Summary
- You can usually claim tax relief on interest if you borrow personally and lend the funds to your company, provided the loan is used for a qualifying purpose such as working capital or buying at least 5% of the company’s shares.
- The borrowing must typically be a personal loan (not a personal overdraft or credit card), although loans from individuals may also qualify.
- The company must be a close, trading company for the relief to apply.
- Anti-avoidance rules apply: if the company repays part of the loan and the money isn’t used to reduce the borrowing, interest relief on that portion is lost.
You can usually claim tax relief for money you borrow personally to lend to your company. It sounds straightforward but there are in fact a number of restrictions to trip you up. How do you secure the tax relief?
Personal business loans
When you incorporate a company, it needs money to get started and it’s common for the owner manager to lend the initial funds. Then, as the business grows, it may need further funding, but a direct loan from the bank to the company (particularly for smaller companies) may not be an option. In order to fund your company, you may need to borrow money personally and then lend it on to your company.
To make the process tax efficient you need to ensure you qualify for a tax deduction on any interest you pay personally.
The right kind of debt
You aren’t entitled to tax relief for interest you pay on a personal overdraft or personal credit card balances to fund your company. A personal loan is therefore your only tax-efficient option, but it doesn’t have to be from a bank. You could, e.g. borrow money from a friend or relative instead. Your company can get a tax deduction for interest paid on a company credit card or company overdraft.If you only need relatively short-term borrowing, there is a way to use a personal credit card or overdraft and still obtain tax relief for interest.
Your spouse could use their credit card or overdraft to pay costs for your company. They could turn this into a flexible loan to you and charge loan interest which would meet the conditions and so qualify for tax relief. However, because your spouse is taxable on the interest you pay them, this is only tax efficient if they either pay a lower rate of tax than you or have unused allowances such as the personal savings allowance.
Funding the company
Your company also needs to tick a couple of boxes, specifically:
- it must be a close company. Broadly, this is one controlled by five or fewer individuals; and
- it must also be a trading company, i.e. one where its main activity isn’t owning and managing investments.
Once you’ve jumped through all those hoops, you’re entitled to tax relief on interest you pay on borrowing which you use for a qualifying purpose. That is, you can either purchase 5% or more of the ordinary capital or lend money to the company for use in its business, i.e. as working capital.
Repayment trap
Watch out for anti-avoidance rules that prevent directors from using their companies to obtain tax relief on interest that would otherwise not qualify.
Example. James is a director shareholder of Acom Ltd. When he set up the company, he borrowed £60,000 from the bank and used it to provide working capital. The interest on the loan was £6,000 in the first and second years for which James received tax relief. After two years Acom repaid James £20,000. Instead of using it to repay some of the money he borrowed, James used it to buy a car. As a result, interest on £20,000 of his bank borrowing no longer qualifies for tax relief.
