Section 24 Tax Planning

Section 24 of the Finance Act 2015 (Part Two) changes the way that private landlords are taxed by disallowing finance costs as a business expense and replacing them with a 20% tax credit.

Before we get into the potential solutions to the Section 24 Tax problem, first let’s take a closer look at what Section 24 tax is, why it’s so unfair and why so many existing landlords are considering the viability of transferring their rental property business in a Limited Company “incorporation”.

The following Case Study compares the tax position of a private landlord vs that of a private hotelier.

Let’s assume that both businesses own assets worth £2,000,000 and have mortgages at 75% of value secured on them at an interest rate of 5%. In other words, their annual finance cost bill is £75,000.

Now let’s assume that both businesses make profits after finance costs and all other expenses of £50,000.

The hotelier will pay £7,500 of income tax. This is broken down as follows; £nil on his first £12,500 of net profit and 20% tax on the next £37,500.

However, the private landlord cannot treat his finance costs as a legitimate cost of business in the same way as the hotelier. Accordingly, his tax bill is £27,500. This is because his taxable income is treated as being £125,000 due to being unable to claim his finance costs as business expenses. Furthermore, for every £2 of taxable income over £100,000 he loses £1 of his nil rate tax band. Accordingly, the landlord pays tax at a rate of 20% on the first £37,500 (which equates to £7,500) and then 40% tax on the other £87,500 (which equates to £35,000). This adds up to a whopping £42,500. The government then grant him a tax credit equal to 20% of his finance costs, in other words £15,000 off the £42,500 leaving him with a net £27,500 of tax to pay.

To summarise, the private landlord pays more nearly four times as much tax as the private hotelier, even though their financing costs and business results otherwise produce identical levels of actual profit.

HOWEVER, if both the landlord and the hotelier operated their businesses within a Limited Company structure, they would pay exactly the same amount of tax.

There are, of course, many other reasons for private rental property businesses to consider incorporation. These might include the following:-

• Since the Prudential Regulation Authority changed the rules on buy-to-let mortgage affordability criteria, Limited Companies can borrow significantly more than private landlords based on rental income calculations.
• There are far more opportunities for property company owners to accrue future capital appreciation of property outside of their personal estates for inheritance tax planning purposes.
• You may be able to structure your finances in such a way that you do not need to declare taxable dividend income.
• If you live outside the UK the ability to be able to structure your finances to enable you to withdraw capital from your company tax free are significantly enhanced.
• If you decide to live in Portugal you may be able to take dividends out of your company without paying income tax in either Portugal or the UK for up to 10 years.

It would be remiss of us not to point out that incorporation is not a ‘one-size-fits-all’ strategy. In fact, we only recommend it to around 1 in 10 landlords who book landlord tax planning consultations with us. There are several alternatives, especially if you have relatives who are not higher rate tax payers and you are considering business continuity and legacy planning as well as your income tax position.