My client owns a rental property and in light of proposed interest changes has decided to re-mortgage the property. Their lender has charged an Early Redemption Penalty. They have the option to settle this in full now or roll it into a new mortgage with a different lender.Would the payments be tax deductible?

Early redemption penalties (“ERP”) can be deductible against the rental profits. Section 272B(5)(c) IITOIA 2005 allows a deduction for:

  • interest,
  • amounts economically equivalent to interest, and
  • the incidental costs of finance.

HMRC manual BIM45820 confirms that they accept that an ERP falls into the final definition of an “incidental cost of finance” so relief for the penalty amount will be allowed.

As it is eligible for relief under s272B, the interest relief restriction in s272A ITTOIA 2005 (introduced by F(No2)A 2015) will equally apply to the ERP.

The effect of this section is that for tax years starting after 6 April 2017, relief for the payment of the ERP, by way of a deduction against rental income is denied and instead relief is given by way of a 20% income tax ‘reducer’.

The amount of relief available is calculated as 20% of the lower of:

  1. The total finance costs incurred,
  2. The profits of the rental business
  3. The total taxable property income (after personal allowances).

Where the ERP is paid in full, it clearly falls under the sections above and would be allowed as a cost in the year of payment.

If however, the ERP was ‘rolled up’ into a new borrowing, payment of the amount would be spread across the life of the mortgage.

If you have any questions, please contact the advice line on 0116 243 7892 quoting your QACC reference number.

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