Charging your company interest
In this post we're going to discuss the tax implications of charging your company interest. This can be read in conjunction with claiming tax relief on a loan to your company.
Overview
The introduction of a savings tax rate and savings band for tax and a new savings allowance provides directors with opportunities for tax planning.
By charging your company interest on a loan at a commercial rate, you can align your financial strategies with these changes.
Charging your company interest - company's position
When you lend money to your company, the company can be charged interest and claim relief for interest charged.
However, special rules apply where the company is a close company and the director is a participator. In other words you are a director/shareholder in your company.
For your company to benefit from tax relief on any interest paid the correct procedure must be followed. Therefore if you're a shareholder in a close company, interest must be paid within 12 months from the end of the company's accounting period.
If the interest is not paid within this period, tax relief is deferred until payment of the interest due.
What interest rate can I charge?
It is important to charge your company interest at a commercial rate. You should therefore compare rates with third party commercial lenders. Additionally you should formally agree any loan terms in a company board meeting.
If they considered the interest rate is excessive, HMRC may reclassify the excessive amount as a distribution. As a result your company will be denied tax relief on those amounts of interest HMRC consider excessive.
Paying interest gross or net?
Where the repayment terms of the loan are less than a year, your company pay you gross interest. However where the company must deduct income tax at the basic rate and pay interest net of tax. Additionally, it must account to HMRC for the income tax deducted using form CT61 quarterly. This ensures compliance and proper tax management.
You are taxed on interest when it is paid to which is a mismatch with the Corporation Tax rules. This is because a company claims relief for interest paid on an accruals basis.
If the tax deducted from your interest exceeds your income tax liability it can be reclaimed via your Self Assessment tax return.
Potential tax issues
Both the director and the company must ensure that the borrowing serves an allowable purpose to obtain tax relief on interest paid.
HMRC may disallow the deduction if the loan merely enables tax-free interest for the director. Additionally, even if disallowed for the company, the director must report the interest as income. However, if there's a written loan agreement, the interest will be treated as such and not salary.
You can claim tax relief on interest paid on a loans to your company, provided certain conditions are met. Most importantly the loan must be used wholly and exclusively for the company's business, which must be engaged in a trade or property rental.
You might opt for this route if you can secure a better personal loan rate compared to a loan taken out by your company.
Summary
Charging your company interest can be a useful method of profit extraction from your company. However, it must be done correctly to maximise benefits and avoid pitfalls.
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