Can One Company Lend to Another? The Tax Implications

Have you ever thought about whether one company can lend money to another without facing a big tax bill? Many business owners are surprised to find out that companies with extra cash can lend to a linked company without causing major tax issues.

Why Some Companies Lend to Others

In today’s economy, some businesses find themselves holding more cash than they need for day-to-day operations. They may not have new projects or equipment to invest in. Meanwhile, other connected businesses might be short on funds. When companies share an owner (or a group of owners), it’s possible for one to lend money to the other—usually at either low interest, no interest, or a higher rate if they choose. The big question is: Will there be tax consequences?

Understanding “Connected Companies”

According to HMRC, companies are “connected” when they’re under common control. This control might come from:

1. The same person controlling both companies,
2. One person controls one company, while people connected to them control the other,
3. Two or more people together control both companies.

Because these companies share owners, HMRC monitors transactions between them closely. Still, it’s generally perfectly legal for one connected company to lend money to another if it follows the right rules.

Loan Relationship Rules

When a company either makes or receives a loan, it falls under special tax laws known as loan relationship rules. These rules apply to both cash and non-cash loans and aim to ensure that any interest or gains from the loan are recognised and taxed appropriately. Here are some important points to remember:

• Arm’s length principle: Even if two companies are connected, the transaction should look like one that could happen between unrelated businesses.
• Interest timing: Under normal loan relationship rules, interest is recognized (or “relieved”) when it accrues in the accounts, not necessarily when it’s paid.
• No immediate tax on the loan itself: Simply transferring cash doesn’t trigger a taxable event. Tax issues mainly show up if interest is charged and received.

Should You Charge Interest?

In many cases, connected companies choose not to charge interest at all. This means:

• The lending company doesn’t pay tax on interest (because there is none).
• The borrowing company cannot claim a tax deduction (because it isn’t paying interest).

If they do charge interest, the lending company must treat it as taxable income, while the borrowing company could claim it as an expense, reducing its tax bill. Whether or not to charge interest can be a strategic decision based on each company’s finances and tax positions.

Lending Surplus Cash for Property Investments

A common scenario is when a trading company has excess funds but prefers not to invest further in its own operations. Instead, it might set up a separate non-trading company to buy property. By keeping the investment property in a different entity, the business owner can:

• Protect the property if the trading company faces liquidation,
• Avoid mixing trading activities with property investments,
• Preserve Business Asset Disposal Relief opportunities for the trading company.

Often, the trading company will lend surplus cash to the property company so it can purchase real estate in its own name. Sometimes, they might also take out a mortgage from a bank. This structure helps the trading company avoid providing personal guarantees or pledging its own assets, which banks sometimes require.

What If the Loan Is Written Off?

Eventually, the property might be sold to repay the loan. But if the lending company decides to write off the loan—basically giving up on getting repaid—this is usually tax-neutral among connected companies. That means:

• No extra tax is charged to the borrowing company,
• The lending company can’t claim any tax relief for the write-off.

This neutral approach is meant to prevent groups of companies from using loan write-offs in tricky ways to dodge taxes.

Formal Loan Agreements: Are They Necessary?

Some owners wonder if they need a lot of legal paperwork. Technically, there’s no law requiring a formal loan agreement for connected companies. When the same individual or family runs both companies, it’s unlikely that one will sue the other for non-payment. However, it can still be wise to have some kind of written agreement for clarity—especially if anyone else needs to see proof of the arrangement (like banks or auditors).

Specialist Advice

1. Yes, one company can lend to another, especially if they’re connected and follow HMRC’s loan relationship rules.
2. Simply transferring the cash doesn’t trigger tax; interest (if charged) is what creates a taxable event.
3. Property investments are a popular way for trading companies to use surplus funds without risking their main business.
4. Writing off a loan between connected companies typically leads to no tax on the borrower and no relief for the lender.
5. A formal agreement isn’t always required, but it’s a good idea for record-keeping.

Inter-company lending can be a valuable tool for businesses, allowing well-funded companies to support related ventures without depending on outside banks. This approach can save money and reduce hassles. By adhering to loan relationship rules and deciding on interest charges, businesses can remain compliant with HMRC while protecting their investments. If you’re looking to maximise your company’s spare cash, consider this option—ensure you follow tax guidelines for peace of mind and better returns!

As always, given the complexity of tax law and its frequent changes, it’s advisable to consult with one of our tax accountant for advice tailored to your specific business circumstances.