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[Spreadsheet]

Is lending to your company tax efficient?

Company borrowing

Company law includes strict rules which dictate when a company is allowed to lend money to a shareholder but there are no equivalent rules relating to directors and shareholders lending to their companies. The question of whether lending to your company and charging it interest is tax efficient is far trickier to answer.

Tax deductibility is the key

If you charge your company interest on money you lend, it is taxable income for you. Therefore, the arrangement will only be tax efficient if it can claim a corresponding tax deduction. The measure of tax efficiency will depend on the rate of corporation tax (CT) your company has to pay (currently 19% rising to up to 25% from April 2023) and the rate of income tax you’ll pay.

Tax deductible or not?

The CT rules differentiate between interest paid by a company for trading purposes and that paid for other reasons. Broadly, the CT rules say that interest incurred “wholly and exclusively” for the purpose of a company’s business is tax deductible like any other day-to-day expenses, while deductions for other interest are subject to more restrictive rules under the loan relationship regime. For example, if you lent your company money to buy the new machinery it needed for its business, that would be a trading expense. Conversely, if you lent it money when it didn’t have any real need for it, the interest would be a loan relationship deficit. At one time this might have deferred or prevented tax relief for your company. However, since April 2017 the CT rules were relaxed so that relief for loan relationship deficits can be deducted from a company’s business profits for the current and future accounting periods (and those of the previous twelve months).

Trap. If you charge interest at a rate that is greater than your company would pay if it borrowed money from a bank etc. HMRC can argue that it’s not entitled to tax relief the excessive interest. Therefore, only charge interest at a commercial rate.

Measuring tax efficiency

The table below compares the net income for 2021/22 from dividends and interest where the cost to the company of paying either is the same (£810) (see The next step ).

As you can see, interest is the most tax efficient. The figures assume that the dividend nil rate band and the savings nil rate band have been used against other income. If they were available, it could swing the advantage the other way but only if the amounts of interest or dividend paid were no more than around £3,000.

Tip. If your spouse or partner pays tax at a lower rate than you, or vice versa, the person who pays the lowest rate of tax should lend the money to your company to increase the tax efficiency.

For the full calculations, visit https://www.tips-and-advice.co.uk , Download Zone, year 22, issue 5.