Case Study: A Kiwi Paying UK Tax on No Income
Also see our other blog articles (a) UK Tax Surprise: Capital Gains on Your Kiwi Property Explained, (b) Tax Advice for Kiwis Moving to the UK
In today’s blog, I want to look at a case study of a Kiwi who is based in the UK, for whom we recently completed a personal tax return. The names and locations have been changed, but the amounts stated here replicate the earnings and tax figures for this person.
In particular, I want to look at how a NZ rental property that made an annual cash loss of NZD 5,000 resulted in a £1,904 UK tax bill.
As a contractor accountant based in the UK, we deal with many cross-border tax issues. This is because historically many clients have moved to the UK from countries like New Zealand, Australia, and South Africa, and some of them continued to have income sources in the countries they were originally from.
We now have a client base of contractors with nationalities from 26 different countries, so it is common for us to deal with the foreign income effects on UK personal taxation.
In this particular case, though, the Kiwi client who approached us was not a limited company contractor. Instead, she had a full-time PAYE job in the UK and owned a rental property in New Zealand. She just wanted to use our personal tax return service to complete her UK personal tax return.
There are two interesting parts to her tax position that I want to highlight in the blog today.
The first is that even though the rental property generated no income for the individual in New Zealand, she still faced a substantial tax bill in the UK.
The second point is the rate of tax that was paid. Although you may read about the top UK tax rate being 45%, in this particular case, the individual paid a 60% tax rate on her rental property taxable income (I have to use the term “taxable income” here because after disallowing certain costs the rental property made a taxable profit, although in reality each year it was making a cash loss).
The Set-Up
Zoe secured a full-time role in the UK shortly after arriving and, for the 2023/24 tax year, had employment income of £99,500. This income was taxed through the usual PAYE system. The necessary tax deductions are made by her employer, and she received her net pay after all tax deductions into her personal bank account.
Normally, Zoe would not expect to have to file a UK personal tax return every year because all of her income is already taxed through PAYE. However, she now has her share of a New Zealand rental property apartment to declare on her UK personal tax return.
As a New Zealand rental property owner, she also needs to complete a New Zealand personal tax return every year, which she has done. Zoe is also aware of the double taxation agreement between New Zealand and the UK, which means she will not pay tax twice on this rental property income.
NZ Personal Tax Return
Zoe’s accountant in New Zealand completed and filed her New Zealand personal tax return. It included rental property income of NZD 15,000 and expenses such as body corporate fees, depreciation, mortgage interest, property management fees, rates, and a small amount for repairs and maintenance. Altogether, the expenses totalled NZD 20,500, which included NZD 500 of depreciation. If we consider the cash position of the rental property (by excluding depreciation), it made a loss of NZD 5,000 (15,000 income less 20,000 in expenses).
The taxable loss reported to the IRD includes the depreciation item and totalled NZD 5,500. Because the rental property made a taxable loss in New Zealand, there was no tax due.
This is an important point. The double taxation agreement between New Zealand and the UK allows a UK tax resident to offset any tax paid in New Zealand against the tax due on rental income that they declare in the UK. In this particular case, there was no tax paid in New Zealand, so there was nothing available to offset the UK tax bill.
UK Income
Zoe had a full-time role where she earned £99,500 in the 2023/24 tax year, and her employer deducted £27,228 in taxes. The tax deductions were correctly calculated, so if Zoe did not have any New Zealand rental property income, she would not have had any extra tax to pay for the year.
It’s now time for another important point. You will see that her income is just below the threshold at which her personal allowance starts to disappear. For every £2 of income earned above £100,000, her personal allowance is reduced by £1. If her earnings exceed £125,140 then her personal allowance becomes £0. In 2023/24 the personal allowance was £12,570 – this was the amount you could earn in the UK completely tax free.
Earning income in the £100,000 to £125,140 band produces a very undesirable tax outcome. Let me give you a quick example:
Person A earns £100,000 a year in a PAYE role. Their employer deducts tax at the correct amount, and Person A pays £27,428 in tax. They get to use their full personal allowance. Person B earns £110,000 a year in a PAYE role. After allowing for the reduction in the personal allowance, Person B pays £33,428 in tax. On the extra £10,000 in income, Person B pays an extra £6,000 in tax – an effective tax rate on that income of 60%.
UK Personal Tax Return
We now need to translate that New Zealand rental property income into UK rental income. The rules for allowable expenses in the UK are fairly similar to those for New Zealand, but there are two distinct differences that always crop up.
The first is that depreciation is not an allowable rental property expense in the UK, so that cost gets removed from the taxable income calculation.
The second, and possibly more important, point is the way that mortgage interest is allowed as a rental property expense on a UK personal tax return. For someone who earns above the basic rate earnings threshold in the UK, like Zoe, the tax relief available for mortgage interest payments is capped at 20% of the smaller amount of
(a) the mortgage interest costs, or
(b) the rental property profit excluding mortgage interest.
When we apply the UK rules to the NZ rental property and remove depreciation (NZD 500) along with mortgage interest (NZD 15,000), the property made a taxable profit of NZD 10,000.
If we apply a basic FX conversion of 1 GBP = 2 NZD (in real life we’re more accurate with this, but let’s make it simple for the blog), then the above figures translate to:
(a) rental income £7,500,
(b) mortgage interest £7,500,
(c) UK taxable profit £5,000.
So, two things are now happening. One, Zoe’s taxable income increases from £99,500 to £104,500 and in doing so she has moved into that awful 60% tax rate zone. Second, the tax credit she gets from her mortgage interest is capped at £5,000 (even though her mortgage interest was £7,500, it gets capped at the rental property profit). So she gets an income tax credit relief of £5,000 x 20% = £1,000.
Once we plug all the figures into Zoe’s UK personal tax return, we calculate that she has £1,904 in tax due.
Summary
This is a fairly well-worked example, and we have gone into a lot of detail. So let’s just grab the key points for those of you who have scrolled all the way to the bottom for the summary without reading everything else 😊
- Although Zoe’s rental property in New Zealand was not generating a profit, when we translated the rental income calculation using UK tax rules it produced a taxable profit in the UK of £5,000
- The taxable profit in New Zealand was $0 (well, it actually made a loss in NZ tax terms) so there was no New Zealand tax to pay. This also meant there was no tax offset we could use against her UK tax (which can be done under the double taxation agreement)
- The taxable profit of £5,000 on her NZ rental property pushed her overall UK earnings into the dreaded 60% taxation zone
- Overall in terms of her cash position, the NZ rental property cost Zoe NZD5,000 for the year, plus she needed to pay £1,904 in tax to the HMRC.
Frequently Asked Questions
Why did Zoe have to pay UK tax if her New Zealand rental property made a loss?
Zoe was a UK tax resident and needed to declare her worldwide income on her UK personal tax return. The UK disallow certain expenses, such as depreciation, and mortgage interest, which are allowable in New Zealand. This resulted in a taxable profit in the UK, despite the property making an actual cash loss.
How does the UK’s 60% tax rate zone work, and why did it affect Zoe?
The UK tax system reduces the personal allowance by £1 for every £2 of income over £100,000, which creates an effective 60% tax rate for income between £100,000 and £125,140. Zoe’s additional rental income pushed her total income into this high tax zone, increasing her tax liability.
How does the double taxation agreement between the UK and New Zealand work?
There are numerous elements to the double taxation agreement between New Zealand and the UK. However, in this case, we just need to look at the taxation of rental property income. The tax treaty allows for tax paid in one country to be offset against tax due in another country. For clients of ours who live in the UK, we generally prefer that they complete and file their New Zealand tax return first. We then use those figures to help prepare their UK tax return and offset any tax already paid in New Zealand against the UK tax bill.
Why wasn’t Zoe’s mortgage interest fully deductible in the UK?
In the UK, for higher earners like Zoe, tax relief on mortgage interest payments is capped at 20% of the smaller amount of the mortgage interest costs or the rental property profit. This limited her tax relief to £1,000.
What could Zoe have done differently to avoid this tax situation?
If the New Zealand property remains in her personal ownership, her tax planning opportunities are limited. She could, for example, consider paying down her mortgage to reduce her mortgage interest costs, which would remove the disparity between the calculations of the two jurisdictions. However, she would need a lump sum of money available for that, and the impact is relatively minor for such a large contribution of cash needed. She could consider taking a lower-paid job to avoid the 60% tax zone, but why on earth would she do that? Finally, she could consider moving the rental property into a different ownership structure (such as a limited company). Because it would then no longer be personal income, it would not get reported on her UK personal tax return. To do this, however, she would need to sell the property into a limited company and absorb all the associated sale and purchase costs, and there could be flow-on tax impacts in NZ which might make the option unpalatable. Primarily, the most important thing for Zoe is to continue operating with an awareness of her UK tax position and how future decisions she makes in relation to her rental property will impact that.
How does foreign rental income impact my UK tax liability?
In this case, you can see that the foreign rental income Zoe faced had a significant impact on her UK tax bill because;
(a) there was no New Zealand tax to be offset against her UK tax bill, and
(b) her rental property income brought her up into the special 60% UK tax zone.