Capping the tax on cheap rate company loans
The bank lending rate is set to increase in the near future and tax on money you borrow from your company will follow suit. How can you pin the tax charges at the current low rate?
Whether you’re a director or an employee there can be tax to pay for you and NI for your company where it lends you more than £10,000. But this can be avoided if you pay interest on the loan equal to HMRC’s so-called “official rate”, currently set at 3.25% per annum. But if the official rate rises, will you have to pay more interest or face a tax bill instead?
Is a rate increase on the cards?
HMRC loosely ties its official interest rate to the Bank of England’s (BoE) base rate, but adds on between 3 and 4%. At just 0.5%, the BoE’s interest rate is currently at an historic low and consequently so is HMRC’s official rate. The BoE rate is expected to rise soon and HMRC’s rate will probably follow suit.
What’s the tax cost?
Where you borrowed £25,000 from your company, perhaps to build that conservatory you’ve always wanted, and repaid it after ten years, the effect of a 1.5% rise in HMRC’s official rate now would cost you extra tax of up to £1,500 assuming you are a higher rate taxpayer.
Tip. Fix the terms of the loan. There’s a neat tax break where you take a loan from your company and fix the period over which it’s repaid and the rate of interest payable. Even where the official rate increases a later year, you’re allowed to pay interest at the original lower rate without getting hit for a tax charge.
Trap. A change of rate could ruin the plan. To qualify for this tax break the amount of interest you pay on the loan in its first year must be no less than the amount due at the official rate. So if the rate changes after you’ve fixed the loan but before the end of the same tax year, the tax break will be lost.
Tip 1. Defer taking the loan until near the end of the tax year – HMRC usually gives a couple of months’ notice of any changes in the official rate of interest. So by taking a loan in March, the last full month of the tax year, and fixing it at the rate in force, you should avoid the trap mentioned above.
Tip 2. HMRC doesn’t mind when the interest is paid; set up the loan so that the repayments only have to be made once a year, say, at the end of March, meaning that the money can stay in your bank account for longer.
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