You borrowed to get your company started and paid thousands in interest before trading commenced. The basic tax rules can prevent your company from ever getting tax relief for it. What steps can be taken to get around this trap?
Start-up loans
If you borrow to help fund a new unincorporated business the interest paid on the loan is automatically treated as if it was incurred on the day that trading commences and is tax deductible from the first business profits. The position is different for companies. Tax relief for interest incurred is subject to special rules known as the loan relationship rules .
Loan relationships basics
The loan relationship rules apply to income and expenses relating to “money debts”, e.g. interest paid or received. Such income is referred to as a credit and an expense as a debit. The net credit (profit) or debit (loss) for an accounting period is taxed separately from trading profits and losses.
Trade and non-trade debits and credits
There are two types of debit and credit, trading and non-trading. Usually, non-trade debits can’t be set against trade credits or trading income of a company. In most cases, a company can only obtain tax relief for non-trade debits if it has non-trade credits from which they can be deducted. This can be a problem for a start-up company if it doesn’t generate much in the way of non-trade credits.
Trap. Interest and finance costs paid on borrowing before trade commences are non-trade debits. It might be years before a company generates enough non-trade credits to use its non-trade debits. In fact, it may never do so which means a company might never obtain tax relief for the pre-trading interest it paid.
Example. Acom Ltd was formed in July 2022. It obtained finance to buy stock. Acom began trading on 30 March 2023 by which time it had paid interest of £11,000. This is a non-trade debit and not tax deductible from Acom’s trading income. Usually, it must generate an equal amount of non-trade credits, e.g. bank deposit interest, if it is to obtain corporation tax (CT) relief for the full amount of interest.
Tip. Acom can elect to override the usual rules and to treat non-trade loan relationship debits as if they were normal trading costs that can be set against trading income (see The next step ). However, it needs to be wary of an HMRC trap.
HMRC’s sneaky trap
HMRC’s guidance says that an election is only effective if the pre-trading loan relationship debit occurs in a CT accounting period (see The next step ). The trouble is a CT accounting period only exists when a company has a source of income. This rule seems contrary to the purpose of the election. The good news is that there’s a simple way to frustrate HMRC’s stingy approach.
Tip. Before borrowing, start an interest-bearing bank account or similar investment. That triggers the start of a CT accounting period and ensures a pre-trading election is effective.
An election can be made that allows you to set the pre-trading interest and finance costs against the company’s first trading income. However, to ensure maximum tax relief is obtained set up an interest-bearing account or other investment before or at the same time as the borrowing.
The next step
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.