Tax impact of rising interest rates spells bad news for buy-to-let landlords

On Thursday 22 September, the Bank of England increased its base rate to 2.25 per cent, its highest level since 2008. Considering the base rate was only 0.1 per cent on 14 December 2021, this will cause significant concern for all businesses that rely heavily on debt financing, especially many in the property sector. We look at some of the potential tax implications that could arise for landlords and how these may impact their behaviours.

The restriction to tax relief on finance costs for unincorporated landlords was phased in from 6 April 2017 and has been a significant change for landlords. Since 6 April 2020, residential letting businesses, excluding furnished holiday lettings, have been unable to deduct finance costs from their rental income and instead receive a flat 20 per cent tax reduction on finance costs. This restriction saw an immediate tax increase for affected higher and additional rate taxpayers, as well as a disproportionate tax increase for those with heavily leveraged property portfolios.

Interest rates are now at a 14-year high and there is now a general expectation that they will climb further into 2023, with the next Bank of England base rate review due on 3 November 2022. Landlords may therefore be significantly impacted by further rising finance costs whilst only receiving limited tax relief for them.

For the quarter to 30 June 2022, we have already seen a 27 per cent reduction in transactions involving the higher rates of stamp duty land tax for additional dwellings compared to the same period in the previous year, suggesting a slowdown in landlords purchasing rental stock in England and Northern Ireland. It is a similar picture in Scotland and Wales with the equivalent property stamp tax revenues also falling from the prior year.

One potential solution to this problem is to incorporate a property letting business and we are starting to see more enquiries from landlords wishing to explore this option, as corporates are not subject to the same finance costs restriction (although there are other rules which can restrict interest deductions for some corporates).

However, there are a number of tax, commercial and, potentially, politically driven considerations to take into account.

Firstly, there are potential capital gains tax and property stamp tax implications of incorporating a property business. Whilst reliefs are potentially available, these need to be reviewed very closely to ensure unintended tax charges do not arise.

Secondly, a transfer of properties to a company is likely to lead to existing lenders wanting to renegotiate finance arrangements. A proportion of the tax saving achieved by incorporation may therefore be lost, due to increased interest costs.

No market thrives on uncertainty, which currently seems to be rife, particularly in the property market. Increasing interest rates, frequent and inconsistent changes to tax regimes and economic instability therefore make a less than ideal environment for landlords at present.

The sooner these uncertainties are resolved, the better for those landlords looking to plan the most efficient holding structure for their property portfolios.