You started your company with the help of borrowed money. At the time the interest rate was reasonable but recent increases have bumped up your repayment costs significantly. How much of the increase can you claim tax relief for?
Qualifying loans
At one time, if you borrowed money for almost any reason all interest you paid qualified for tax relief. These days relief is limited to interest for loans taken out for only a few specific purposes. One of these is borrowing to provide funding for your company. Even then tricky conditions apply to you, your company and the loan. There’s also an anti-avoidance rule to watch out for.
Interest only
Before considering the conditions remember that it’s only the interest you pay on borrowing that qualifies for tax relief and not the full amount of your repayments. To help you claim the right amount the lender must, on request, give you a statement of interest paid for each tax year.
Qualifying conditions
When you borrow money to lend to your company tax relief can only be claimed if the:
- loan is used to purchase 5% or more of the ordinary share capital in a close company, i.e one controlled by five or fewer individuals, or lent to a close company (in which you own 5% or more of the ordinary share capital) for use in its business, e.g. as working capital
- company is a trading company, i.e. its main activity is not owning investments; and
- borrowing is not an overdraft, incurred on a credit card or borrowed through a similar arrangement.
Tip. Where you personally need to borrow to fund your company’s expenses consider a flexible loan account rather than using an overdraft or credit card. That way you’ll be entitled to a tax deduction for the interest you pay.
Anti-avoidance
Special rules prevent directors from lending to their companies, drawing some or all of the money back while continuing to get tax relief on loan interest.
Example. Nick is a director shareholder of Acom Ltd. He borrowed £50,000 from a bank which he lent to Acom for working capital. Nick claimed income tax relief for all the interest paid on the loan. After two years Acom repaid Nick £10,000. Instead of using it to repay part of his bank loan, Nick used it to pay off personal bills. He later lends Acom another £10,000. From the time Acom repaid Nick £10,000 he ceases to be entitled to tax relief on a proportionate amount of the interest.
Repayment of working capital
The example above shows that a repayment of capital by your company, even a temporary one, will cause a permanent loss of tax relief for the interest on the money you borrow. Tip. To prevent this you could convert the loan to your company into share capital; only if you sell or transfer the shares will you lose tax relief. Or if you don’t want to tie up your money in shares make sure that your director’s (current) loan account stays in the black.
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.