Offsetting Capital Gains Tax Liability

Tax Question

My client is selling his rental property and is having to pay an early redemption fee on his mortgage from his lender. Can I offset this against the capital gains tax liability?

Tax Answer

Unfortunately, not as confirmed by the First tear tribunal case of John Arthur Day and Amanda Jane Dalgety v HMRC [2015]. In this case, the tax payer attempted to offset the break premium against the CGT liability. The Tribunal panel reviewed the lists of costs detailed in s38 TCGA1992 and commented that the items in this list were exhaustive and included only those items which are eligible for relief in computing a capital gains tax liability. Section 38 does not include mortgage fees in any form and as such the early redemption payment could not be counted when computing the capital gains tax position.

However, all is not lost as BIM45820 in HMRCs manuals confirms that “The majority of break payments that take the form of a penalty for early redemption of the loan will represent genuine compensation to the lender. In such circumstances the break payment will not amount to a premium and will therefore attract relief as “incidental costs of raising loan finance”. This statement means that the early redemption charge should be allowable as an expense against the rental income in the tax year that it arises.

This is confirmed in HMRC’s Property Rental Toolkit which states, “The incidental costs of obtaining finance that are wholly and exclusively incurred for the purpose of acquiring the property are normally allowable.”

Finally, as the charge falls within the definition of a finance cost of the rental business, it will fall under the restrictions introduced in Finance (No 2) Act 2015 and now within s272B IITOIA 2005 which limits the ‘above the line’ deduction against rental income to only 25% for the 2019/20 tax year (0% for 2020/21), with the remaining balance being utilised as an income tax reducer providing a saving at the basic rate.

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