Are there downsides to getting a foreign loan?

Are there downsides to getting a foreign loan? What should someone borrowing money from abroad be aware of?

Understanding the tax implications is important to avoid potential risks and ensure a smooth borrowing process. When borrowing money from abroad, it’s important to consider several key factors, such as interest payments and tax implications.

HMRC will review the interest rate on the loan. If the rate exceeds what would be considered commercially reasonable, HMRC may not allow the excess interest as an allowable expense. This is because expenses must be ‘wholly and exclusively’ for the business, in this case, a property business. Therefore, it’s crucial to ensure that the interest rate is in line with market rates to avoid potential issues with tax deductibility.

Under UK tax law, interest on loans with a term of 12 months or more is classified as ‘yearly interest’. This classification triggers specific tax obligations for the UK borrower, which it’s important to understand and fulfil. According to the Income Tax Act 2007, section 874, the UK borrower is required to deduct basic rate tax (currently 20%) from the interest payment before remitting it to the overseas lender. The deducted tax must then be paid to HMRC.

Double taxation agreements (DTAs) between the UK and the country where the lender is based can change the requirement for withholding tax. These agreements may allow for either a total exemption from UK tax or a reduced rate of withholding tax. It’s important to note that the responsibility for claiming this exemption or reduced rate lies with the non-resident lender, not the UK borrower. The lender must formally apply to benefit from these provisions.

These rules apply universally, regardless of whether the UK borrower is an individual, a trust, or a company. Due to the complexities involved, including the need to navigate international tax agreements and ensure compliance with HMRC regulations, it’s advisable to seek professional tax advice when considering or entering into an overseas loan arrangement. This can help ensure that all tax obligations are met and that the loan terms are structured to maximise tax efficiency while remaining compliant with UK tax law.