant property business carried on by the trustees, do the following:

  • Identify the interest and finance costs which would be deductible in arriving at taxable profit for that property business, were it not for the restriction imposed by section 272A.  If the property business in question is one operated by a partnership of which the trust is a member, the relevant amount is the amount which (without section 272A) would have been deductible by the partnership in arriving at its profits, multiplied by the trust’s percentage profit entitlement.
  • Add any as yet unrelieved amount relating to that business (or the trust’s share of that business) brought forward from earlier years – see below.

The total of these figures gives the trustees’ “relievable amount” in respect of that property business.

 

 

Step 2 – calculate relevant profits

For each relevant property business carried on by the trust, do the following:

  • Calculate the profits for the property business in question and deduct any loss brought forward under section 118 ITA 2007. Where the property business in question is carried on in partnership, the figure needed is the trust’s share of the profits, less any loss brought forward under section 118, which is accumulated or discretionary trust income.

 

 

Step 3 – Find “L” – lower of the results of Steps 1 and 2

For each relevant property business carried on by the trust, do the following:

  • Compare the results of Steps 1 and 2 above
  • Take the lower figure - this is “L”.

Step 4 – Calculate basic rate reducer

Multiply “L” by the basic rate of income tax for the year – this is the amount of tax which may be deducted from liability.