Unused residential finance cost
Since 2017/18, the amount of income tax relief that landlords with residential properties have been able to claim on residential property finance costs (e.g. mortgage interest) has gradually been restricted such that for the year 2020/21 the restriction is now given as a tax reducer at the basic rate of tax (i.e. 20%). Loans that are wholly for commercial properties, land and property dealing or development businesses or properties used for a furnished holiday letting business are not affected.
Landlords affected by this restriction may have noticed a box on the 2020 tax return as being Box 45 – Unused residential finance costs brought forward.
Completion of this box records the amount of interest that has not been utilised in one year to be carried forward and to the finance costs figure of the following year. The tax reduction for that following year is then calculated using both the amount brought forward and the current year’s finance costs. The tax reduction applies to each property business separately such that any ‘excess’ tax reduction on an overseas property business cannot be used against a UK property business or share of partnership property business or vice versa. If the property has made a loss then no tax deduction will be given either and the unused finance cost amount for that year will be carried forward and utilised in the following year’s calculations. The tax reduction cannot be used to create a tax refund.
Calculating the amount of restriction to be applied can be complicated in some circumstances. The amount to claim is the lower of the finance costs incurred, the profits of the property business (less losses brought forward) and the taxpayer’s total taxable income (after deduction of the personal allowance but ignoring savings and dividend income). This restriction may result in an amount being disallowed, therefore the amount not used is carried forward to be utilised in any following year and recorded in box 45.
Basic Example:
Tax year 2019 – 2020
Employment before tax = £40,000
Rental income = £21,000
Other expenses = £(8,000)
Property profits = £13,000
Finance costs = £14,000 (£3,500 allowable against rental income – 25%)
Taxable income = £49,500 (£40,000 + £13,000 – £3,500)
Income Tax calculation:
£49,500 less personal allowance (£12,500) = £37,000
Tax due: (£37,000 x 20%) £7,400
Finance cost tax reduction calculated
on property profits (£9,500 x 20%) £ (900)
Final Income Tax = £5,500
The tax reduction is calculated as 20% of the lower of:
- finance costs = £14,000
- property profits = £9,500
- adjusted total income (exceeding personal allowance) = £49,500
The lowest figure is property profits, so £9,500 x 20% = £900 tax reduction. £1,000 finance costs (£10,500 – £9,500) that have not been used are shown in box 45 and carried forward being added to the finance costs for that year and then the total amount restricted accordingly.
If a landlord has brought forward amounts of restricted finance costs from earlier years and has receipts from their property business of £1,000 or less then they have the choice of either claiming expenses and using the reducer calculation in the normal way or claiming the Property Income Allowance (PIM) tax exemption. If they choose the PIM route then the restricted finance costs figure is carried forward to be used in any future years’ income tax liability calculation. Individuals can decide on a year by year basis which approach to take.
The ability to carry forward unused finance costs will be beneficial to those landlords with a temporary reduction in property income possibly because a property is vacant for a period or a short-term increase in costs (e.g. due to refurbishment).
Renovating the holiday let during lockdown
The Covid-19 pandemic has hit the hospitality and leisure industry hard. Landlords with furnished holiday lettings have been unable to let their properties for considerable periods of time as a result of national and local lockdowns.
Properties need regular maintenance and refurbishment, and while being in lockdown is not ideal, it does provide a window in which to undertake repairs and generally refresh and improve the property. Where expenses are incurred during a period for which the property is unavailable for letting, are the associated expenses deductible in computing the profits or losses of the furnished holiday business?
General rule
Expenses are deductible in computing the profits and losses for a property business as long as they are revenue in nature and are incurred wholly and exclusively for the purposes of the business. If the accounts are prepared using the cash basis, capital expenditure may also be deductible in accordance with the cash basis capital expenditure rules.
Impact of property closure
It will generally be the case that repairs and refurbishments are undertaken while the property is not let – no one wants to rent a holiday home to find they are sharing it with builders.
Where the property is kept solely for letting as furnished holiday accommodation, but is in fact closed for part of the year because there are no customers or no business, HMRC allow a deduction for all associated expenses incurred in this period as long as there is no private use. Consequently, where the furnished holiday let is closed during lockdown, a deduction should be forthcoming for expenses incurred in this period.
However, a deduction is not permitted where the property is used privately. Consequently, if the landlord is living in the property during lockdown and undertaking the work at the same time, a deduction will be denied for expenses incurred during the period of private use. The landlord may need to balance the convenience of living in the property while doing the work against the loss of associated deductions for tax purposes.
Repairs v improvement
Where significant work is undertaken, it is important to understand the distinction between repairs, which essentially maintain the property, and improvements, which enhance it. A repair will include replacing roof tiles blown off in a storm, whereas a new extension would constitute an improvement. Repairs are revenue expenses which can be deducted, whereas improvement expenditure is capital expenditure which cannot in computing profits.
Self-employment and the £2,000 Dividends allowance
All taxpayers, regardless of the rate at which they pay tax, are entitled to a tax-free allowance for dividends. For 2020/21 this is set at £2,000, so if you’re thinking of branching out to be self-employed or have made the switch last year, this is what you need to consider.
Nature of the allowance
If you’re self-employed and own your limited company, you can take money out of your company as a dividend, or you may receive a dividend payment if you own company shares.
Although termed the ‘dividend allowance’ it is in fact a zero rate band. Dividends covered by the allowance are taxed at a zero rate of tax, but count towards band earnings.
Where the personal allowance has not been otherwise utilised, dividends sheltered by the personal allowance are also received free of tax.
Dividends not covered by the allowance
Where dividends are not sheltered by either the dividend allowance or the personal allowance, they are taxable at the dividend rates of tax. Where the taxpayer has different sources of income, dividends are treated as the top slice of income. For 2020/21, dividend income is taxed at 7.5% to the extent that it falls within the basic rate band, at 32.5% to the extent that it falls within the higher rate band and at 38.1% to the extent that it falls within the additional rate band.
Using the 2020/21 allowance
The dividend allowance is lost if it is not used in the tax year. As the end of the 2020/21 tax year approaches, it is sensible to review your dividend policy and consider whether it desirable, and indeed possible, to pay further dividends before the 2020/21 tax year comes to an end on 5 April 2021.
Where an individual receives dividends both from their investments and their family or personal company, depending on their shareholdings, their dividend income may have fallen in 2020/21 as a result of the Covid-19 pandemic. This may provide the scope to pay higher dividends than normal from the family or personal company in order to utilise the allowance.
However, remember that dividends can only be paid from retained earnings.
Where profits are low for example if you have just started a business, or a loss has been made in 2020/21 as a result of the pandemic, this does not necessarily prohibit the payment of dividends – dividends can be paid as long as retained profits brought forward are sufficient to cover both any loss and any dividends paid out.
To comply with company law requirements, dividends must be paid in accordance with shareholdings. However, using an alphabet share structure (such that one shareholder has A class share, another has B class shares, and so on) overcomes this restriction and allows dividend payments to be tailored to utilise family members’ unused dividend (and indeed personal) allowances for 2020/21.
When to tell HMRC about your new business
Lockdown restrictions have forced many businesses to close temporarily. Selling goods or clothes on sites such as eBay and Depop offers the opportunity to raise some much needed cash in these difficult times.
What are the associated tax implications and do you need to tell HMRC about it?
Badges of trade
There is a difference between occasionally selling an unwanted item and running an online business. When selling items online, it is necessary to consider whether you are actually trading. The courts have looked to the ‘badges of trade’ to answer this question. These are indicators that taken together provide an overall impression as to whether a trade exists.
The badges of trade are as follows:
- profit-seeking motive — an intention to make a profit indicates trading;
- the number of transactions – systematic and repeated transactions indicate trading;
- the nature of the asset – an asset that it can only be turned to an advantage by sale suggest trading;
- existence of similar trading transactions or interests – transactions that are similar to those of an existing trade may themselves be trading;
- changes to the asset –repairing, modifying or improving the asset to make it more easily saleable or saleable at a greater profit indicates trading;
- the way the sale was carried out – selling the asset in a way typical of trading organisations suggests trading;
- source of finance – selling the asset to repay funds borrowed to purchase it may indicate trading;
- interval of time between purchase and sale – a short interval of time between purchase and sale may indicate trading;
- method of acquisition – assets acquired by inheritance or as a gift are less likely to suggest trading.
There is no single overriding factor that provides conclusive proof that a person is trading; rather it is a question of forming an overall impression by considering the badges of trade.
Trading allowance
Even if the sale of goods amounts to a trade, it not always necessary to tell HMRC about it, or pay tax on any profits.
The trading income allowance removes the need to tell HMRC about trading income where the gross annual income from one or more trades is £1,000 or less for the tax year. If you are self-employed and sell goods on eBay as a side line, it is not possible to use the trading allowance for the side line if income from your main trade is more than £1,000 – you must report both to HMRC.
What to tell HMRC
If your gross income from all trades that you carry out is more than £1,000, you must tell HMRC about your income and expenses on your self-assessment tax return (registering for self-assessment first if you are not already registered).
In working out your profit you can either deduct expenses wholly and exclusively incurred in connection with the trade or, if more beneficial, the £1,000 trading allowance. Deducting the allowance will generally be more beneficial if expenses are less than £1,000. However, as the deduction of the allowance cannot create a loss, if after deducting actual expenses there is a loss, it is better to deduct the actual expenses rather than the allowance so you can benefit from the associated loss relief.
If your profits are high enough, you may also need to pay Class 2 and Class 4 National Insurance contributions. For 2020/21, you will need to pay Class 2 National Insurance if you profits from self-employment are more than £6,475 and Class 4 if your profits are more than £9,500.
Personal and family companies – you have time until April to use up your dividend allowance to reduce your additional tax.
*Nature of the dividend allowance*
One allowance that is available to all taxpayers, regardless of the rate at which they pay tax, is the dividend allowance. The allowance is set £2,000 for 2020/21.
Although called an ‘allowance’, the dividend allowance is more of a nil rate band. Dividends sheltered by the allowance are taxed at a zero rate of tax. However, the dividends covered by the allowance count towards band earnings.
Once the dividend allowance and any remaining personal allowance have been used up, any further dividend income (treated as the top slice of income) is taxed at the relevant dividend tax rate:
• 7.5 for dividends falling within the basic rate band;
• 32.5% for dividends falling within the higher rate band; and
• 38.1% for dividends falling within the additional rate band.
*Personal and family companies*
If you have a personal company and have sufficient retained profits, consider paying a dividend if you have not already done so to mop up your dividend allowance and any unused personal allowance. Although dividends are paid from profits which have already suffered corporation tax, the availability of the dividend allowance allows retained profits to be extracted without incurring any additional tax. A further benefit is that there is no National Insurance to pay on dividends.
In a family company scenario, making family members shareholders provides scope for family members to utilise their dividend allowances, allowing profits to be extracted in a tax-efficient manner.
There are some points to watch. Dividends can only be paid from retained profits and must be paid in proportion to shareholdings. However, the use of an alphabet share structure whereby each family member has a different class of shares (e.g. A shares for one person, B shares for another, and so on) provides the flexibility to declare different dividends for each person, depending on their available allowances and their marginal rate of tax.
Example
Mr Wilson is a director of W Ltd. His wife and two adult daughters, Emily and Evie, are both shareholders. The shareholdings are as follows
• Mr Wilson – 100 A Ordinary shares;
• Mrs Wilson – 100 B Ordinary shares;
• Emily Wilson – 100 C Ordinary shares
• Evie Wilson – 100 D Ordinary shares.
Mr Wilson is a higher rate taxpayer. None of the family has used their dividend allowance for 2020/21.
Mr Wilson wishes to declare a dividend of £8,000 for 2020/21.
If he declares a dividend £80 per share for A ordinary shares only, he will receive a dividend of £8,000, of which the first £2,000 will be covered by the dividend allowance of £2,000. The remaining £6,000 will be taxed at the higher dividend rate of 32.5%, giving rise to a tax bill of £1,950.
However, if instead, he declares a dividend of £20 per share for A, B C and D Ordinary Shares, each member of the family will receive a dividend of £2,000, which will be sheltered by their dividend allowance and received tax-free. By taking this route, the family’s tax bill is reduced by £1,950.
Advantages of using a property LLP
Advantages of using a property LLP
A limited liability partnership (LLP) can be used for a property business and offers some advantages over unincorporated businesses and limited liability companies. A property LLP is something of a halfway house, providing the comfort of limited liability with the flexibility as to how profits are shared.
The use of a property LLP can be particularly useful in a family situation where the individuals each hold property in their own name, but a different income split would be beneficial from a tax perspective.
*Setting up a property LLP
Like a company, a property LLP must be registered at Companies House.
An LLP can hold property in its own right. The LLP can acquire property or the partners can transfer property that they already own into the LLP.
Transferring property into the LLP can be advantageous from a tax perspective. The property is held on trust in the LLP, but the underlying legal ownership is unchanged, meaning there is no SDLT to pay. Where a member transfers property into the LLP, the value of that property at the time of transfer forms the opening balance on their equity account.
*Flexibility to share profits and losses
One of the key benefits of the LLP is the flexibility to share profits and losses. This provides the potential for a tax efficient distribution.
The default position is to share profits and losses in accordance with the ratios on the members’ capital accounts. However, the ability to pay salaries in a different ratio provides flexibility to tailor the distribution in a tax efficient manner. Providing or withdrawing capital will also change the default profit sharing ratio.
*Tax position
From a tax perspective, an LLP is transparent for tax purposes.
This means that the individual partners are treated as being self-employed and must pay income tax on their share of the profits, and also Class 2 and Class 4 National Insurance contributions where relevant.
Where a property is sold realising a gain, the individual partners pay capital gains tax on their share of the gain.
Each individual partner must return their income from the LLP on their personal tax return. The LLP must file a partnership return.
It is important that the LLP is carried on with a view to making a profit as anti-avoidance rules may apply which have the effect of switching the tax transparency off.
Speak to a member of our team to explore this further.
