LOANS - 21.09.2022

Can paying interest on your director’s loan account save tax?

Borrowing from your company

As an employee or director of a company borrowing or using its money for private purposes is usually a taxable benefit in kind, but not in all cases.

Tip. If the amount you owe your company doesn’t exceed £10,000 at any time there’s no taxable benefit. However, if you owe more than £10,000 at any time in a tax year the tax charge applies for that year based on the whole debt and not just the excess over £10,000.

Tax and NI charges

The taxable benefit for a cheap-rate or interest-free loan or advance from your company for 2022/23 is 2% of the average debt less any interest paid. For example, if you owed your company £50,000 for a full tax year, the taxable benefit is £1,000 (£50,000 x 2%). As a higher rate taxpayer you would owe £400 tax on this and your company, £150 Class 1A NI (£1,000 x 15.05%). Overall, the total tax and NI cost of £550 is not much for a £50,000 loan but if it can be reduced or eliminated altogether, so much the better.

Paying interest

The tax/NI charge is reduced if you pay interest on the debt. For every £1 of interest paid the taxable benefit is reduced by the same amount. So, in our example if you paid interest of £1,000 the tax/NI bills would be zero. Initially, this doesn’t seem cost effective because the tax and NI saving is less than the interest you need to pay to achieve it. However, if you own all or most of the shares in your company the position needs to be considered more closely.

The big picture

Your company must pay corporation tax (CT) on the interest it receives from you. This increases the company’s coffers but when you withdraw the money you paid as interest you’re likely to have to pay tax on it. The question is, will the tax and NI saved by paying interest be greater than the tax payable if you don’t? The answer depends on how you take the money derived from the interest you paid from your company, and your personal tax position at the time.

Example - company’s position. Emily, a higher rate taxpayer, owns all the shares in Acom Ltd. Her director’s loan account is in the red by £50,000 throughout 2022/23. To avoid the benefit in kind charge she pays interest of £1,000 on which Acom’s CT bill is £190 (£1,000 x 19%) leaving £810. It pays this to Emily as a dividend on which she pays tax of 33.75%, i.e. £273. Overall, this saves Acom £123 which it can pay to Emily, say, as a dividend.

Example - Emily’s position. The £1,000 interest is a cost to Emily but it is partly funded by the £810 (£537 after tax) and £123 (£81 after tax) she receives from Acom. This means Emily has to find £382 from her own pocket to pay the interest compared to the £400 if she had to pay the tax.

Tip. Paying interest to cancel the taxable benefit on a loan is tax efficient if you own all or most of the shares in your company. The tax saving for a higher rate taxpayer is modest but increases significantly if you pay tax at lower rates (see The next step ).

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