Many Buy To Let properties were purchased in individual names, that was norm before, then from 2017/18 we saw the introduction of clause 24 (section 24).
Essentially Section 24 removes Interest from the property expenses and gives you tax relief (finance allowance) at 20% (basic rate). So Higher rate tax payers will pay more tax.
Historically, its been common for BTL owners to regularly remortgage and with draw capital, basically cashing in on house price rises.
But what many owners seem to have overlooked is that if the mortgage exceeds the original property value (including SDLT and related costs) plus any improvement costs, then the mortgage interest is further restricted.
Increasing a mortgage
If you increase your mortgage loan on your buy-to-let property you may be able to treat interest on the additional loan as a revenue expense, as long as the additional loan is wholly and exclusively for the purposes of the letting business.
Interest on any additional borrowing above the capital value of the property when it was brought into your letting business is not tax deductible.
£2 million (for returns from 2013 to 2014 onwards)
£1 million (for returns from 2015 to 2016 onwards)
£500,000 (for returns from 2016 to 2017 onwards)
is owned completely or partly by a:
company
partnership where any of the partners is a company
collective investment scheme – for example a unit trust or an open ended investment vehicle
Returns must be submitted on or after 1 April in any chargeable period.
Some properties are not classed as dwellings. These include:
hotels
guest houses
boarding school accommodation
hospitals
student halls of residence
military accommodation
care homes
prisons
It is possible that dwellings contained within the same building can be treated as a single dwelling, and the aggregate value applied. The details can be found in Section 117 FA 2013.
However, for a standard HMO property, where each of the dwellings is separately accessible, and none can be accessed privately via any of the other dwellings in the property, then none of the property values may need to be aggregated for the £500k threshold.
You pay Class 2 if your profits are £6,515 or more a year
Class
Rate for tax year 2021 to 2022
Class 2
£3.05 a week
So for the whole year that’s £158.60
Are you running a business?
You have to pay Class 2 National Insurance if your profits are £6,515 a year or more and what you do counts as running a business, for example if all the following apply:
being a landlord is your main job
you rent out more than one property
you’re buying new properties to rent out
If your profits are under £6,515, you can make voluntary Class 2 National Insurance payments, for example to make sure you get the full State Pension.
You do not pay National Insurance if you’re not running a business – even if you do work like arranging repairs, advertising for tenants and arranging tenancy agreements.
As soon as you reach state pension age, you stop paying Class 2 NIC if you carry on working. You only have to pay them on any earnings that were due to be paid to you before you reached state pension age.
In addition Companies who own properties don’t pay national insurance, national insurance is only paid by employees and the self employed.
Class 2 NI would also not apply if you use a letting agent to collect the rents – average fees would be 15%, even if it is a relative or your own company as then your role will only a passive investment role.
The key case on this topic is Rashid v Garcia (Status Inspector) (2002) Sp C 348
Decision released 11 December 2002.
National Insurance – Class 2 contributions – Self-employed earner – Landlord – Taxpayer had income from letting property – Claim for incapacity benefit – class 2 National Insurance contributions paid to qualify for benefit – Revenue took view that property rental activities did not entitle taxpayer to pay class 2 contributions as he was not carrying on business – Benefit refused – Whether taxpayer was self-employed earner carrying on business – Social Security Contributions and Benefits Act 1992, s. 2, 122.
The taxpayer had four properties income £10,942.
It was estimated that the taxpayer spent two to four hours per week on managing the properties and members of his family acting on his behalf spent 16 to 24 hours per week. The Special Commissioner considered this was insufficient activity to constitute a business so no Class2NI was due.
Samantha lets out a property that she inherited following the death of her great aunt. This will not constitute a business.
Bob owns ten properties which are let out to students. He works full time as a landlord and is continually seeking to increase the number of properties he owns for letting. Bob is running a business for NICs purposes.
Claire owns multiple properties that are let. She spends around half her working time carrying out duties as a landlord and is not looking to increase the number of properties she owns. If the only duties that Claire undertakes are those normally associated with being a landlord, then this would not constitute a business.
Hasan purchases properties using “buy to let” mortgages. He places all letting duties in the hands of a property letting agent who acts as landlord on his behalf. If the only duties that the property letting agent undertakes for Hasan are those normally associated with being a landlord, then this would not constitute a business.
The new HMRC penalties cover late submission, late payment and interest harmonisation and unlike the old penalties you will now get points and penalties even if you owe no tax or are due a refund! there will be no soft landing period.
The new penalties take effect:
for VAT taxpayers for their first VAT return period starting on or after 1st April 2022
for ITSA (Income tax and self assessment) taxpayers within income over £10k subject to Making Tax Digital (MTD) for their first tax year or accounting period starting on or after 6th April 2023
for ITSA taxpayers with income below £10k starting 6th April 2024
In theory the penalties are fairer but they can work out more expensive than the current penalties.
The new system is based on points, each late return gets a penalty point which expire after 24 months.
The points only apply to VAT and ITSA (not to other taxes at the moment)
Once the penalty threshold is reached there is a fixed penalty of £200 for each missed return, there is an appeals process.
Submission Frequency
Penalty Theshold
Annual
2 points
Quarterly
4 points
Monthly
5 points
Total points will only be reset to zero once when the following 2 conditions are met
A period of compliance based on their submission frequency
All submissions that were due within the preceding 24 months have been submitted
Submission Frequency
Period of Compliance
Annual
24 months
Quarterly
12 months
Monthly
6 months
Late Payment Penalty
Late Payment could potentially mean you get two penalties depending on when you pay!
The first penalty will be levied 31 days after the payemnt due date and will be based on a set percentage of the balance outstanding.
The second penalty will be calculated on amounts outstanding from day 31 until the principle balance is paid in full or a payment plan agreed.
Time to Pay Payment plans suspend penalties.
HMRC will notify the penalties separately.
Penalty
Days after payment due date
Penalty charge
First Penalty
0 to 15
No penalty payable
16 to 29
Penalty calculated at 2% of what was outstanding at day 15
30
Penalty calculated at 2% of what was outstanding at day 15
Plus 2% of what is still outstanding at day 30
Second Penalty
Day 31 plus
Penalty calculated as a daily rate of 4% on APR for the duration of the outstanding balance
There will be a ‘period of familiarisation’ for the first year which is based on 30 days.
Interest Harmonisation
The VAT interest rules will change to be inline with ITSA
When an amount is not paid by the due date, late payment interest will be charged to the taxpayer from the date that the tax becomes overdue until the date payment is received
VAT Repayment Supplement will be replaced with Repayment Interest. Repayment Interest will be paid from the later of:
the due date of the return
the date the return is submitted
If HMRC owe you interest it will be paid at the Bank of England Base Rate -1% but if you owe HMRC interest its at the Bank of England base rate +2%.
Other things to note
The Gateway will tell you how many points you have
The Gateway will tell how penalties have been calculated
Agents will not be able to pay the penalties
When appealing you will need to say who was to blame for missing the deadline
When claiming the deadline was missed due to a health issue a declaration of honesty is required
Companies can have multiple classes of shares and the shares can have different rights. These rights cover:
Voting
Capital Growth
Income via Dividends
This can be of particular benefit to families, the topic is covered in a free publication you can download from our website
Family Investment Companies (FICs), sometimes called Smart Companies, are particularly useful for Inheritance Tax (IHT) and have been used for over a decade as an estate planning tool.
In its simplest form parents lend money to the company and the company is owned by their adult children, but FIC’s can be structured to go beyond that with different assets and share classes.
They are a great alternative to partnerships which are taxed at income tax rates allowing faster growth as Corporation Tax is 19% and income tax can be as high as 45%.
Capital Gains Tax is paid at Corporation Tax Rates (19%) and they don’t suffer from 10 year anniversary or exit charges that are applied to Trusts.
The only slight downside is that extracting profits from a company will incur tax for the individual.
Over a period of time the income and capital shares will be moved to younger members of the family and the older members will retain the voting rights.
HMRC Family Investment Companies Unit
HMRC have been investigating FICs since 2019 and have now stopped, their findings are published in the meeting minutes 13th May 2021
In the research we undertook there was no evidence to suggest that there was a correlation between those who establish a FIC structure and non-compliant behaviours. As with any analysis of a taxpaying population, the same broad range of tax-compliance behaviours were observed, with no evidence to suggest those using FICs were more inclined towards avoidance.
Tax risks related to FICs The key findings in relation to the tax risks associated with FICs are outlined below: • The use of FICs appears to be a planning strategy, often with the primary objective generational wealth transfer and mitigation of Inheritance Tax. • There is some diversity in the way that a FIC is structured and managed, creating tax risks and compliance activity across a variety of tax regimes, including Inheritance Tax, Capital Gains Tax, Stamp Duty Land Tax and Corporation Tax.
Conclusions The team have been subsumed into WMBC and FICs are now looked at as business as usual rather than having a dedicated team
A business commences on 1 October 2010. The first accounts are made up for the 12 months to 30 September 2011 and show a profit of £45,000.
The basis periods for the first three tax years are:
2010-2011
Year 1
1 October 2010 to 5 April 2011
2011-2012
Year 2
12 months to 30 September 2011
2012-2013
Year 3
12 months to 30 September 2012
The period from 1 October 2010 to 5 April 2011 (187 days) is an `overlap period’.
It is a complicated and confusing process and the overlap profit is effectively taxed twice and given back later as tax relief.
There are two ways to gain access to your overlap relief: cease trading or change your accounting date.
The Proposal
The HMRC proposal affects the self-employed, partnerships, trusts, and estates with trading income. The proposal affects unincorporated businesses that do not draw up annual accounts to 31 March or 5 April, and those that are in the early years of trade.
Having carried out a short informal consultation with a range of businesses and tax experts, the government intends to implement the proposed reform ahead of the mandation of Making Tax Digital for Income Tax in April 2023.
The consultation period end on 31st August 2021.
Example
A business draws up accounts to 30 June every year.
Currently, income tax for 2023 to 2024 would be based on the profits in the business’s accounts for the year ended 30 June 2023. Part of the accounts are outside of the tax year, and part of the tax year is not included in profits taxed.
The proposed reform would mean the income tax for 2023 to 2024 would be based on:
3/12 of the income for the year ended 30 June 2023, plus 9/12 of the income for the year ended 30 June 24.
Basis periods are straightforward for the estimated 93% of sole traders and 67% of trading partnerships that draw up their accounts to 5 April or 31 March every year. But if a different accounting date is chosen then the rules are more complex and can be confusing for businesses to understand and apply. The rules can be particularly challenging for new or unrepresented businesses, leading to errors and mistakes in tax returns.
Aligning the basis of assessment for trading income with other forms of income enables wider, simpler reforms to be considered in the future. In particular, transitioning to the tax year basis in the tax year 2022 to 2023 will simplify the introduction and experience of Making Tax Digital for Income Tax. For simplicity, the government proposes a one year transition period, with an option to spread any excess profit arising in that transition period over five years.
The transition tax year would introduce the equivalence rule. This means that businesses can treat the end of the tax year for their tax year basis as any date between 31 March and 5 April.
Alongside this transition, the proposals would mandate that all overlap relief must be claimed in the transition tax year, including any historic transitional overlap relief, or overlap relief generated during the new transition year. No overlap relief would be carried forwards into the new tax year basis, and no new overlap relief would be generated after the transition year.
The new rule, proposed by HM Revenue & Customs under the guise of simplification, could generate a badly needed windfall of more than £1bn for the Treasury next year.
Aligning the reporting date with the tax year would mean that profits that arise in each reporting year would be allocated to that tax year. Currently, profits are taxed for the year in which the business’s accounting period ends. Many partnerships thus end their accounting period on 30 April, allowing them 11 months’ grace.
In summary
The basis period reform will apply from 2023-24.
There will be a transition period in 2022-23.
Accounting periods that end between 31 March and 4 April inclusive will be treated as ending on 5 April.
In the 2022-23 transition year, business profits will be reported from the end of the previous period assessed in 2021-22 up to 5 April 2023.
Businesses with a 31 March 2023 accounting date will report business profits up to that date. This will be deemed to be 5 April 2023.
The subsequent accounting period will be deemed to start on 6 April 2023.
Making Tax Digital (which some have dubbed ‘Making Tax Difficult’) is coming.
Self-employed businesses and landlords with annual business or property income above £10,000 will need to follow the rules for MTD for Income Tax from their next accounting period starting on or after 6th April 2023. However, its expected that HMRC will encourage businesses to start from 6th April 2022 to gain experience in the process before it becomes compulsory.
Its compulsory! failure to comply will result in penalties – you will have 30 days from the end of the quarter in which to file
When it starts the key issues will be
You will basically have 2 returns to file at the same time one for the previous year and new quarterly reporting
The basis periods are expected to be re-aligned so that all the self employed and landlords start at the same time – 6th April 2023
A single annual self assessment will become at least 6 new filings – 4 quarters, end of period and a new self assessment return
The primary legislation for Making Tax Digital relating to VAT and Income Tax is contained in the Finance (No.2) Act 2017.
Business will have to use HMRC approved accounting software, for example
Xero
Sage
Freeagent – free if your business banks with NatWest/RBS
Quickbooks
When we refer to MTD-compatible software, we mean software that can integrate with HMRC systems to send updates to HMRC.
HMRC is not offering its own software products but has provided the Application Programming Interfaces (APIs) that commercial software developers are using to develop a range of applications that enable businesses to keep their records digitally and integrate with HMRC systems. An API is software that links 2 or more software programmes together, allowing them to exchange data.
So there won’t be a Government Gateway where you can enter the information, you have to use commercial software approved by HMRC.
You have to have all your self employed and property businesses in a single piece of software but be able to report the information separately for each business in the following formats
Furnished Holiday Lets
Income
Accounting Basis (Traditional or Cash)
Rent paid, repairs, insurance and costs of services provided
Loan Interest and other financial costs
Legal, management and other professional fees
Other allowable property expenses
Private use adjustment
Profit or Loss
Residential Property Income
Total Rents and other income from property
Accounting Basis (Traditional or Cash)
Rent, rates, insurance and ground rents
Property repairs and maintenance
Non-residential property finance costs
Legal, management and other professional fees
Costs of services provided, including wages
Other allowable property expenses
Profit or Loss
Private use adjustment
Residential property finance costs
Self Employed
If the turnover is below £85,000 only Turnover and Total Expenses need to be reported otherwise you will need
Turnover
Accounting Basis (Traditional or Cash)
Costs of goods bought for re-sale
Car, van and travel expenses
Wages, salaries and other staff costs
Rent, rates, power and insurance costs
Repairs and maintenance of property and equipment
Accountancy, legal and other professional fees
Interest and bank and credit card etc financial charges
Telephone, fax, stationery and other office costs
Other allowable business expenses
Profit or Loss
What is the process?
Stage One – Sign Up and Software
Business that fall within the scope of MTD ITSA (Income Tax Self Assessment ) will need to be signed up before April 2023
‘Digital Records’ need to kept on approved HMRC software
The minimum amount of information will be Date, Amount and Tax Category
The information needs to be summarised in the format noted above
Each property and business activity will need its own reports
Stage Two – Quarterly Reporting
An electronic submission of summary totals for specified categories from digital records of each business on a quarterly basis (obligation period) from software to HMRC needs to be made
The first submission will include designatory data
Updates are due from 10 days before to one month after the quarter end date
The update does not need to include a statement that the data is complete and accurate
HMRC will return a calculation of the tax liability based on the information sent but payment will due on the current pre-MTD dates (or at least for now)
Stage Three – End of Period Statement
Process to finalise the taxable profit or allowable loss for any one source of business income
The process will pull together the quarterly submissions and allow you to claim allowances and reliefs
You will be able to exclude disallowable expenses
This submission does require a declaration that the information is complete and correct
HMRC will then calculate the tax due
Stage Four – Final Declaration (New Self Assessment Return)
Referred to as crystallisation
It will take into account all sources of income and gains not just those from Self Employment or Property
Every year we are given a personal tax allowance, this year its £12,570 (2021-22) last year it was £12,500 (2020-21).
The allowance is the amount we can earn before we pay tax.
The tax bands are currently (2021-22)
Band
Taxable income
Tax rate
Personal Allowance
Up to £12,570
0%
Basic rate
£12,571 to £50,270
20%
Higher rate
£50,271 to £150,000
40%
Additional rate
over £150,000
45%
But on your tax return the personal allowance is allocated in a specific order
Non-savings income – comprised of earnings, pensions, taxable social security payments, trading profits and income from property. The highest type gets the first allocation.
Section 25 (2) states …deduct the reliefs and allowances in the way which will result in the greatest reduction in the taxpayer’s liability to income tax.
What makes this even more complicated is the the way that other allowances work for example the Savings Allowance and Dividend Allowance.
Your allowances for earning interest before you have to pay tax on it include:
your Personal Allowance
starting rate for savings
Personal Savings Allowance
Starting rate for savings
You may also get up to £5,000 of interest and not have to pay tax on it. This is your starting rate for savings.
The more you earn from other income (for example your wages or pension), the less your starting rate for savings will be.
If your other income is £17,570 or more
You’re not eligible for the starting rate for savings if your other income is £17,570 or more.
If your other income is less than £17,570
Your starting rate for savings is a maximum of £5,000. Every £1 of other income above your Personal Allowance reduces your starting rate for savings by £1.
Personal Savings Allowance
You may also get up to £1,000 of interest and not have to pay tax on it, depending on which Income Tax band you’re in. This is your Personal Savings Allowance.
To work out your tax band, add all the interest you’ve received to your other income.
Income Tax band
Personal Savings Allowance
Basic rate
£1,000
Higher rate
£500
Additional rate
£0
Dividend Allowance
The Dividend Allowance is currently £2,000
You only pay tax on any dividend income above the dividend allowance.
Tax band
Tax rate on dividends over the allowance
Basic rate
7.5%
Higher rate
32.5%
Additional rate
38.1%
Your SA302 Tax Calculation should show you how the allowances have been allocated.
This is often referred to clause 24 or section 24 relating to Finance Act 2015 (No 2) [Section 26 Finance Act 2016] that introduced the change which started from 6th April 2017. It took full force for the tax year 2020/21. The rules restrict interest relief to the basic rate of tax (20%).
The legislation was inserted into Income Tax (Trading and Other Income) Act 2005: Sections 272A, 272B and 274A-274C and Income Tax Act 2007: Sections 399A and 399B.
The legislation does not apply to Furnished Holiday Lets or Limited Companies.
Finance Costs include all finance costs, even those to buy furnishings and the incidental cost of arranging the finance.
The Relief
Its calculated as 20% of the lower of
Finance costs not deducted from income, or
The profits of the property business, or
The adjusted total income
What is adjusted Total Income?
Net income is defined in the Income Tax Act 2007 Section 23
23 The calculation of income tax liability
To find the liability of a person (“the taxpayer”) to income tax for a tax year, take the following steps. Step 1
Identify the amounts of income on which the taxpayer is charged to income tax for the tax year.
The sum of those amounts is “total income”.
Each of those amounts is a “component” of total income.
Step 2
Deduct from the components the amount of any relief under a provision listed in relation to the taxpayer in section 24 to which the taxpayer is entitled for the tax year.
See [F1sections 24A and 25] for further provision about the deduction of those reliefs.
The sum of the amounts of the components left after this step is “net income”.
It excludes Saving and Dividend Income (ITA07/S18 (3) & (4)).
It excludes the personal allowance and blind persons allowance (ITA07/S23).
The end results is adjusted total income (ATI) – S274AA.
A tax reduction can not be used to create a tax refund but it can be carried forward.
Example 2020-21 onwards
Fred has
Employment Income £45,000
Residential Property Income £25,000
Mortgage Interest £10,000
Allowable expenses £5,000
Property Losses Carried Forward £15,500
Unused Finance Costs carried forward from 2019-20 £2,000
Calculation as follows
Employment Income
£45,000
Property Income Calculation
Rental Income
£25,000
Finance Costs – you can’t deduct Mortgage Interest
£0
Allowable Expenses
-£5,000
Property Business Profits
£20,000
Less Property Losses Carried Forward
-£15,500
Taxable Property Business Profits
£4,500
Net Income – Employment and Property
£49,500
Income Tax Calculation
Personal Allowance £12,500 at 0%
Basic Rate £37,000 at 20%
£7,400
Higher Rate £0 at 40%
Income Tax Liability before Residential allowance
£7,400
The Basic Rate Tax 20% reduction for Residential Property is the lower of
Finance Costs not deducted in this case that’s £10,000 Mortgage and £2,000 Unused Finance Costs carried forward from 2019-20 which totals £12,000
Property business profits which are £4,500
Adjusted total income (exceeding personal allowance) £37,000 (£49,500 – £12,500)
The lowest amount is the
Property business profits which are £4,500
So the basic rate tax reduction is 20% x £4,500 = £900
We can now deduct that from the £7,400, leaving £6,500 as the final income tax liability.
Unused Finance Costs
Residential Finance Costs
£12,000
Used in the Basic Rate Reduction
-£4,500
Unused Residential Finance Costs
£7,500
The Unused Residential Finance Cost is carried forward to the next tax year, in this example 2021-22.
We repeat the calculations above in 2021-22, following all the same steps.
Let’s assume in 2021-22 his net income from Employment and Property is £60,000
The tax would be 0% x £12,570 plus 20% x £37,700 plus 40% x £9,730 = £11,432
The Basic Rate Tax 20% reduction for Residential Property is the lower of
Finance Costs not deducted £10,000 Mortgage as in the previous year and £7,500
Unused Finance Costs = £17,500
Property business profits which are £20,000 (assuming its the same as the previous year – losses having been used up in the previous year)
Adjusted total income (exceeding personal allowance) £47,430 (£60,000 – £12,570)
The lowest is £17,500.
So the basic rate deduction is £17,500 x 20% = £3,500
£11,432 less £3,500 gives a final income tax liability of £7,932
Unused Finance Costs
Residential Finance Costs and carried forward amount
£17,500
Used in Basic Rate Reduction
-£17,500
Unused Residential Finance Costs to be Carried Forward
