You personally borrowed money to provide extra working capital for your company. It’s going to reimburse you, but if it’s not done the right way it will result in a tax and NI bill. How can you turn this potential tax trap to your advantage?
Funding your business
Businesses need cash for any number of reasons, such as during the start-up period or for working capital. If your company is unable to obtain a loan but you are, you can borrow and lend the money to your company. However, this could result in a tax charge that reduces the tax relief normally allowed for business loan interest.
Loan interest payments
Your company can meet your loan repayments and qualify for tax relief on the interest element of the loan. This has to be done the correct way or tax and NI charges may apply. The tax charge is not a problem but the NI is.
Simple reimbursement method
If your company simply reimburses your loan repayments, the element which relates to capital is tax free, but the interest counts as earnings to which PAYE tax and NI (employers’ and employees’) applies.
The tax charge can be cancelled out by claiming a personal tax deduction for the interest payments. HMRC will adjust your tax code number to allow the deduction, but this won’t have any affect on the NI.
Example. Sally is a director of Acom Ltd. She took a loan and then lent the money to Acom so that it could purchase new equipment. Acom reimbursed Sally for each loan repayment she made. In the first year the interest part of the reimbursement was £8,000. The NI payable on this was £2,064 (£8,000 at 12% (employees’) +13.8% (employers’)), which can’t be reclaimed.
Paying extra salary
If a company pays extra salary to cover loan repayments the effect is exactly the same as if it made reimbursements. That is, the NI payable on the extra salary can’t be reclaimed.
One way to dodge the NI problem is for the company to make the loan repayments directly. HMRC’s practice is that the company is not required to account for PAYE tax or NI contributions. However, there might be a more tax and NI efficient option.
Draw up a loan agreement between you and the company, but rather than it just covering the cost of the loan repayments, charge the company interest at 2% or 3% higher than the rate you’re being charged. While the extra income you receive is taxable it’s not subject to NI.
Example. George, who is a higher rate taxpayer, borrowed £150,000 which, under the terms of an agreement, he lent to his company for use as working capital. In the first year George paid £15,000 interest on his loan and in turn he was paid £18,000 interest by his company. George has to pay tax on the extra £3,000, but no NI. What’s more, Acom can claim a tax deduction for all the interest it pays George.
Tax efficient? Yes, interest is an even more tax efficient way to take income from your company than being paid dividends.
If you borrow money and lend it to your company don’t just get it to reimburse your repayments. Draw up a loan agreement and charge it interest at a rate a few percent higher than you’re paying. The extra interest you receive is taxable, but it’s a very efficient way of extracting income from your company.