Loan to an associated company
There can be good commercial or management reasons for having separate companies. How can you switch profit from one to the other in order to save some Corporation Tax?
Separate companies
Scenario. There are some circumstances in which moving profits from one company to another can be tax efficient. The aim is to remove the profit from one and inject it into another where there are losses or where the small company rate band has not been fully utilised.
For example, Company G (a dormant holding company) has two subsidiaries H Ltd and I Ltd. The projected profit for the group is £300,000 for the year ended July 31, 2008. However, the split of the profits between the two companies is £10,000 from H Ltd and £290,000 from I Ltd. What are the CT bills?Total CT liability for the group is £77,000 (£2,000 + £75,500). This figure is arrived at as follows:
Table 1. H Ltd’s CT bill on £10,000
| Profits (£) | CT rate | CT liability (£) |
| On 10,000 | 20%(*) | 2,000 |
| Total | 2,000 |
Table 2. I Ltd’s CT bill on £290,000
| Profits (£) | CT rate | CT liability (£) |
| On first 150,000 | 20%(*) | 30,000 |
| On next 140,000 | 32.5%(**) | 45,500 |
| Total £290,000 | 75,500 |
(*) This CT rate moves to 21% for 2008/9.
(**) Normally the marginal CT rate of 32.5% doesn’t start until profits exceed £300,000. But with two companies it starts at £150,000 (£300,000/2).
Classic solution. In practice you would try and equalise the profit between the companies, for example with the use of management charges (seeThe next step). However, there is another solution.
Loan interest solution
Alternative solution. If H limited lends money to I Ltd it can then charge interest at a commercial rate on the loan. The interest is income in H Ltd’s accounts but an expense in I’s accounts. In other words, you increase profits taxed at 20% in H Ltd but reduce profits charged at 32.50% in I Ltd.
Tax saving. If H lends £20,000 to I Ltd at a commercial rate of 9% (about 3% above base) the interest figure for twelve months is £1,800.CT saved is (£1,800 x (32.50% - 20% = 12.50%)) £225.
Table. CT saving for various size loans assuming an interest rate of 9%.
| Interest at 9% (£) | CT saving at 12.50%(*) | |
| £5,000 | 450 | 56.25 |
| £10,000 | 900 | 112.50 |
| £20,000 | 1,800 | 225.00 |
| £50,000 | 4,500 | 562.50 |
| £100,000 | 9,000 | 1,125.00 |
(*) 12.5% = 32.5% - 20%.
Tip 1. Have a formal loan agreement in place between the two companies. Do not route the money through you personally.
Tip 2. If you charge another company 20% interest in order to shift tax liability, you will have a problem with the Taxman. However, bank base rate plus about 3% is safe. The lending is unsecured to a private company, so a risk uplift to the rate is appropriate. With the bank base rate at 5.75% an inter-company rate of 9% is reasonable.
The next step
For a previous article on inter-company management charges, visit http://tax.indicator.co.uk (TX 07.20.03).
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