Interest on directors' loan into company

Interest on directors' loan into company

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My husband is setting up a company which we are financing through taking out an increase in our mortgage (this amount will be ring-fenced from the mortgage at the start), and we will be putting the money into the company by way of a loan rather than equity. The interest that will be payable on this loan is therefore identifiable.

His accountant has advised that we should not charge any interest on the loan to the company. He has advised that if we do charge interest then a) there is a whole heap of paperwork required and b) that we would need to declare the interest as income on our personal tax returns (and then get taxed accordingly on it).

Whilst I accept that some paperwork is doubtless necessary, it seems a little 'unfair' that the net effect on us is that we'll end up paying more tax (either corporation or income). Had the company taken out a loan then the interest would have been allowable, and so my gut instinct is that we should be able to charge interest on the loan to the company at the same rate as we are incurring it as individuals.

Please can someone give me their thoughts on this?
Catherine Catchpole

Replies (11)

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By User deleted
04th Jan 2007 09:03

Tax relief on interest paid
I agree with the comments made so far - the company SHOULD pay interest, and deduct 20% tax via the CT61 form proceedure on a quarterly basis. So for some extra paperwork tax relief is obtained.

What intrigues me is how your accountant was going to alternatively secure tax relief for you on the interest paid. Was his idea pay a higher salary (sufferring 45.8% tax/NIC) then get 22% tax relief - an NIC cost to you of 23.8% on the interest ?

This question needs answering - an advisor causing you to pay 23.8% NIC on interest on borrowed money (or alternatively get no tax relief) is of questionable ability !

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By Euan MacLennan
04th Jan 2007 09:16

I agree
...that the company should pay interest on its loans from whatever source, but even if it does not, I would point out that the husband and wife can still claim on their tax returns for the interest paid on the additional mortgage loan as it is being used to fund an investment in their close company (provided that it is not a close investment company).

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By AnonymousUser
04th Jan 2007 09:23

EL ...
But the individual can claim a deduction against total income for qualifying loan interest paid anyway, without need for the company to 'reimburse' him.

Looking at marginal rates only, if company is paying tax at 19%, and he is 40% taxpayer there is no point in paying the interest - why increase his tax bill by 40%, only to get a 19% deduction by the company? Of course, the other points about paying interest rather than salary, or indeed dividends, remain valid.

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By AnonymousUser
03rd Jan 2007 22:18

My thoughts
First of all, there is nothing whatsoever to stop your husband charging interest on his loan to the company.

Yes, there is additional paperwork involved, but hardly "a whole heap". Any interest paid would need to be done so net of tax at 20%, this income tax being paid over to the Revenue quarterly (and, just like bank etc interest received, treated as tax deducted at source when completing the personal return).

What you need to consider are the respective tax rates of the company and the individual - yes the company can claim a deduction for interest paid, but the lender is charged to income tax on the same. It will depend on whether the additional income is required by the individual. If the company is paying tax at 19% and the individual at higher rates, there is a net charge to tax of 11% on interest paid and so no point in paying it just for the sake of it. However, it would be cheaper to pay interest than to take additional remuneration in the form of salary or dividend. Of course, if the company is paying tax at 32.75% and the individual is a basic-rate only taxpayer, it's a no-brainer - take the interest.

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By User deleted
04th Jan 2007 06:45

The lender can offset the interest though
In the tax return, the lender is taxed on the interest income but can also claim a deduction for interest actually paid on the loan, so assuming he is simply recharging the interest on, he would get back the 20% tax deducted at source by the company - net effect - no tax paid by lender and interest reimbursed.

So yes, if it is a genuine business loan taken out by an individual for a company on which you are paying real interest, I would recharge the interest paid despite the tedious but not huge amount of extra paperwork.

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By djw090
04th Jan 2007 09:11

A couple of extra points
Even though we are talking about an owner managed company the loan between your husband and the company should be documented. If the company has any assets you may want to take a charge.

You should consider charging the company a higher rate of interest than the rate you are paying. You have borrowed the money secured against property, low risk, and you are lending it to a start up company, high risk, so a premium can be justified. It is often an efficient way of extracting profit from the company.

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By User deleted
04th Jan 2007 10:50

David
It depends how his remuneration package is structured. If he is taking a minimum salary of say £5035 and the rest as dividends, he won't get tax relief on the loan interest unless the company pays him some interest because the divi tax credit is not refundable, but the interest tax credit would be. If he is paying himself a salary of more than £5035 plus the amount of interest to be claimed, then you are right, but to save NI, he should pay himself salary of £5035, interest to agree with interest paid and then divis on top.

Obviously this is a simplification and there may be many other factors to consider.

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By AnonymousUser
04th Jan 2007 11:08

EL
We are in complete agreement on this. I was, prima facie, dealing only with the effects of taking interest for the sake of it (I have had clients who wanted to take interest only because they thought they were entitled to it - "if I'd lent money to a 3rd party I would receive interest so why not the same for a loan to my own company?" They wanted the interest in ADDITION to the remuneration already drawn).

So, yes, if the individual has no income liable to tax, he should charge interest to secure the tax relief on the interest paid by him. Also, as I did suggest, if there is already salary subject to NIC and/or dividends at higher rate, replacement of this with interest should be considered.

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By User deleted
04th Jan 2007 13:23

Claim relief against general income
This calim, mentioned by David Lochead is only of use if there is other taxable income.

If, as is most often the case other income might only consist of low salaries and dividend income, in effect there will then be no basic rate tax relief on the interest paid - unless bigger salaries with a 45.8% tax/NIC charge are created, just to get 22% tax relief.

So, unless there's other taxable income, I'd recommend the company paying interest and deducting tax via the CT61 route. This route avoids the inequitable National Insurance cost that could arise by going down the increased salary route.

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By User deleted
04th Jan 2007 13:53

Follow up question...
I was also told the 'not worth charging the company interest cause there's loads of paperwork' story, so my husband and I haven't charged our company anything.

However, I'm still interested in getting the tax relief on the interest we've paid on personal loans taken out to lend the company money. I've found the help sheet IR340, which is good, but not very thorough. It says that 'you cannot claim relief for interest on overdrafts or credit cards' and I'm wondering if anyone can tell me if a flexible loan, such as Cahoot's would be deemed to be a qualifiying loan, or whether it is more like an overdraft? And if it is a qualifying loan - is it enough just to keep the statements which show the interest charged each month, or should I get a certificate of interest?

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By AnonymousUser
04th Jan 2007 14:38

What is a loan?
I am unfamiliar with Cahoots accounts, so am not qualified to answer this follow-up question. It really depends on the terms of the account. Although there is no definition of loan (that I can find) in the legislation, more than web definition of overdraft refers to a short-term loan so at first glance you might think you could argue that overdraft interest should be allowable. However, s353(3)(a) specifically bars such reilef (or does it refer only to cases where an account is overdrawn in excess of an agreed limit, such that overdraft borrowing within an agreed limit qualifies still as a loan?)

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