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Consider a situation where a person borrows money privately to launch a business. At the time of the business launch, the interest rate was appropriate, but it has dramatically increased and consequently has burdened the business cash flow. Can the Director claim 100% relief on the interest; well, there are some conditions to consider.
There was a period when any interest paid on a loan for nearly any purpose qualified for tax relief. Nowadays, this relief is restricted to interest on loans for specific purposes. Borrowing money for financing your business is one of the qualified options. Even then, complex terms apply to you, your business, and the loan. There is also an anti-avoidance regulation to be aware of.
When you analyse the requirements, remember that only the interest you pay on borrowing qualifies for tax relief, not the whole amount of your repayments. To assist you in claiming the correct amount, the lender must provide you with a statement of interest paid for each tax year upon request. To claim tax relief on your loan:
- The Company must be a trading company and not an investment company;
- The borrowing must not be an overdraft incurred on a credit card or borrowed through a similar arrangement; and
- You must own at least 5% of the ordinary share capital in each Company when you make your claim for repayment (or 3% if you and your partner jointly own two companies).
Consider the following scenario: a director obtains a loan from a bank in the amount of £50,000 and lends it to his Company to provide working capital. He may be eligible for income tax relief for the entire interest paid on the loan. After two years, the Company will pay the Director back £10,000. Director decided to utilise the money to pay off some of his debts rather than put it towards the repayment of a portion of the bank loan he had taken out. Later on, he lends the Company an additional £100,000. As soon as the Company has given back the Director the sum of £10,000, he will no longer be eligible for tax relief on a portion of the interest accrued to him.
The example above indicates that even a partial capital repayment by your Company would immediately lose tax relief for interest on borrowed money. However, the loan to the Company can be converted into share capital to avoid this; tax relief is only lost when the shares are sold or transferred.