The Summer Budget squeezes contractors may have missed
It seems now like it was too many moons ago to count, but last month’s Summer Budget has potentially adverse changes on the horizon for contractors’ personal finances, owing to how they may operate as a consumer or investor, writes IFA Contractor Money.
Buy-to-let mortgage interest payments to get more taxing
Targeting the latter, specifically those in the property market, the chancellor said he would move against the tax relief such buy-to-let investors get on mortgage interest payments – a “huge advantage” he’s stripping back.
In fact, under the current rules, income tax is only payable on the profit made by a landlord after offsetting the interest payments they’ve made towards their mortgage – effectively rendering the portion of their rental income which they use to cover the mortgage interest payments ‘tax free.’ So currently, contractors with a buy-to-let can effectively benefit from a tax relief of between 20% and 45% (depending on their marginal tax rate) on their mortgage interest payments.
Vowing to “level the playing field” for individuals paying residential mortgages (where no such tax relief exists), the chancellor announced that from 2017, this effective tax relief will be gradually ratcheted down so that only a basic rate of income tax can be claimed.
Higher rate contractors will be hit hardest
Unfortunately for them, contractors who fall into the higher rate tax bracket with annual mortgage interest payments of £10,000 will therefore need to pay a further £2,000 to HMRC – the difference between the basic rate of tax at 20% and the higher rate at 40%.
Contractors whose retirement or Plan B project depends on their buy-to-let are understandably feeling a little picked on. They’re unlikely to feel less victimised by another move the Treasury is making – a £200m tightening up on tax relief on the cost of maintaining a property’s furnishings.
A workaround for ‘Ltd’ contractors with or wanting a buy-to-let
But don’t despair if you’re a limited company contractor. An arrangement we have in place is tailor made for such PSCs whether they wish to purchase a buy-to-let now or mitigate the tax on their existing buy-to-let(s). It involves purchasing the investment property through a new limited company which is a wholly owned subsidiary of the contracting company.
As the new limited company is ring fencing the property and its income, you won’t be caught by the new rules, saving thousands of pounds from 2017 and allowing you to potentially undercut less savvy landlords who will inevitably need to up their rents to cover their additional tax levy.
Savvy contractors can then use the retained earnings in the contracting company as a deposit for the purchase, so this structure allows you to fund the new buy to let without the need to draw down, and pay tax on, a dividend – as would be the case if you purchased the property in your personal name. This initial saving is set to grow even further as a result of the punitive changes to dividend taxation.
Lastly, once the investment property is purchased, the buy-to-let profit can be reduced by offsetting 100% of the mortgage interest and any allowable operating expenses. The profit you make attracts corporation tax and can be retained in the company for further property investments or to pay down the mortgage at a later date.
Osborne isn’t as anti-property as the press pretend
Not being up to speed on this arrangement, the mainstream press are heralding the Summer Budget’s paring back of tax allowances on buy-to-let mortgage interest payments as the ‘end of buy-to-let.’
Even without the arrangement, the chancellor said that wasn’t his goal. In fact, he decided against cutting the tax relief entirely because “many hard working people who’ve saved and invested in property depend on the rental income they get.”
Nonetheless, the uncertainty it seems to be creating will drive many property investors to ground in the short term – and less competition for buy-to-let property can only be a good thing for contractors ‘in the know.’
Meanwhile, there was better news on July 8th for contractors looking to get more out of their residential property as an ‘amateur landlord.’ By renting a spare room to a lodger, they will next year get an increase in the amount of rent they can charge tax-free, as the threshold will rise from £4,250 to a much more generous £7,500.
The cost of cover is set to rise
Less positively, and as I mentioned in this piece’s introduction, insuring the building you live in; its contents and even your vehicle that sits outside (or in a driveway/garage) – is going to become more expensive, from November this year.
That’s because the insurance premium tax – a levy on people and businesses at the point at which they buy a general insurance product - will be hiked then from 6% (currently) to 9.5%. So that means you’re likely to have to pay an extra £9.48 a year on your house insurance, plus an additional £12.25 on your annual car insurance. Both calculations, made by the Association of British Insurers, assume you have an average policy. The ABA says: “It’s very disappointing to see a more than 50% tax increase being imposed on consumers.”
Also caught by the increase is private medical insurance and, potentially, some professional indemnity policies, depending on whether they are arranged using a contract of insurance.
The government has been at pains to frame the changes as a tax on insurers rather than consumers, but it is expected that these costs will be passed down to consumers in the form of higher premiums. Thankfully, long term insurances such as life insurance, critical illness cover and income protection (also known as permanent health insurance) are exempt from the insurance premium tax and therefore won’t be affected.