Finance Bill

Written evidence submitted by the Residential Landlords Association (FB 72)

SUBMISSION TO THE PUBLIC BILL COMMITTEE CONSIDERING THE SUMMER FINANCE BILL 2015 – CLAUSE 24 (RESTRICTIONS ON MORTGAGE INTEREST RELIEF FOR INDIVIDUAL RESIDENTIAL LANDLORDS)

About the Residential Landlords Association (RLA)

The Residential Landlords Association (RLA) is the premier national landlords association operating in England and Wales. We have over 20,000 subscribing members and 1800 guest members. Our members own or control over 250,000 units of accommodation. Primarily our members are landlords in their own right but a number are managing and letting agents, some of whom are also landlords. Our members operate in all sub-sectors of the Private Rented Sector (PRS). Properties are rented out to families, working people, young professionals, the elderly, students and benefit claimants.

Summary

· The Association is strongly opposed to the measures contained in Clause 24.

· Withdrawing the right to deduct interest is fundamentally unfair.

· The Government should pause the measure for further investigation as to its impacts. The Government has failed to fully appreciate these. If introduced the measures should not mean that tax payers are moved into a higher tax band; nor should it apply to anything other than completely new borrowings.

· The Government has failed to appreciate that this measure will affect tenants as much as landlords.

· We set out various important realities which the proposed measure ignores including issues around higher rents resulting, adverse impact on housing supply, the importance of debt finance to the sector as well as the significance of the tax regime in which it operates.

· A worrying feature is the loss of the right for individuals/partners to deduct interest when calculating profits so that tax will be on an inflated imaginary profit; not the real profit.

· 50/60% of landlords are affected; not 20% as the Government suggests.

· Contrary to Government expectations rents will rise as a result.

· We highlight the disadvantageous tax position of landlords.

· Estimates vary between 44% and 75% as the number of landlords that will raise rents as a result and there is "slack" in rental levels which allows this to happen.

· We set out the ways in which tax payers will be affected whether by moving into a higher band, a higher effective rate of tax or landlords being pushed into loss making situations.

· All of this has to be looked at against the background of possible increases in interest rates.

· The measure will result in adverse reduction in property standards.

· Private landlords should be regarded as being in business not just as investors.

· The measure will adversely impact on the supply of housing.

Introduction

This Memorandum is submitted as evidence to the Public Bill Committee considering Clause 24 of the Finance Bill 2015. This Clause both restricts mortgage interest relief for private residential landlords who are individuals or partners to the basic rate of tax but also significantly, provides that mortgage interest relief and other finance costs will no longer be deductible in computing the profits of a residential rental property business for tax purposes. This does not, however, apply to corporate landlords.

This Association is strongly opposed to the measure. We believe that withdrawing the right to deduct interest is fundamentally unfair. As well as opposing this measure we have called upon the Government to "pause" the measure for further investigation as to its impacts. We consider that the Government has failed to fully appreciate the implications of what is proposed. Furthermore, this measure, if implemented, should only apply to entirely new borrowings, i.e. new loans or additions to existing borrowings. It should not apply to re-mortgages of existing borrowings.

Both landlords and tenants are impacted adversely

In bringing this measure forward, the Government has failed to appreciate that it is not simply a measure affecting landlords but it would also have adverse consequences for tenants, as well as the private rented sector generally.

What the proposal ignores

Regrettably, the proposed measure ignores important realities –

· Additional resultant tax costs, along with the other expenses of running a business, will be passed through to consumers of the business, in this case private tenants. This will lead to higher rents as a direct consequence.

· Due to a rising population, as a result of an increased net inward migration and a population who live longer, there is overall increased demand for housing, which is currently not being met.

· Rising house prices, relative restraint on wages and stricter regulatory requirements around owner/occupiers obtaining mortgages mean that many who want to buy are excluded from the market. At the same time public finances to support social housing are limited and, due to reduced house building, subsidies for social housing (via Section 106 monies) are inadequate, so that the supply of social housing is restricted.

· As a result, private renting has expanded and is predicted both by Government and PWC to represent 25% of overall housing provision by 2025.

· Increased housing supply to fill the gap is therefore dependent on private landlords investing their capital to meet the supply needs for those who can neither afford to buy nor are able to access social housing (or even prefer to rent anyway).

· Many landlords simply do not have sufficient resources of their own and are dependent on borrowing to fund their purchases. It is most certainly not a question of them borrowing more to buy more expensive properties; rather they have to borrow in the first place to be able to buy at all.

· Debt finance via banks and buy to let lenders is essential to fund the expanding market for private rented sector housing. Small and medium sized private landlords are the backbone of the private rented sector. Institutional investors are simply not interested in older stock which is "pepper potted" around. Institutions are only interested in purpose built new accommodation and even then only in very limited quantities.

· As with any business, the tax regime in which it operates is extremely important. The ability to offset debt interest in full, which is a very real expense of a business, is permitted for every other kind of business, irrespective of the rate at which tax is paid.

· For any business according to normal accountancy and tax principles you are entitled to deduct interest costs in arriving at your true profit. Tax is only then exacted on this profit; not an imaginary profit which results from adding back interest charges.

· If you change the tax regime in which a business operates this has adverse consequences for that business.

All of these key factors are being ignored by the Government as it brings forward this proposal which threatens to destabilise the private rented sector, which is now the second largest sector in housing, with the very real risk of severe adverse consequences for the sector as a whole; not just landlords but tenants and prospective tenants seeking to rent homes.

Removal of the right of deduction of finance costs

A worrying feature of this measure is the loss of the right for individuals and partners to deduct interest when calculating their profit. This means that they will now be taxed on an inflated imaginary profit; not the real profit from their rental businesses. As a matter or principle, you should only be taxed on the genuine profit of your business.

The Government’s assessment of impacts

We challenge the assessment of the impact of these measures made both by the Government and also by the Office of Budget Responsibility (OBR). We believe that they are wrong in two important respects –

1. The number of affected landlords.

The Government suggest that only 20% of landlords will be affected. We believe that this is totally wrong and more like 50% or 60% of landlords will be affected in some way. The Government cannot say how many properties will be affected but it is the number of properties/tenants who will be impacted which is key, particularly in relation to the issue of rising rents which will ensue.

2. Rising rents

Amazingly, in our view, the OBR have confirmed the Government’s view that these measures will not lead to an increase in rents. This measure must of course not be looked at in isolation because alongside this proposal is the intended removal of the 10% wear and tear allowance for depreciation of furniture in fully furnished lets. At the same time market forces are pushing up rents in many areas, but not all of them. This has led to major concern on the part of tenants and their representatives. We believe that the restrictions to be imposed on mortgage interest relief, with the loss of the wear and tear allowance, will pour further fuel on the flames of increasing rent driven by market forces, due to the overall shortage of accommodation.

The tax position of private landlords

Supposedly this measure is being put in force to a "level playing field" between landlords and owner/occupiers. As various commentators have pointed out this analogy is wholly misplaced. Private landlords are in business; owner/occupiers are not. More importantly, the tax position of private landlords, when compared with both owner/occupiers providers of social housing, is the worst of all, as well as when it is compared with other trades and businesses. This means that there is a tax cost which is passed onto a tenant. The private landlord is subject to the following:-

· Capital gains tax on sales (unlike owner/occupiers and social housing providers).

· No capital gains tax rollover relief or entrepreneur relief.

· No ability to offset any losses against other income.

· No ability to claim tax relief on pension contributions against rental income.

· Inability to claim various allowances otherwise available to others in business such as capital allowances and special reliefs for certain energy efficiency improvements etc.

· Inheritance tax paid on their properties.

Additionally, as one would expect, the landlord pays tax on his/her rental income but the social housing provide does not; nor does the owner/occupier pay any tax on the imputed benefit of having the use of their property. The owner/occupier pays no capital gains tax.

The Government has recently announced a new relief for owner/occupiers for their own homes in relation to inheritance tax but no such relief is available to the private landlords. Social housing providers are either exempt from tax because they are charities or because they are local authorities.

This adverse tax position for landlords has a direct bearing on tenants. As we have explained above the pass through principle means that anyone in business looks to recover their tax costs as part of their pricing, i.e. when fixing their rents. Anyone in business looks at their net return after tax. Landlords are no different.

This Association working with Professor Michael Ball of Reading University has estimated that because in effect the private tenants is already taxed to the tune of £1,000 per year per tenancy because of the way in which the tax regime overall is structured in relation to private renting. Tenants of social housing providers have the benefit of renting from landlords who are tax exempt so there is no tax to pass on unlike in the case of the private landlords. This one of the ways in which social landlords keep their rents down compared with private renting. The Government’s measures will simply worsen this position and increase the tax burden which will be passed on.

Impact on rent levels

In July 2015 the RLA carried out a survey of landlords immediately after the announcement of this measure. This shows that almost three quarters of landlords will buy to let mortgages are considering raising rents as a result. A similar response has been recorded in other research into landlord behaviour. Rentify also carried out a survey in July which showed that 56% of landlords wanted to increase rents. A further survey in September by Easy Roommate suggested 44% would increase rents. Surveys of tenants have shown that they are worried that this will happen and it is their perception that rents will rise. As things stand, the market will in many areas allow it to happen because of the shortage of supply and the increase in demand.

Further, there is currently "slack" in the system which will allow rent rises to take place. The behaviour pattern for landlords is to increase rents at the beginning of the new tenancy and either not to raise them at all while the tenancy runs on, or limit increases. This is confirmed by the results of the English Housing Survey. Landlords do have the scope to increase rents to offset these extra costs. If you are faced with a significantly higher tax burden what do you do? You have to cover your tax costs from somewhere so if you can increase your prices, i.e. rents, then you will do so. This measure means that tax has to be paid on non existent profits or even a loss. After all, the landlord still has to meet the mortgage repayments even though they no longer get the tax relief on them. This demonstrates why the tax regime in which businesses such as private rentals operates is so important.

The number of landlords impacted

We have already made the point that in our view the Government woefully underestimates the number of landlords who will be adversely impacted. The way in which the impact will work are as follows:-

· Tax payers will be moved into a higher banding. Those who currently pay tax at the basic rate will be moved into higher brackets in many cases and likewise the direct tax payers will be moved into the additional rate banding.

· The effective rate of tax on the real profit will be much higher; in some cases landlords could, in effect, be paying 75% tax as a direct measure as a result.

· Some landlords will be pushed into a loss making situation. They will be paying tax on an imaginary profit. This is a direct consequence of the adding back of mortgage interest because it is no longer deducted when you arrive at your taxable profit. Again, alongside paying tax on this non existent profit/loss landlords will still have to make their mortgage repayments.

Example 1 in the Appendix shows how someone who is a basic rate tax payer will be dragged into the higher rate. Unfortunately, at the moment, many basic rate tax payers are not aware that this is the case. Example 2 demonstrates how the effective rate of tax will be calculated as a consequence of this measure.

Accountants, Smith and Williamson, have estimated that in the case of a higher rate tax payer if you are more than 75% borrowed (your loan to value ratio) then your business will become loss making and in the case of additional rate tax payers if you have a gearing level of more than 68% then again your business is no longer viable as it is making a loss.

Further, the RLA’s own survey of its members throws huge doubt on the Government’s one in five figure. The Government have made their calculations based on current self assessment returns, but because rental incomes are lumped together, they cannot actually say how many properties will be affected. What ever the Government’s figures show they are not consistent with the RLA’s own survey. In September we surveyed 1,200 landlords who used our tax calculator feeding in real figures for their current tax liabilities which were then adjusted to see what would happen under the new regime. Of the 1,200 landlords who participated 719 of these currently pay basic rate tax. 449 of these, over 60%, will be put into the higher tax band by 2020. A further 74 higher rate tax payers out of 435 surveyed would now find themselves paying the additional rate, i.e. 45% instead of 40%.

Therefore, a significant number of basic rate tax payers will be affected so that some of these will now be expected to pay 40% tax on at least part of their income, even though they have no real increase in their income other than a fictional increase resulting from the additional mortgage interest costs.

Rising interest rates

None of this, of course, takes account of what happens as and when interest rates rise. We do not know when this will be but it is fair to assume that eventually we will reach an environment where interest rates are at least 3% above current levels. This will further adversely impact on those affected, both landlords and tenants. Critics claim that this is an undeserved "tax break" for landlords. In reality, the current regime is a fair and proper allowance for the private rented sector as a whole, including tenants who are its customers. As we see interest rates rise ever greater pressures will impact adversely on landlords resulting in higher costs being passed onto tenants through increased rents. Example 3 shows the impact of a 3% rise.

Adverse impact on property standards

Another consequence will be adverse consequences for the state and condition of rental properties resulting from less money to spend on both repairs and improvements. This was a dire consequence of the Rent Acts so it is not idle speculation. 43% of our July survey said that they would spend less on their properties as a result. The Government countered by saying that there are minimum standards but in any case there is no compulsion to carry out improvements. The woeful state of housing enforcement means even though there may be minimum standards it does not mean that they are followed. Landlords may still do repairs but they may do less work or they may delay in carrying out the work simply through lack of funds to effect them.

Business -v- investment

Unfortunately, Government treat private renting as an investment when it suits them, not a business. The reality is that private landlords, as providers of private rented housing, are in business. They provide a vital service. After all those who rent out furnished holiday lettings receive advantageous tax treatment as if they were traders, unlike private landlords letting out peoples homes, who are treated in a wholly disadvantageous way by the tax system, as we have already seen. This treatment seems at odds with the increasing amount of regulation which private landlords face. Further measures came into force in October of this year. Even before this we estimated that the private rented sector is subject to around 100 pieces of legislation, containing some 400 or more measures which affect the sector. Talking to Civil Servants they regard private renting as akin to investing in stocks and shares or antiques. This is a wholly misconceived perception and nothing can be further from the truth. Many landlords have to be licensed; licensing will become universal for self managing landlords in Wales this autumn, for example. Landlords commit a considerable amount of time to their businesses. After all if the same activities are carried on by their managing agent this is treated as a trade but not if it is done by the landlord himself/herself!

Adverse impact on supply

We have already pointed out the adverse consequences so far as the supply of housing is concerned. Private rental is a key provider, meeting the needs of all sections of the community, including the less well off and families. After all many families have not now rent in the private sector because social housing is not available for them.

The Government’s clear intention is to try to promote owner/occupation at the expense of private renting. This is ignores the realities, however, since as already stated, many who want to do so simply cannot access owner/occupation. The Government believe that private landlords are in competition with owner/occupiers forcing up prices. We have seen no real evidence of this.

If landlords are forced to sell they will sell with vacant possession, which means that tenants could be dispossessed as a direct consequence of this measure. The Government after all are talking about giving four years for landlords to adjust they way in which they operate their businesses. Clearly for some selling up and divesting is one option which could mean more sales but at the expense of current tenants having to move out. This would be a regrettable result for those who would then be affected by having to find new homes.

Time to pause and to look at the consequences

As we said in our Introduction the RLA opposes the measure and calls on the Government to pause the proposals for further careful and more detailed consideration of the clear adverse impacts which will result in the whole private rented sector, including tenants, being harmed.

We call upon the Government to introduce the following measures, if the misconceived proposal is to continue –

· Restricting the changes to new borrowing from April 2016 onwards. This would protect previous investment decisions and allow existing mortgages to continue under the current tax regime. The new regime would only apply to increases in borrowings and not with finance on existing loans.

· The introduction of a mechanism that assesses tax liability on real profit after deduction of mortgage interest allowing landlords’ current tax bracket to be unaffected. Additionally a proposed period of relief from both capital gains tax and stamp duty land tax for those landlords who choose to incorporate their business allowing them to transfer their existing properties to a company without the penalty for having to pay capital gains tax and stamp duty land tax.

At the end of the day, however, we believe that this measure is wrong and should not proceed.


EXAMPLE 1

A higher rate tax payer has a net rental profit after running expenses and interest of £6,000 in a tax year with his mortgage interest payable amounting to £10,000. NB: Current tax rates and allowances are applied.

The current position

Net profits –

£6,000 x 40% = £2,400

Tax payable

After the changes

taxable profit £6,000.00

Add back interest interest £10,000.00

£16,000.00

£16,000 x 40% = £6,400

Less £10,000 x 20% allowing for tax reduction = £2,000

Net tax payable £4,400

However, the real profit is still £6,000

Tax £4,400.00

Real profit £6,000.00 x 100% = 73% approx.

Note: The above assumes the measures are fully in force after the transitional period has expired.

EXAMPLE 2

Before the change

The landlord’s position is as follows:-

Total rent received £60,000.00

Less expenses £5,000.00

£55,000.00

Less mortgage interest

Payments £40,000.00

£15,000.00

Add other income £25,000.00

£40,000.00

Less personal allowance £10,600.00

£29,400.00

X 20% 5,880.00 tax payable

After the changes –

Rental income £60,000.00

Less expenses £5,000.00

£55,000.00

Add other income £25,000.00

£80,000.00

Less personal allowance £10,600.00

Taxable income £69,400.00

£31,785.00 taxed at 20% £6,356.00

The balance of £37,615.00 taxable at 40% £15,044.00

£21,400.00

Less tax reduction of 20% of £40,000

interest paid £8,000.00

£13,400.00

The difference

Tax now payable £13,400.00

Less tax previously payable £5,880.00

£7,520.00

Note: the above takes account of the fact that the landlord still will pay basic rate of tax until the marginal rate of 40% becomes payable. These figures assume current tax rates and allowances and are calculated once the transitional period has gone by.

EXAMPLE 3

A higher rate tax payer is paying interest on a loan of £200,000.00 at the rate of 5% which equals £10,000.00 per annum. As a result of the 3% rise in interest rates this amount goes up to £16,000.00 per annum. The rental income after non mortgage expenses is £13,000.00.

The current position.

Rental income after non mortgage expenses £13,000.00

Less interest payments £10,000.00

Net profit £3,000.00 x 50% = £1,200.00

per annum tax payable

Actual profit

Rent after non mortgage interest expenses £13,000.00

Less mortgage interest payments £10,000.00

Net profit £3,000.00

Tax paid £1,200.00

Net profit £1,800.00

After the interest rate rise the interest payable increases from £13,000.00 to £16,000.00. Currently, under the current regime this wipes out any profit so there is no tax to pay.

After the change

Rent net of non mortgage expenses £13,000.00

Tax on £13,000 @ 40% = £5,200.00

Less tax reduction at basic rate of 20%

On the interest payment of £10,000 £2,000.00

Tax payable £3,200.00

Add interest payable £10,000.00

£13,200.00

Less rent received £13,000.00

Loss £200.00

As against rental income of £13,000 after this income tax burden is made the landlord makes a loss of £200.

Once interest rates rise by 3% the position is as follows:-

Rent net of non mortgage expenses £13,000.00

Tax on £13,000 at 40% £5,200.00

Less tax reduction of 20% on £16,000 £3,200.00

Tax payable £2,000.00

Add interest payable (at the increased

interest rate) £16,000.00

£18,000.00

Less rental £13,000.00

£5,000.00

The loss increases dramatically by £4,800 to £5,000 as a result.

NB: current tax rates and allowances are used in this example.

October 2015

Prepared 14th October 2015