The controversy surrounding HMRC’s recent rewrite of BIM45690 and BIM45700 initially appeared to concern a relatively narrow question: whether a landlord can refinance a property business, withdraw capital and continue to obtain tax relief for the interest where the money withdrawn is then used for personal purposes.
The implications may be considerably wider than that.
A positive capital account does not consist only of the cash originally introduced when a business began. It may also include many years of accumulated profits on which the proprietor or partners have already paid Income Tax, but which they chose to leave in the business rather than withdraw.
Those retained profits may have been used to repay mortgages, fund improvements, provide working capital, cover rental voids or finance further acquisitions. The business owner has nevertheless been taxed on those profits as they arose. They do not become untaxed merely because the owner decided to leave the money in the business.
HMRC’s rewritten guidance now appears capable of penalising a proprietor who later wishes to withdraw those accumulated, already-taxed profits and replace them with commercial borrowing.
The position becomes even more serious where a landlord is preparing to incorporate. Mainstream professional commentary warns that a substantial positive capital account should generally be drawn down before incorporation, because otherwise its value may become locked into the shares issued by the company. This is why Simon’s Taxes B9.112, “Incorporation relief—conditions for relief”, is so important. It expressly states that where an unincorporated business has a substantial capital account, the owner should be advised to draw it down before incorporation; otherwise, that capital will become locked into the value of the shares received. This is not an aggressive interpretation developed by landlords or promoters. It is established professional tax commentary explaining the practical consequences of section 162 Incorporation Relief.
The potential result is extraordinary. A landlord may have paid Income Tax on profits when they arose, retained those profits within the business for entirely prudent commercial reasons and then found that HMRC challenges the interest on borrowing used to release them. If the profits are not withdrawn before incorporation, their value may instead become embedded in the company shares and potentially suffer another tax charge when the landlord eventually wishes to extract the money.
This goes much deeper than whether somebody refinances a rental property to buy a holiday home. The real question is whether HMRC is attempting to trap profits that have already been taxed.
Landlords are taxed on profits, not on what they withdraw
An individual landlord or partner in a property partnership pays tax on their share of the taxable profit arising from the business. The tax liability does not depend upon how much money happens to be withdrawn from the business bank account.
Consider a husband-and-wife property partnership that makes a taxable profit of £100,000. The partners may decide to withdraw only £40,000 for their living costs and leave the remaining £60,000 in the business to repay mortgages or fund property improvements. They will nevertheless be taxed on the whole £100,000 allocated to them.
The £60,000 retained within the business is therefore not untaxed money. It represents profit that belongs economically to the partners and on which they have already accounted for Income Tax.
Depending on the accounts, the balance may be described as capital, a partners’ current account or another form of proprietors’ funds. The accounting label does not alter the underlying commercial reality. The partners earned the profit, paid tax on it and then chose to leave it at the disposal of the business.
Over a period of 10, 15 or 20 years, those retained profits can become substantial. A successful property partnership may accumulate hundreds of thousands of pounds of positive balances, quite apart from the money originally introduced when the business was established.
HMRC’s own guidance still recognises this point. BIM45710 distinguishes unrealised revaluations from accumulated realised profits, both capital and revenue, on which a proprietor is free to draw. That acknowledgement is important because it confirms that the amount available for withdrawal is not confined to the original cash or assets introduced into the business.
A proprietor who leaves £500,000 of taxed profits in a business has, in economic terms, provided a further £500,000 of funding. The business may use that funding to reduce debt, purchase assets or provide working capital. If the proprietor subsequently arranges a commercial loan and withdraws £500,000, the business remains funded to the same extent. The source of that funding has simply changed from retained profits to external borrowing.
HMRC’s former guidance recognised this distinction
Before the July 2026 rewrite, BIM45700 expressly stated that a proprietor could withdraw the profits of the business and the capital introduced into it, even where substitute finance then had to be provided through interest-bearing loans.
The former guidance said that the interest on those loans was allowable because the purpose of the additional borrowing was to provide working capital for the business. Relief could be restricted where the proprietor’s capital account became overdrawn, but that limitation made commercial sense.
It discouraged a proprietor from withdrawing more than the capital and accumulated profits available and then attempting to claim that all the resulting debt related to the business. It did not discourage the proprietor from withdrawing a genuine positive balance.
The Office of Tax Simplification reproduced this longstanding HMRC position in its 2022 review of residential property income. Its understanding was that interest on borrowing used to enable a proprietor to withdraw capital could qualify, provided that the capital account did not become overdrawn.
HMRC’s revised wording appears to move away from that analysis. BIM45700 now says that simply exchanging existing capital for loan finance does not, on its own, satisfy the wholly and exclusively test. HMRC instead places greater emphasis on whether the borrowing is used for business expenditure or the acquisition of business assets.
Its revised examples also focus heavily on what the proprietor does after the money has been withdrawn. Additional borrowing used to purchase a private residence is treated as non-qualifying, while borrowing followed by a withdrawal towards an overseas holiday home is presented as evidence of a possible private purpose.
The significance of this change should not be underestimated. Under the former guidance, the central question was whether the proprietor had sufficient capital and accumulated profits available to withdraw. Under the revised guidance, HMRC appears increasingly interested in how the proprietor spends the money after withdrawal.
Those are not the same test.
What if the balance represents profits taxed at 40% or 45%?
Imagine a property partnership that has operated successfully for 15 years. The partners originally introduced £300,000 of their own capital. During the following years, the business generated £1.2 million of taxable profits, of which the partners withdrew £500,000 to meet their living costs.
The remaining £700,000 was left within the business. It may have been used to reduce borrowing, refurbish properties and strengthen the partnership’s overall financial position.
The partners have already paid Income Tax on the full £1.2 million of profits allocated to them. Their combined positive balance is now £1 million, consisting of the original £300,000 and £700,000 of accumulated taxed profits.
They later decide that they no longer want so much of their personal wealth tied up in the property business. The portfolio is refinanced and £800,000 is withdrawn, leaving a positive balance of £200,000.
The partners might use the £800,000 to fund retirement, repay the mortgage on their home, help their children or purchase a property abroad. None of those personal decisions changes the fact that the £800,000 was already represented by capital and taxed profits standing to their credit.
Under HMRC’s previous guidance, the central question would have been whether the withdrawal exceeded the capital and profits available. It did not.
Under the revised approach, HMRC may seek to argue that the private use of the £800,000 gives the borrowing a private purpose.
That would mean HMRC was not merely restricting interest on borrowing used to extract an untaxed uplift in property value. It would be penalising the withdrawal of profits on which the partners had already paid Income Tax.
The prudent landlord may now be treated worse
The revised interpretation also produces a commercially perverse result.
Suppose the partners had withdrawn every pound of profit as soon as it arose. The property business would then have needed to borrow more money much earlier to fund refurbishments, mortgage repayments and expansion. Subject to the normal rules, interest on borrowing used for those purposes would have arisen directly from business expenditure.
The partners instead chose the more prudent course. They retained profits, reduced the need for borrowing and strengthened the financial position of the business.
Years later, when they finally decide to take those profits, HMRC may argue that replacement borrowing has a private purpose because the money is being used outside the business.
The tax system would therefore reward the proprietor who withdraws everything and borrows from the outset, while penalising the proprietor who leaves already-taxed profits within the business and avoids unnecessary debt.
It is difficult to believe that this is what Parliament intended.
Incorporation makes the problem more serious
The issue becomes particularly important where an unincorporated property business is transferred to a limited company.
Incorporation Relief under section 162 TCGA 1992 can defer capital gains where a business is transferred as a going concern with its assets, wholly or partly in exchange for shares. The deferred gains are broadly reflected in a reduced base cost for the shares received.
A substantial positive capital balance cannot simply be assumed to become a tax-free director’s loan account after incorporation. Where consideration is left outstanding as a loan or current-account balance, it may be treated as non-share consideration and restrict the amount of Incorporation Relief available.
This is why the extract from Simon’s Taxes is so important. It states that where there is a substantial capital account in the unincorporated business, the owners should be advised to draw it down before incorporation. Otherwise, the capital will be locked into the value of the shares.
That is mainstream professional commentary, not an aggressive interpretation created by landlords seeking a tax advantage.
The warning reflects a practical consequence of the incorporation rules. If the proprietor does not withdraw the positive balance before incorporation, it does not necessarily become a debt that the company can later repay without further tax consequences.
Taxed once as profit and taxed again when accessed
Return to the property partnership with a £1 million positive balance.
If the partners draw down £800,000 before incorporation and replace it with commercial borrowing, HMRC’s revised BIM45700 may be used to question the interest relief because the partners subsequently spend the £800,000 personally.
If they do not withdraw it, a substantial part of the value may become embedded in the shares issued by the company.
The company cannot simply repay the value of those shares as though it were settling a director’s loan account. To access the money later, the shareholders may need to receive dividends, sell shares, undertake a capital reduction or extract value through a liquidation. Each route carries its own potential tax consequences.
The landlord may therefore have paid Income Tax when the profits first arose, left the money in the business instead of spending it, and then faced a further tax charge when the value was eventually extracted from the company.
It may not technically be double taxation under the same provision or on the same taxpayer, but the economic effect will feel very similar to the landlord concerned.
The profits were taxed when earned. They were retained for sound commercial reasons. HMRC’s revised guidance then made it harder to withdraw them before incorporation, with the result that their value became trapped in shares and potentially subject to another layer of taxation.
HMRC’s former example went far beyond cash originally invested
The former BIM45700 included an important example involving a landlord who had purchased a London flat for £125,000 with an £80,000 mortgage.
The flat was initially the landlord’s home. By the time it entered the property business, it was worth £375,000.
The opening balance sheet of the rental business therefore showed the property at £375,000, the mortgage at £80,000 and a capital account of £295,000.
The landlord later borrowed a further £125,000 and used the money to buy a flat in Rotterdam. HMRC said that the interest was allowable in full because the total borrowing did not exceed the market value of the London property when it was introduced into the rental business and the capital account was not overdrawn.
The importance of that example is not simply that the money was used to buy a private home abroad. It is that the positive capital account was not limited to the original money paid for the property.
The landlord had purchased the flat for £125,000, but the capital account recognised a substantially higher value when the property entered the rental business.
HMRC therefore accepted that the landlord could borrow against value represented within the business, withdraw capital and use it to acquire a private overseas residence.
The former guidance did not treat the private use of the money as determinative. It focused on whether the borrowing exceeded the capital standing to the proprietor’s credit.
Private Residence Relief was part of the wider picture
The London flat in HMRC’s former example had previously been the landlord’s home.
The example was concerned with interest relief rather than a disposal for Capital Gains Tax, so it did not calculate Private Residence Relief separately. Its treatment was nevertheless consistent with the fact that the property entered the rental business at its then market value rather than remaining fixed at the historic purchase price.
Private Residence Relief is not an administrative concession invented by HMRC. It is a statutory relief deliberately enacted by Parliament to exempt gains attributable to occupation of a person’s only or main residence.
HMRC’s former guidance appeared to recognise the resulting economic value within the proprietor’s capital account and accepted that borrowing could replace part of that value, even where the money released was used to buy another home overseas.
It is difficult to reconcile that approach with a new interpretation that appears to make the proprietor’s personal use of the withdrawn money decisive.
NRCGT rebasing creates similar questions
A similar issue arises where a non-resident landlord benefits from statutory rebasing under the Non-Resident Capital Gains Tax rules.
Depending on the circumstances, those rules can calculate the post-5 April 2015 gain by treating the property as though it had been acquired at its market value on that date.
That is not an artificial revaluation inserted into the accounts to manufacture a capital balance. It is a statutory basis of calculation created by Parliament.
Private Residence Relief and NRCGT rebasing operate differently. Private Residence Relief exempts qualifying gains, whereas NRCGT rebasing may substitute a statutory market value for historic cost in calculating the relevant gain.
Both may nevertheless affect the amount of economic value that can be transferred on incorporation without an immediate Capital Gains Tax charge when compared with a calculation based solely on historic purchase cost.
HMRC now needs to explain how its revised interest guidance interacts with those statutory outcomes.
Can borrowing replace value that Parliament has expressly relieved or rebased? Can the proprietor withdraw that value before incorporation? Does the answer change depending on whether the money is used to purchase another rental property or a private retirement home?
Those questions cannot be answered simply by pointing to the private use of the money after it has been withdrawn.
Two very different transactions are being confused
There is an obvious distinction between a business borrowing to fund drawings that exceed the proprietor’s available capital and accumulated profits, and a business borrowing to replace genuine capital and taxed profits already invested within it.
The first situation may justify an interest restriction. If a proprietor repeatedly withdraws more than the business has earned or more than has been introduced, some of the borrowing may genuinely be financing private expenditure.
The second situation is different. The proprietor is withdrawing an amount that already stands to their credit and replacing the funding with commercial debt.
HMRC’s revised examples risk treating both situations as though they are the same.
The immediate destination of the money should not necessarily be conclusive. HMRC’s own BIM45665 continues to refer to the principle in Scorer v Olin Energy Systems Ltd that the purpose of a loan cannot always be identified merely by looking at the immediate use of the money. The purpose is a question of fact, determined by examining the transaction as a whole.
Where a business has been funded by accumulated profits and the proprietor subsequently replaces those profits with borrowing, the commercial function of the loan is to continue financing the business assets and working capital.
What the proprietor does with the money returned to them should not automatically change the purpose served by the borrowing within the business.
A taxpayer may now have to prove this at Tribunal
HMRC may eventually confirm that the revised guidance was not intended to discourage proprietors from withdrawing accumulated taxed profits or recognised capital balances.
The current wording does not provide that reassurance.
An HMRC officer may now rely on BIM45690 or BIM45700 to challenge interest relief where a landlord refinances before incorporation and uses the money for retirement, succession planning, family support or the purchase of a home abroad.
The landlord would then face a deeply unattractive choice. They could accept HMRC’s interpretation and pay additional tax that they do not believe is legally due, or they could endure years of correspondence, professional fees, uncertainty and stress before asking the First-tier Tribunal to decide whether HMRC’s manual correctly reflects the law.
Even a taxpayer who eventually succeeds may never recover all the professional costs, time and disruption involved.
That is how questionable interpretations can become accepted in practice. Many taxpayers cannot afford to challenge HMRC, which means the interpretation may continue to be applied without a court ever deciding whether it is correct.
Some unfortunate taxpayer may now have to fund a test case merely to restore a distinction that HMRC’s previous guidance had recognised for many years.
What changed in the law?
Property118 has published an Open Letter to HMRC asking what changed in the law behind BIM45690 and BIM45700.
The questions raised by the changes now go considerably further than BRRR refinancing or the purchase of a holiday home.
HMRC needs to explain whether replacement borrowing can still fund the withdrawal of accumulated realised profits, including profits on which the proprietor has already paid Income Tax. It also needs to explain why the proprietor’s personal use of those returned profits should determine the business purpose of the replacement borrowing.
There are equally important questions about incorporation. HMRC should clarify how landlords are expected to deal with substantial positive capital balances before a business is transferred to a company, particularly where professional commentary warns that the value will otherwise become locked into shares.
HMRC should also explain how its revised interpretation interacts with Private Residence Relief, NRCGT rebasing and its own former Rotterdam example, where additional borrowing was accepted even though the money was used to purchase an overseas home.
Most importantly, HMRC should identify the legislation or binding judicial authority that justified the change.
These are not artificial tax-planning questions. They concern profits that business owners have earned, declared and already paid tax on.
HMRC should not be able to turn those profits into permanently trapped capital by quietly rewriting an internal manual.
Please read and share our Open Letter to HMRC.
Landlords, accountants and tax advisers who have dealt with retained profits, positive capital accounts, former main residences, NRCGT rebasing or pre-incorporation refinancing are also invited to share their practical experiences in the comments. The wider the consequences of this change become, the more important it is that HMRC provides a clear and properly reasoned response.
This article expresses the author’s opinion on HMRC’s revised published guidance. HMRC manuals do not have the force of law. The tax treatment of borrowing, capital withdrawals and incorporation depends upon the facts, the accounting basis adopted and the relevant legislation. Separate restrictions apply to residential finance costs and to property businesses using the cash basis. Professional advice should be obtained before refinancing or incorporating a property business.
