Removing debt tax relief would be ‘disastrous’, Osborne warned

18 Jun 2010

Policy area: Tax & Finance

Increasing the cost of debt by limiting the tax relief it attracts could have a disastrous impact on the economy, chancellor George Osborne has been warned ahead of next week’s emergency Budget.

If the relief against Britain’s legacy of debt is removed, many borrowers currently making their interest payments may no longer be able to do so, forcing the banks to call in thousands of loans. That would that put some borrowers out of business and could give rise to substantial new losses on bank balance sheets.

A round of repossessions and sales of commercial property by lenders would push down commercial property values – currently 36% below their 2007 peak – placing even greater strain on the balance sheets of both property owners and those who have lent against property.

Given that £150bn of commercial property debt is held by the state-backed Royal Bank of Scotland and Lloyds Banking Group, it could create a serious headache for the new government. 

The British Property Federation and an array of leading tax experts have said that many firms currently managing to service their borrowings would be sent over the edge.

There is around £300 billion of debt just against commercial property, and hundreds of billions more of ordinary business lending which is secured on borrowers’ premises.  So far, however, many banks are turning a blind eye to breaches of loan-to-value covenants which alone make up about £50 billion. This is because many borrowers are able to afford repayments despite massive drops in the value of their assets.

Liz Peace, chief executive of the BPF, said: “Restricting tax relief for financing costs could be the last straw for many businesses that are managing to make their interest payments in challenging conditions.  Halving relief would increase the true cost of debt service by between 16% and 20%, equivalent to a significant increase in interest rates.”

She added: “As well as making it more difficult to manage, restructure or refinance existing loans, increasing the cost of borrowing would reduce funding available for new projects. It is these new projects which will stimulate economic activity and create the jobs we need to climb out of recession."

Jonathan Thompson, partner and head of real estate at KPMG, said: "Private sector investment in  infrastructure including property is vital to the UK's economy. Debt is a vital part of any investment decision and borrowing organised to match the contracted rental cash flows.  There are many situations where property values have fallen but the rents are sufficient to pay interest on the borrowing.  Restricting interest relief would divert cash from servicing loans causing many to default and risking another property and banking crisis.  At a time when the property and banking sectors are trying to deleverage this proposal would achieve the opposite."

Rupert Clarke, chief executive of Hermes and president of the BPF, said: “We urge the government to consult fully before implementing measures which will undermine the financing fundamentals of the whole real estate market. Given the significant exposure of the financial markets (including RBS and Lloyds) to commercial property, such a move will inevitably lead to a significant deterioration in UK credit ratings.”