Is borrowing money against rental property, spending the proceeds elsewhere and claiming tax relief for the loan interest against the property rental income too good to be true?
 Mark McLaughlin
Tax issues relating to property lettings are perhaps the most popular and commonly raised subjects by taxpayers on TaxationWeb's Tax Forum. The question of tax relief for interest on let property has been asked before, but still appears on the Forum on a regular basis. The following query (from 'mknight') deals with interest on borrowings secured against commercially let property, where the loan capital is used for a non-business purpose. Query from TaxationWeb visitor ('mknight') I borrowed £20k against a commercial property I own. The money was used to pay off a debt. Is the interest on the loan an allowable deduction against the rental income? If so, a link to the appropriate HMRC citation will be appreciated. Editor’s CommentsAs 'Kingmaker' points out in the responses below, HMRC's published guidance on loan interest relief is encouraging on this particular issue. HMRC's view broadly appears to be that a property rental business is like any other business, in terms of establishing how much capital its owner has introduced. In the case of a property business, when a property is introduced into the letting business, the capital introduced is generally the market value of the property at that time, less the amount of any mortgage or loan in respect of it. HMRC's Business Income Manual (at paragraph 45700) indicates that it is possible to borrow additional funds against a let property up to this net amount, and to obtain tax relief for those additional borrowings regardless of how the further borrowed funds are spent. The relevant part of the Business Income Manual is reproduced below (subject to Crown Copyright): 'Example 2 Mr A owns a flat in central London, which he bought ten years ago for £125,000. He has a mortgage of £80,000 on the property. He has been offered a job in Holland and is moving there to live and work. He intends to come back to the UK at some time. He decides to keep his flat and rent it out while he is away. His London flat now has a market value of £375,000. The opening balance sheet of his rental business shows: Property at market value £375,000 Mortgage £80,000
Capital account £295,000 He renegotiates his mortgage on the flat to convert it to a buy to let mortgage and borrows a further £125,000. He withdraws the £125,000, which he then uses to buy a flat in Rotterdam. The balance sheet at the end of Year 1 shows: Property at market value £375,000
Mortgage £205,000 Capital account
[B/F £295,000
Less Drawings £125,000]
C/F £170,000 Although he has withdrawn capital from the business the interest on the mortgage loan is allowable in full because it is funding the transfer of the property to the business at its open market value at the time the business started. The capital account is not overdrawn.' When tax advisers became aware of the above guidance, some were surprised by HMRC's apparent generosity! There are anti-avoidance tax rules regarding loan interest, which are intended to deny tax relief if an arrangement has been made wholly or mainly to obtain a deduction for loan interest paid. However, it would seem that mortgage arrangements similar to those in HMRC's example are considered acceptable. As always, professional advice is recommended based on the specific circumstances of each particular case. Forum responses included those reproduced below.'Peter D' commented:It depends on what the money was used for. Was this a business debt or a personal debt. 'mknight' replied:A personal debt (paying off tax liabilities to HMRC). Unrelated to the commerical property. 'Peter D' said:No. 'King_Maker' commented:If it was to re-finance your business capital account (and the total loan did not exceed the value of the property when the property was intorduced into the business), then the answer is Yes. The utilisation of the loan proceeds is not relevant. 'mknight' replied:The total loan did not exceed the value of the property. However, I am not exactly sure what you mean by "to re-finance your business capital account". 'King_Maker' said:To get the flavour of it, have a look at Example 2 in the Inland Revenue's Business Income Manual at section 45700: http://www.hmrc.gov.uk/manuals/bimmanual/BIM45700.htm -------------------------------------------------------------------------------- To view this discussion online (including any possible updates), go to:
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