The tax increase, on which there was no consultation, will be phased in from 2017 and fully implemented by 2020.
The change was unexpected, and the new regime is highly complex, and many investors remain unaware of the change, or underestimate its severity.
All higher-rate taxpayers who own buy‑to‑let properties on which there is a large mortgage will pay substantially more tax. Some current basic-rate taxpayers will also be hit, because the change will push them into the higher-rate tax bracket.
Those who are worst affected will see:
- the actual tax they pay on their investment rising twofold or more;
- the tax rate payable rising above 100pc, meaning that more than all of their profit is paid in tax;
- a degree of tax that pushes them into loss, making their investment financially unviable and forcing them to increase rents sharply – or sell.
Here is a worked example assuming you, the landlord, pay 40pc tax.
Your buy-to-let earns £20,000 a year and the interest-only mortgage costs £13,000 a year. Tax is due on the difference or profit. So you pay tax on £7,000, meaning £2,800 for HMRC and £4,200 for you.
Tax is now due on your full rental income of £20,000, less a tax credit equivalent to basic-rate tax on the interest. So you pay 40pc tax on £20,000 (ie £8,000), less the 20pc credit (20pc of £13,000 = £2,600), meaning £5,400 for HMRC and £1,600 for you. Your tax bill has therefore gone up by 93pc.
Consider if the Interest Rate rises lifting your mortgage cost to £15,000, while your rent remains at £20,000.
You will have to pay £5,000 tax in this scenario, so you make no profit at all.
What is also becoming clear is that worst hit will be those modest, middle-class savers who have prudently chosen to invest in buy‑to‑let, often alongside pensions and Isas, as a means to supplement their income.
The mechanism of Mr Osborne’s tax attack is the removal of landlords’ ability to deduct the cost of their mortgage interest from their rental income when they calculate a profit on which to pay tax.
So very wealthy landlords who do not need mortgages are untouched.
In effect, the Chancellor is to taxing landlords on their turnover rather than their profit, meaning that tax will be payable on nonexistent income. This explains why tax rates will, for some, exceed 100pc: landlords will have to pay all of their profit in tax, and then pay more tax still.
Any 40p rate taxpayer landlord whose mortgage interest is 75pc or more of their rental income, net of other expenses, will see buy‑to‑let investments become loss-making.
For additional-rate (45p) taxpayers, the threshold at which their investment returns are wiped out by the tax is when mortgage costs reach 68pc of rental income.