A matter of interest
A change in HMRC’s internal guidance has left tax experts baffled. The trouble relates to a paragraph in HMRC’s business income manual ( BIM45700 ), which refers to landlords raising loans to pay themselves back for capital they put into their rental businesses.
Example. In 2001 Hal moved into a house owned by his financée, and let his flat. At the time it was worth £150,000 and had a mortgage of £100,000 against it. The flat, which he still lets, is now worth £240,000 and the mortgage remaining is just £20,000. In 2017 Hal remortgaged the property for £180,000 and uses the extra cash towards the purchase of a holiday home for himself and his now wife.
Tax-deductible limits
BIM45700 used to make clear that in a situation like our example, the interest was tax deductible from rental income. The deductible amount is that paid on £150,000 of the loan, i.e. the amount of capital Hal introduced to the rental business (in the form of his flat) when he started to use it in his rental business.
Why is the interest allowable?
At one time there were differing opinions over whether the interest on the loan was tax deductible. The arguments went like this:
The incorrect view. The borrowing was for the purchase of Hal’s second home. Tax relief is not allowed for interest on loans to purchase homes and so a tax deduction can’t be claimed.
The correct view. The true order of the transactions was that Hal borrowed the money so that his rental business could repay the capital he provided it. This is a tax-allowable reason. He used the cash to buy the second home. The second part of the transaction is irrelevant because it only concerns what Hal did with the cash which he had borrowed for a tax-allowable purpose. Eventually HMRC included an example, at BIM45700 , which specifically confirmed someone in Hal’s position was entitled to claim a deduction for the interest.
What’s changed in 2017?
HMRC has done two things; first it has amended BIM45700 to remove the example mentioned above and amended text to make the position less clear. Second, it is due to argue before the First-tier Tribunal (FTT) that to be allowable the capital repaid to the landlord must be used “wholly and exclusively” in the course of the rental business, i.e. as working capital. If you’re in the same position as Hal, what should you do?
Tip. Our advice is to carry on claiming a deduction for interest as before (subject to the new rules for residential lets which have applied since 6 April 2017 – yr.17, iss.11, pg.6 , see The next step ). Based on the facts we know about the FTT case, HMRC’s argument is bound to fail. If challenged by HMRC you can still use BIM45700 to justify your claim – it’s just not as clear as it was before (see The next step ).