Your company borrowed start-up cash from the bank with a personal guarantee from you. It paid substantial interest before trading began. Can the company obtain tax relief for the pre-trading loan interest paid against the tax payable on its trading profits?
Pre-trading expenses
Most businesses have to spend money before they are in a position start selling their goods or services. Special rules apply to pre-trading expenses and usually a deduction is allowed for the accounting period in which the business starts trading. However, the loan relationship rules (which only apply to companies) mean that the tax deduction might be deferred for longer, perhaps indefinitely.
Loan relationship rules
The loan relationship rules apply to income and expenses arising from debts, e.g. loan interest. Where a loan relationship expense (debit) doesn’t relate to a company’s trading, it can only be used to reduce tax on non-trade income (credits) such as loan interest received. This can pose a problem for start-ups. Whilst it’s not unusual for a company in the process of setting up to incur interest and charges on loans to pay for, say, the purchase of a premises, it might not generate loan relationship credits, or enough of them, against which the expenses can be set so it can obtain tax relief.
Trap. Although a company can carry forward unused loan relationship debits to use after it starts trading, it’s quite likely that even then it won’t have enough loan relationship credits to set the expenses against. It wouldn’t be unusual for it to never generate loan enough credits, in which case there will never be tax relief for the debits.
Tip. The good news is that in a start-up situation a company can make an election to treat loan relationship debits as if they were a normal trading expense, which can then be set against trading income.
Example. Acom Ltd was formed in April 2021. The company obtains finance to help it purchase equipment and pay the premium on a leasehold premises. Acom opens its doors for business on 1 November 2021 by which time it has incurred interest and arrangement costs on its borrowing of £7,000. If the directors make an election, the £7,000 can be claimed as a tax deduction in Acom’s first accounts as if it were a trading expense.
Conditions
The election is subject to conditions. They are:
- that the company notifies HMRC within two years of the end of the accounting period in which the loan relationship debit arises; and
- it begins to trade within seven years of that period; and
- the debit would have been tax deductible from its profits had it been incurred after the business had started trading.
An important catch!
According to HMRC, an election is only effective if the loan relationship debit to which it relates falls into a corporation tax (CT) accounting period. The trouble is a pre-trading period isn’t usually a CT accounting period because there’s no source of income liable to CT. The way around this trap is to open an interest-bearing bank account early in the setting up period of your company – this triggers the start of a CT accounting period.
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.