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Where Taxpayers and Advisers Meet
New Residential Mortgage Interest Relief Restriction: Review of Principles and Legislation
23/11/2015, by Lee Sharpe, Tax Articles - Property Taxation
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The following is a copy of an e-mail which was sent to the HMRC contact for the forthcoming interest relief restriction for residential landlords. The e-mail was originally sent in September.

The first part considers the broader implications of the new policy. The second part analyses the draft legislation as originally issued. 

The legislation has now received Royal Assent, sporting a new ITTOIA 2007 s 274B to cover a Basic Rate tax credit for discretionary Trusts. But other issues remain, as set out below. In particular, readers may wish to note that there seems to be scope to forfeit relief, thanks to the tension between tax relief and tax credits.

 Update - Interpretation of the Legislation Confirmed as Accurate; further points raised 30/12/15 as below

Dear Madam,

Clause 24: A Review of Restricting Finance Cost Tax Relief for Residential Property Businesses FB2015

I am writing to express several concerns about the new measures which seek to restrict tax relief for the finance costs of those landlords who are individuals.

My concerns are with both principle and practical implementation. These concerns derive from advising clients who will fall within the scope of the regime and also through the TaxationWeb forum.

I shall outline those concerns in brief and then go into further detail. They are based on my appreciation of how the new regime will work. It may well be that I have misunderstood the application of the rules. If this should prove to be the case, then I should in turn be most grateful for your explanation of HMRC’s understanding of how the regime will work.

Sources are:

  • Clause 24 of the Finance Bill 2015 and the proposed additional sections in ITTOIA 2005
  • Explanatory Notes published alongside
  • The Overview Of Tax Legislation and Rates (“OOTLAR”) pp 67 - 69

The Measures

The aim of the measures is to deny those individual taxpayers who are landlords the full extent of the tax relief which they currently enjoy on the costs of financing their residential property businesses. In brief, this is achieved by disallowing those costs in full, and taxing the individuals on correspondingly higher profits, then allowing only 20% tax credit against their resulting tax liabilities. In effect, those landlords secure only Basic Rate tax relief on their finance costs.


The rationale is that landlords are in competition with private homeowners (or aspiring homeowners) and that it is unfair that landlords should get tax relief on their mortgage costs, while private homeowners cannot.

The rationale is utterly specious:

  • Private homeowners are not particularly disadvantaged as against landlords. It is equally arguable that landlords are in fact already disadvantaged as against private homeowners since landlords are obliged to pay Capital Gains Tax on any capital profit in their properties, while homeowners are basically ‘exempt’ from CGT thanks to the provisions of TCGA 1992 s 222 et seq., namely Principal Private Residence Relief. (Please do not infer any criticism of that important relief, whose merits should be obvious, and are as relevant today as when they were mooted in 1965).  Homeowners may bank the capital appreciation in their properties without fear of losing 28% of their gain to the taxman. Landlords, however, have no choice: they are not able even to postpone the charge by rolling the gain into a new property – unlike trading businesses (TCGA 1992 s 152) – nor to pay at the lesser rate afforded by Entrepreneurs’ Relief (TCGA 1992 s 169H, et seq.)
  • Furthermore, the ‘advantage’ enjoyed by residential landlords is equally enjoyed by all other businesses, broadly without exception.

To illustrate the point, I might say that I intended to travel from Manchester to London for some private purpose. I might travel using my own car, or I might instead choose from various alternative carriers:

  • ‘Plane
  • Train
  • Automobile (private hire car or taxi)
  • Coach

I might fume at the cost of any or all of these alternatives but I do not, as a rule, demand that they be denied tax relief on the cost of financing their fleet / rolling stock simply because I cannot claim tax relief for financing the cost of my car. It would be ridiculous to do so, since that is their business, and they pay tax on their surplus, net of (broadly) the economic cost of undertaking that business.          

There are a huge number of businesses which effectively compete with someone acting in a private capacity, and are able to claim tax relief on their costs, unlike a private individual. But those businesses are also paying tax on that activity, which is why they get tax relief in the first place. Why should landlords be treated differently?

Briefly, then, as to principles:

  1. The measures are unfair
  2. They introduce artificial barriers to a market
  3. They are likely to have negative consequences beyond that which may have been considered
  4. And seem doomed to fail. 


The concept of unfairness can be both subjective and emotive. (It may be appropriate at this point to mention that I am not a landlord, although I do of course advise several). Nevertheless, the measures seem to me to be unfair because they disadvantage a minority. The measures are unfair because they fall on a small minority of businesses, as explained in Rationale above, and only a proportion of residential property landlords – i.e., those individuals who both require finance and are exposed to higher rates of tax. Companies are specifically excluded. (ITTOIA 2005 s 272A (5)).

Perhaps the most unsettling aspect of these measures is that they will, in significant numbers, create the very mischief they purportedly set out to address. By disallowing tax relief on mortgage interest and similar – which for many rental businesses can be 50% of the business’ turnover or higher – these measures will ‘create’ landlords exposed to higher rates of tax. Their taxable profits will be completely at odds with their real economic profits. Their other expenses will then effectively be saving them from higher rates of tax.

Artificial Barriers

By imposing an additional tax cost on borrowing to finance residential lettings, the measures will actively discourage entry into the lettings market. Those businesses which are well established, with little or no exposure to finance costs, and companies which let properties, will be able to consolidate their positions in the letting market with relatively little fear of competition from new entrants. It seems to me doubtful that they will reduce their prices in the face of a lack of competition, so as to benefit tenants.

Negative Consequences

  1. Rental businesses are likely to fail as a direct consequence of these measures. I have advised medium-sized rental property businesses with quite modest net profits in real terms but whose finance costs are on a scale such that, once artificially disallowed purely for tax purposes, the resulting additional tax cost will irreparably damage the business. Landlords have likewise posted in to our forum with similar concerns. The problem is exacerbated by high (albeit currently sustainable) levels of gearing and imminent rate rises. Perhaps business failures as a result of these tax measures are seen by the government as a positive outcome, on the basis that it might act to stimulate the housing market in favour of homebuyers. But will tenants not also be adversely affected if a landlord’s business fails?
  2. Tax-Motivated Incorporations or “TMIs” were mentioned in the 2015 Summer Budget Report in the context of the introduction of the new increased rates of Income Tax on dividends, as part of measures to start reducing the incentive to incorporate. (See pages 44 and 73). They were alluded to in the Chancellor’s Speech. Given that TMIs are frowned upon, it seems fearsome strange that one of the Budget’s key measures will undoubtedly encourage significant migration to incorporate residential lettings businesses, so as to avoid the finance costs disallowance; this will, from that perspective, be seen as a negative outcome.
  3. Individuals will suffer other negative effects of being ‘deemed’ taxable at higher rates, such as the forfeiture of Child Benefit, Transferable Personal Allowances, and increased Student Loan Repayments.


Frances has a modest residential letting business, with 3 properties in aggregate resulting in:

£36,000 in gross rental income

£20,000 in finance costs (other allowable expenses ignored for simplicity) and

£16,000 net rental profit

Frances also has a part-time salary of £24,000, taxed under PAYE. She has two children for whom she claims Child Benefit. Frances’ spouse has elected to transfer some of his Personal Allowance to her, in accordance with the new ITA 2007 s 55A et seq., because he does not fully utilise his own tax-free Personal Allowance, as he is the main carer for their children. Frances also has a student loan.

If we compare Frances’ 2016/17 tax position with that projected for 2020/21, using rates and allowances for 2017/18 as the latest available:

















Rental Profit




Add-back Rental Finance Costs

N/A - starts 2017/18



Tax-adjusted income








Tax Charge




Tax Reduction – finance cost

N/A – starts 2017/18



Transferable Tax Allowance



N/A – income too high

Student Loan Repayment




High Income Child Benefit Charge

N/A – income too low







Tax liability








Increase in tax, etc., on 2016/17








Once the new finance relief restrictions are fully phased in by 2020/21, Frances’ effective tax cost will have almost doubled, and her net income from letting almost halved.

Businesses with proportionately higher finance costs may suffer even higher tax costs through their tax returns. However, in the above example, more than half of the additional cost to Frances comes from indirect consequences of her being artificially deemed a higher rate taxpayer, rather than directly as a result of the additional tax on finance costs. Was this really intended – as well as possible adverse effects on Tax Credits entitlements, which are also determined (basically) by reference to taxable income?

  1. Whatever the government’s position on the likely impact of business failures on the residential lettings market, it is presumably the case that the government agrees that there is both a critical and a chronic shortage of suitable housing in the UK. It is therefore quite incredible that the measures include legislation which will discourage landlords from building new homes for letting out. (The cost of financing the creation of new housing is specifically brought within the scope of a “dwelling-related loan” subject to disallowance, by reason of ITTOIA 2005 s 272B (3)). While it may be seen as a necessary anti-avoidance measure, there has for many years been legislation in the VAT code sufficient satisfactorily to isolate the creation of new dwellings (so as to rank for a reduced rate of VAT cost). The risk would seem therefore to be manageable. Why does one tax regime encourage home-building, but another now seek to discourage it?

Of course many properties are developed purely for resale, rather than to hold as a letting investment. But there are landlords who go on to develop new properties to add to their portfolio. I have acted for such clients and I expect many advisers will have done likewise. They now face increased costs to develop property, as well as to let it, and it seems likely that some will decide not to proceed. That cannot be good for the UK.


If it is accepted that people need more houses, it seems that a fundamental rule of economics applies if landlords’ costs should increase: rather than make housing more accessible, prices will rise because demand is inelastic. The extra tax cost will be passed on to consumers in the form of increased rents. This is of course a simplistic model, and I am no economist. But what grounds are there for believing this will not apply?

Implementation – The Legislation

I believe that there are problems with the legislation as well, inasmuch as some parts appear not to achieve the desired effect. Key areas are:

  1. Trusts
  2. Gross Finance Costs definition
  3. Process of the Tax Reduction
  4. General Risk in Tax Reductions

The legislation appears to me to be both confused and confusing. It seems capable of being written much more concisely. Some of the tension appears to derive from the difference between a tax relief, which reduces the amount to be taxed, and a tax reduction, which reduces the amount of tax itself.


ITTOIA 2005 s 272A disallows tax relief, for dwelling-related loans, on profits for Income Tax purposes. Trusts are subject to Income Tax and will therefore fall within the new disallowance regime.

ITTOIA 2005 s 274A (2) provides for  a reduction in tax (a “Step 6” tax reduction by virtue of adjusting ITA 2007 s 26(1)(a) in Chapter 3 of Part 2 of that Act) for an individual. Trusts, therefore, seem currently ineligible for any measure of tax reduction, in relation to their disallowed finance costs.

It could be argued that a beneficiary with an “interest in possession” in a Trust’s rental income may be eligible to claim the Step 6 reduction because he or she will be able to identify a corresponding amount of rental income in his or her own tax return. But an individual’s income from a discretionary Trust may not recognise any particular category of income.

It does seem quite unfair for discretionary Trusts effectively to be penalised by no party’s being eligible to claim at least a Basic Rate tax credit. I have in the past acted for discretionary trusts, set up for disabled individuals, which as part of their investment profile to provide for care in later years, have invested in rental properties subject to mortgage. In this scenario, such a substantial tax hike risks eroding funds painstakingly gauged to provide for a lifetime of essential care.

Gross Finance Costs

The new ITTOIA 2005 s 274A (6) (b) defines Gross Finance Costs Relief as “the total relief to which the individual is entitled under this section…”. But the total ‘relief’ available under s274A is defined in terms of a tax reduction in 274A (3): BR x L. In fact one is referred to as a relief but the other is (should be) a tax reduction.  Gross Finance Costs Relief should surely be defined simply as the aggregate of each “L” to which an individual is entitled in a tax year, and then a rate of tax should be applied to achieve the tax reduction which is both the aim and the title of s274A. Otherwise the restriction of ‘relief’ in 274A (4) makes no sense: BR would feature in both the numerator and the denominator of the fraction, leaving a relief rather than a reduction.

The Process of the Tax Reduction

I should question the steps of the tax reduction itself on two grounds.

1. The thrust of ITTOIA 2005 s 274A (3) is to allow the tax reduction so far as it is ‘covered’ by net rental profits, net also of rental losses brought forwards. But s (4) further restricts the tax reduction so that the overall relievable amount cannot, in effect, exceed that amount of net income which is actually taxed at the Basic Rate of 20%. This might apply where:

  • Interest costs are relatively high,
  • Other expenses are such as to significantly restrict net rental incomes, and/or
  • The tax-free Personal Allowance is otherwise relatively unused

Perhaps optimistically, my appreciation is that the motive for the provisions is to ensure that the tax reduction is fully offset, and none wasted. But this is unnecessary, since a tax reduction does not require rates to be matched in order to be fully effective. The only risk to the taxpayer would be in terms of set-off against income already covered by an otherwise unrecoverable tax credit and in this regard dividends would be the obvious cause. But this problem will not now arise, because it is avoided by the impending changes to dividend taxation – specifically, the abolition of the notional tax credit. These changes are to take effect from April 2016, a year ahead of the introduction of the new measures affecting landlords. We are now left with the prospect of the restriction in s274A (4) serving predominantly to inhibit the most beneficial utilisation of the new tax reduction. In other words, to hinder rather than to help. I rather hope that the government agrees that this is not desirable, given that relief is already curtailed to no more than 20%. If I have misunderstood and the government’s intent is indeed further to restrict the utilisation of the tax credit, then I (and no doubt landlords and other advisers) should be keen to know what mischief the measure seeks to prevent.

2. ITTOIA 2005 s 274A (5) provides for a carry-forwards of unutilised relievable amounts. Helpfully, it works in absolutes: if the tax reduction turns out to be less than the full measure of what would be afforded by virtue of (3)(a), then the shortfall may be carried forwards to be included in (3)(a) in future years. It seems there is scope for unutilised relievable amounts to be carried forwards indefinitely – albeit not beyond the life of the property business. However, there appear to be opportunities to forfeit reductions, as set out in the following example.


Let us assume that in 2020/21, where Personal Allowances have remained at £11,200:




Jim has gross residential rental income of                      



Mortgage interest of                                                               



Rental losses brought forwards of                                     



Unused relievable amounts brought forwards of       



And earned income of                                                              



This means that:

  • ITTOIA 2005 s 272A (4) determines that there is no tax relief for the loan interest, which is fully added back. Tax-adjusted rental profits for the year are therefore £40,000.
  • Conventional rental losses brought forwards reduce the taxable rental income to £30,000.
  • Combined with other income, the total assessable income is £31,200.
  • Net of tax-free Personal Allowances, taxable income is £20,000.
  • Prior to adjusting for any tax reduction, the resulting tax charge is £20,000 x 20% = £4,000.

With regard to the tax reduction:

ITTOIA 2005 s 274A (3) sets the relievable amount “L” by reference to the lower of:



The aggregate of the mortgage interest disallowed       


+ unutilised relievable amounts brought forwards           






Taxable property profits net of conventional losses        


The lesser amount, “L” is


ITTOIA 2005 s 274A (4) then compares

Gross Finance Costs relief (in this case essentially L)                 £25,000        


Adjusted Total Income, or ATI. ATI is a complicated affair. It aggregates total income, presumably as defined in ITA 2007 s 23 at Step 1, but extracts savings and dividends income. It then deducts the Step 3 Allowances (tax-free Personal Allowance and Blind Persons’ Allowance) so as broadly to derive the amount of income which will be taxed at the Basic Rate of 20%.

ATI deliberately overlooks Step 2 of the normal tax liability calculation at ITA 2007, which deducts various trading losses, and property losses brought forwards. In this example, one consequence is that ATI is not reduced by property losses brought forwards.

ATI is therefore (£30,000+£10,000)+£1,200-£11,200 =               £30,000        

Since Gross Finance Costs Relief is not constrained by Adjusted Total Income in this example, the adjustment of relief under ITTOIA 2005 s 274 A (4) does not take effect.

The relievable amount (L) remains at £25,000, taxable at the Basic Rate of 20%. The tax reduction is £5,000, while the tax liability is only £4,000. The excess tax reduction does not secure a refund, because ITA 2007 s 29 (2) restricts any and all tax reductions to no more than the aggregate tax liability.

ITTOIA 2005 s 274A (5) deals with carrying forwards unutilised relievable amounts. Again, it is complicated but appears essentially to allow a carry-forward of any excess relievable amount over and above that calculated at ITTOIA 2005 s 274A (3) (a) as above. This would be in point where the relievable amount were derived from ITTOIA 2005 s 274A (3) (b), or s 274A (4) instead.

But this is not the case here, since neither alternative part is in point; it is instead the standard ITTOIA 2005 s 274A (3) (a) which applies.

In this example, despite an excess of tax reduction, there is no carry-forwards of relievable amount to later tax years, and the in-year excess is forfeit. A similar result to the above example might happen with trading losses brought forwards under ITA 2007 s 83. It might also happen with other loss relief claims, such as trading losses claimed against general income (ITA 2007 s 64) although it might reasonably be argued that there is an element of choice about a claim against general income, since it is at the taxpayer’s discretion. But trading and property business losses brought forwards (ss 83 and 118) are not discretionary: they must be applied against next available profits. I do not think that it was intended that there should be a forfeiture of tax reduction in such cases. Were ATI re-defined so as to ensure that the tax reduction be restricted actually to meet amounts ultimately taxable at a non-zero rate, then this mismatch should not arise.

General Risk in Tax Reductions

While I observed earlier that there appears to be scope to carry forwards unutilised tax reductions indefinitely, the tax reduction collapses to nil, if there be no rental profits, by reason of ITTOIA 2005 s 274A (3) (b). There is no facility to carry back unutilised tax reductions on cessation of a rental business. There are of course opportunities to carry back trading losses, either through ITA 2007 s 64 or, if appropriate on cessation, ITA 2007 s 89. It seems quite plausible that property businesses will suffer to the point of cessation because of the disallowed finance costs, only to suffer again because there is insufficient scope fully to utilise the corresponding accumulated tax reductions. If the government’s intention is to restrict tax relief on finance costs to just 20%, then it seems unfortunate, and hopefully unintended, that there seems to be so much opportunity for the proposals to cost landlords so much more. It seems to me to be symptomatic of an attempt to use tax reductions outside of their normal parameters: mainstream use tends to be limited to minor adjustments to a taxpayer’s liability, rather than a substantial reduction as now proposed.


I hope that the foregoing has proved useful. If any further issues arise, I shall let you know. Any feedback will be welcome – we shall be happy to disseminate to other interested parties, as appropriate.

With regards,

Lee Sharpe



Update 30/12/15

Dear Madam,

Thank you for your confirmation. I fear I must also raise a further point with you.

I had previously noted that the unutilised relief brought forwards could not of course outlive the property business, by reason of the new ITTOIA 2005 s 274A (3) (b). Having had cause to reflect further on the legislation, I now think the legislation is more punitive than this: any unutilised relief carry-forwards cannot outlive the loan.

I had thought that s274A (3) (a) (ii) would allow for the preservation of unutilised relief brought forwards without requiring current year disallowances / relievable amounts.

But I see now that the opening lines of s274A are:

274A Tax reduction for individuals

(1) Subsections (2) to (5) apply if 

(a) an amount (“A”) would be deductible in calculating the profits for income tax purposes of a property business for a tax year but for section 272A, and

(b) a particular individual is liable to income tax on N% of those profits, where N is a number—

(i) greater than 0, and

(ii) less than or equal to 100.

(2) The individual is entitled to relief under this section for the tax year in respect of an amount (the “relievable amount”) equal to N% of A.

In other words, on re-reading, I think that s274A (3)(a)(ii) applies only where there is a disallowance under s272A in the current year.

To me this seems potentially to be a very strong disincentive to pay off one’s mortgage, if there are substantial amounts of unutilised credit brought forwards, it would be most inefficient to pay off the loan.

I can appreciate the logic of defining Adjusted Total Income (s 274A (6)) to exclude savings and dividend income. Initially I had assumed that this was to preserve the tax credit against only “real” tax but on further reflection I think it is meant to motivate affected landlords to pay down their debt with surplus investment funds (i.e., those funds that are generating the dividends and/or interest). That seems to fit in with the underlying purpose of reducing BTL borrowings.

But if I have understood the effect of the legislation as set out above, that part seems to run utterly opposite. Or is the point basically that landlords must pay off as much as possible before the disallowance applies in full and (hopefully before) any unutilised/able relief arises? If so, then I think landlords need to be made aware of this, and the sooner the better.

With kind regards

About The Author

Lee is TaxationWeb's Articles & News Editor and writes for TaxationWeb. He is a Chartered Tax Adviser with experience of advising individuals and owner-managed businesses over a broad spectrum of tax matters.
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