INTRODUCTION
The Scottish Government’s new tax legislation on additional residential homes will have serious unintended negative consequences for both the private rented sector and first time buyers, those the legislation was actually designed to help. We have already seen a stampede of landlords deciding they have had enough and are looking to sell their buy-to-let portfolios. This will have severe consequences on the private rented sector further down the line.
Many respected organisations have been asked to comment on the potential impact of this new legislation. It appears the many issues raised have been totally ignored by the Scottish Government. Many organisations are concerned with the pitfalls and confusion surrounding this ill thought out legislation which it is set to become law on April 1st, subject to Royal Assent.
The Scottish Government are clearly copying the proposals announced by the Conservative Government in Westminster, who introduced this new tax in response to an entirely different set of issues, where many first time buyers are unable to get on the housing ladder due to highly inflated and unaffordable property prices in the South of England. In London, you have a housing market bubble dominated by rich foreign buyers, with many of these people not even living in the properties. This distorts the housing market and it is right to look at addressing this issue, but a slab tax of 3% across the country is definitely not the answer.
In Scotland, the housing market is entirely different from the South of England. In Scotland, houses are much more affordable versus average earnings, and if anything, there is a shortage of rental property. In the major cities such as Edinburgh, it is difficult to secure a rental property. Students, professionals, foreign nationals and DHSS are all competing for available rental accommodation.
THE NEW TAX IS ESTIMATED TO RAISE £17-29 MILLION
I am not sure how these estimated tax receipts are calculated, however I believe the Scottish Government are in for a shock as I predict demand in the first year for second homes and buy-to-let properties could reduce by up to 50%. Many people believe that this additional tax is only designed to achieve increased tax receipts and has little to do with helping first time buyers compete with buy-to-let investors. I would be very surprised if the new tax receipts exceed £10m - £15million.
Irrespective of whether these figures are accurate or not, the tax revenue forecasted to be raised is extremely small compared to the very high risks of restricting liquidity in the buy-to-let market and will unduly penalise many people buying second homes who are rarely competing with the first time buyer market place.
According to the Council of Mortgage Lenders survey, 79% of properties bought with a buy-to-let mortgage in the first quarter of 2015 were for properties below £145k. This means that a significantly high number of these properties would now be subject to this new 3% slab tax, with no consideration for progressive bandwidths. Therefore this new tax will significantly add to transaction costs and will simply undermine market liquidity. This will, in turn, force up rents due to a lower number of buy-to-let landlords (who are unwilling to take on this extra cost) or landlords increasing rents to cover the increased costs of ownership. This will mean future first time buyers will inevitably face increased rents which will ultimately delay purchases as they will have to save much longer for deposits.
The survey also states that turnover of the Scottish housing stock is already only two thirds the level of a decade ago. It would appear that the Scottish Government does not really want people to freely move up and down the housing market without taking a big slice of extra tax from them. Property buyers are an easy target for tax revenue, as opposed to tackling the real issues of the Scottish economy like the increased number of people claiming welfare benefits.
IMPACT ON LANDLORDS
The latest figures available suggest that almost 15% of Scottish households are in private rented accommodation. As already stated, McEwan Fraser Legal are already seeing many landlords looking to sell up and it is the same story across the country. Many landlords are taking the view that they have had enough as the LBTT and the 3% slab tax is only part of a bigger picture. Shortly many landlords will also face significant reductions in mortgage interest relief and the removal of 10% wear and tear relief. This will mean landlords who have a highly geared portfolio are very likely to have a loss making portfolio and will face the ridiculous scenario of having to pay tax on this loss. Many landlords are still unaware of this new reduction in mortgage tax relief. What other business can you name that makes a loss and yet has to pay tax on the loss?
Many landlords in Scotland also face uncertainty with proposed changes in the Private Housing (Tenancies) Bill, where the changes only appear to be based on improving tenant rights with absolutely no consideration for the financial risks and challenges faced by landlords from rogue tenants. There is a much higher percentage of rogue tenants than rogue landlords, evidenced by the amount of landlords taking tenants to court for eviction and rent arrears daily in the Scottish Courts. The Scottish Government is clearly chasing private landlords away from the private residential sector with more and more new legislation aimed at making life more difficult for landlords. The Scottish Government will need to consider a Plan B, and quickly, as very shortly there will be voids in the private rented sector. As a result, it will soon become the Scottish Government’s task to house tenants unable to find accommodation in the private sector.
PATIENCE IS A VIRTUE
The Scottish Government would be well advised to wait and see the extent of the problems this new slab tax will have in England and Wales rather than rush through this ill-conceived legislation by civil servants who clearly don’t understand the dynamics of the Scottish private rented sector. Many of the proponents of this legislation have never been private landlords or had a second home and therefore don’t understand the issues faced. It is time that the committees who draft this type of legislation have representations by experienced landlords who can provide a balanced view of the housing market and provide some sense to the chaos that is in front of us all.
ADVICE
As a legal firm we still can’t advise our clients how this new legislation will affect them, as full details of this new legislation have still not been finalised due to various amendments. It is very clear that the legal profession and the general public have had insufficient time to prepare themselves for this new punitive tax regime.
DRAFTING WEAKNESSES
The Scottish Government also needs to define what they actually mean by “main principle private residence.” For example, if someone rents a property which they elect as their main residence and then buys their first home but rents it out, is this considered a second home? It would appear not as this is a new first home. But this could be directly competing with first time buyers? If someone buys a second home in a foreign country, would they have to pay the 3% slab tax on this transaction? Would this transaction need to be disclosed in the tax payer’s income tax return? Why should someone be liable for tax if you have a buy-to-let property in a foreign country but be liable for the tax if you buy your first home in Scotland? What about people who own properties abroad and don’t declare this to their solicitor? How does a solicitor obtain access to records of all properties a client has bought throughout the world? Who would be held accountable?
CASE STUDY HIGHLIGHTING TRANSACTION COSTS
If someone buys a 5 bedroom HMO property for £400,000 in Marchmont, Edinburgh, the total tax will be a whopping £25,500 (LBTT and 3% second home tax). So almost 7% of the property purchase will go to the government in property tax, with Scotland becoming one of the highest property tax environments in the world.
If someone earns, say, £30,000 per year, after paying tax and NI and normal living expenses, this person will need to work for approximately 5 years to accumulate savings to pay the tax on this level of property purchase. Is this a fair and transparent tax? Is this the type of property a first time buyer would buy? There is a distinct shortage of HMO properties in popular areas of cities and this will serve to only exasperate the problem.
In the situation where a genuine home mover has difficulty selling their main residence and buys their next main residence, is still liable for the extra tax until they sell their first property. There is the facility to claim the extra tax back if you sell your first house within 18 months but how will many homeowners fund this extra tax? Is someone moving to their second, third or fourth home is this type of mature buyer really competing with first time buyers?
THE DIFFERENCE BETWEEN LBTT AND SDLT WHICH HAS KILLED SCOTTISH PROPERTY TRADERS
Everyone should remember England and Wales still operates under SDLT which has on most bands lower rates of property tax than Scotland.
What many people fail to realise is that SDLT is a tax on taking title to a property whereas LBTT taxes the actual property transaction, whether you take title or not. This is a very important, fundamental difference and provides a property trader South of the border a significant competitive advantage over their Scottish counterpart and has very much gone under the radar. So let me explain property trading companies now don’t benefit from sub sale relief. For example, if a property investor agrees to buy a number of properties on a certain date but wanted to sell one of the properties on the same date (that perhaps did not fit the property traders criteria) before taking title, the property trader would still be liable for LBTT on the transaction. So effectively the Scottish Government enjoys LBTT twice on the same property if the property transfers to a different buyer without the first buyer taking title even on the same day.
Many property trading companies who play a very important part in the liquidity of the property market here in Scotland have now been taxed out of the market. Companies who operate in the Part Exchange sector who play a vital part helping buyers and sellers move home are struggling to operate without sub sale relief particularly at the higher valued properties. All that is going to happen is the medium to top end of the property market is going to stagnate. There is relief on LBTT for builders who operate their own Part Exchange schemes but many builders rely on property trading companies to operate their Part Exchange function. These companies can take out the buyer of the seller’s property who is buying the new build property but there is absolutely no relief for property trading companies on this type of transaction yet this plays a vital role in creating liquidity in locked property chains.
OTHER POINTS TO CONSIDER
The Cabinet Secretary for Finance, John Swinney, should be honest and address the real issues for first time buyers and not penalise homeowners who aspire to live in a better home who may own an investment property to help fund their retirement with a punitive tax. How many properties transactions are going to collapse going forward with people who can’t fund this new tax and penalising many people who will not in any way be competing with first time buyers?
The Scottish Government is also penalising limited companies or “non-natural persons” with this extra tax even on their first purchase of a residential property. If for example you buy a residential property in a limited company and then buy your first property in your own name it is unclear if the additional supplement would apply because in this scenario you would clearly own two properties but in two separate legal entities. Is the government about to change the meaning of a separate legal entity? I believe this part of the new legislation could be open to challenge if it did apply. It could also mean buying shares in limited company that own residential property, could may well find you having to pay the slab tax on the share purchase, albeit the legislation is currently silent on this so one can only assume this does not apply. So therefore buying the limited company that owns the property seems to be more tax efficient in terms of eliminating the slab tax than buying the actual property in the company. I guess buyers of property would not be interested in the ramifications of a company purchase but on higher valued properties for developers this might be a consideration for many.
CONCLUSION AND WARNING!!
In reality, what is going to happen is that the Scottish Government will seriously discourage investment in property in Scotland, as home based property investors will look at less punitive property tax environments overseas. Scotland will fall off the radar for international property investors. The reality is Scotland needs a buoyant property market as many businesses rely on a buoyant property market for survival; letting agents, estate agents, legal companies, tradesmen etc. The Scottish Government, single-handedly will more than likely instigate the next downturn in the Scottish property market and, certainly over the next year, will stagnate the second home purchases and the investor market place. We need more investment in property to meet the demands of a growing population, not an ill thought out deterrent such as this new tax.