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).
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.