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For many homeowners, the idea of getting tax relief on their mortgage interest might seem like a distant dream. After all, it’s been nearly three decades since this tax break was available. However, if you’re a shareholder in a private company, there might be a way to turn that dream into a reality.
The key lies in owning shares in a close company, which is defined as a company controlled by five or fewer individuals. If the main purpose of the company is not holding investments, and you either work full-time for the company or own at least 5% of its ordinary share capital, you could be eligible for tax relief on the interest paid on a loan used to buy shares or provide working capital to the company. If you and your spouse or civil partner collectively own 5% of the company’s ordinary shares, you’ll also meet this condition.
To take advantage of this tax relief opportunity, you’ll need to restructure your finances. The objective is to decrease the amount of borrowing related to your home purchase and simultaneously increase the borrowing related to funding your company shares or working capital.
Let’s consider an example to illustrate how this works. Sarah and Michael are a married couple who each own 15% of the ordinary shares in XYZ Ltd, a company valued at around £400,000. Sarah is a full-time director at XYZ Ltd. The couple owns a home valued at £600,000, with a joint mortgage of £150,000 and an annual interest of approximately £7,500.
To unlock the potential tax relief, Sarah and Michael can follow these steps:
- They take out a second mortgage on their home for £150,000.
- Michael uses the money to purchase some of Sarah’s shares in XYZ Ltd, worth £150,000 and pays the interest on the entire loan. (Sarah does not pay capital gains tax due to special rules for transfers between spouses and civil partners.)
- Sarah uses the £150,000 received from Michael to repay their original mortgage.
Before the refinancing, Sarah and Michael had a £150,000 home loan. After the refinancing, they still owe £150,000, but the purpose of the loan has changed. It is now used to purchase shares in XYZ Ltd. Consequently, Michael can claim tax relief on the interest he pays. Assuming Michael is a higher-rate taxpayer, if the interest in the first year after refinancing is £7,500, he’ll save £3,000 in taxes (£7,500 x 40%). If the total interest over the remaining mortgage term is £60,000, the total tax saving will be £24,000.
To put this plan into action, Sarah and Michael may need to obtain valuations of XYZ Ltd’s shares and their home, pay legal fees for the remortgage, and pay stamp duty at 0.5% (£750) on Michael’s purchase of shares from Sarah. However, the tax savings will more than offset these additional costs and administration.
It’s important to note that while this strategy can be highly effective in reducing your tax liability, it’s not without its complexities. There are several factors to consider, such as the company’s trading status, your level of involvement in the company, and the ownership structure of the shares. It’s always wise to consult with a qualified Tax Accountant or Tax Advisor to ensure that you’re following all the necessary rules and maximizing your tax savings.
One of the key benefits of this approach is that it allows you to effectively “refinance” your home loan in a way that provides tax relief. By shifting the purpose of the loan from purchasing your home to investing in your company, you can transform a non-deductible expense into a tax-deductible one. This can result in significant savings over the life of the loan, particularly if you’re in a higher tax bracket.
Another advantage is that this strategy can help you to utilize your financial resources more efficiently. By using the funds from the second mortgage to invest in your company, you’re essentially “recycling” the money in a way that can generate future income and growth. This can be particularly beneficial if your company is poised for expansion or has strong growth potential.
However, it’s crucial to approach this strategy with caution and careful planning. Taking on additional debt always carries risks, and it’s essential to ensure that you have a solid plan in place for repaying the loan. You’ll also need to carefully consider the impact on your finances and ensure that you’re not overextending yourself.
In addition, it’s important to keep in mind that tax laws and regulations can change over time. What may be a viable strategy today could become less advantageous in the future if tax rules are modified. This is why it’s so crucial to work with a knowledgeable Tax Accountant or Tax Advisor who can help you navigate the complexities of the tax system and make informed decisions based on your specific circumstances.
If you and your spouse or civil partner own shares in a private trading company, you could unlock a valuable tax relief opportunity by restructuring your home loan. By taking out a second mortgage and using the funds to buy shares from your spouse or civil partner, you can transform your borrowing in a way that qualifies for tax relief on the interest payments. While this strategy requires careful planning and execution, the potential tax savings can be substantial. As always, it’s essential to consult with a qualified tax professional to ensure that you’re following all the necessary rules and optimizing your tax position. With the right approach, you could turn your home loan from a tax burden into a tax-saving opportunity.