Your company’s profits are ticking over nicely, unfortunately it hasn’t got the money in the bank yet.
So when the company declares a dividend of £10,000 payable to you it doesn’t actually have the money to pay you. So this amount goes into your director’s account as a loan.
However you’d like the company to pay you interest on the amount it owes you. The problem is your company can’t afford to pay you any interest either.
It’s not often we say this, but the taxman does offer you some good news… and there’s a neat little method that could save you thousands of pounds in tax.
You can charge your company interest for the money it owes you even if it can’t afford (or simply doesn’t) pay you.
So what does the HMRC think about this?
Well let’s use the following example to show what we mean…
Kirk owns 75% of the shares in Enterprise Ltd. Over a five year period he has re-invested dividends to provide working capital for the business. In Enterprise Ltd’s financial year ended 31 December 2014, the credit on Kirk’s loan account was £125,000 throughout.
Kirk charged Enterprise Ltd 6% interest per annum on this loan.
The interest due to Kirk is £7,500 but Enterprise Ltd doesn’t pay it. If it claims the interest in its 2014 accounts it will cut its Corporation Tax (CT) bill by £1,500.
So if it hasn’t actually paid the interest to Kirk is it allowed to do this?
HMRC’s position on ‘loan relationships’ determines the amount of interest on which a company can claim CT relief. They say that tax relief can be claimed on interest due even if it hasn’t yet been paid.
However be warned as this isn’t always the case and there’s a nasty trap lurking if you’re not careful.
A loan to a close company (one controlled by 5 or fewer people) from a shareholder is subject to the ‘late interest rule’.
So what’s the late interest rule?
Well this specifies that a company can’t claim a CT deduction unless it pays the interest within 12 months after the end of its financial year.
If it doesn’t, then it has to wait until the year it actually pays the interest to get a tax deduction.
So how does Enterprise Ltd claim CT relief for the interest if it hasn’t been paid during the year ended 31 December 2014?
Provided the interest is paid by 31 December 2015, Enterprise Ltd can claim a deduction in the previous year’s accounts. However the interest can’t simply be credited to Kirk’s loan account – Enterprise Ltd must actually pay the cash into his bank account.
There are also two further advantages to paying interest this way.
Firstly, by deferring the payment of interest to Kirk until say 6 April 2015, it won’t count as income for Kirk’s personal tax until the 2015/16 tax year. So Kirk won’t need to pay any tax on this interest until 31 January 2017.
Not only can Kirk defer his tax payment he can also reduce it.
How can he do that?
He can justify charging a higher interest rate to the company on his loan – say 12% – because the loan he’s effectively made to the company is unsecured and a high risk. So this would double the amount of interest that could be paid to him by Enterprise Limited to £15,000.
How does this reduce his tax bill?
Well he could then afford a salary sacrifice equal to the amount of extra interest he’s received.
What does this mean?
Well, if Kirk was intending to take additional salary of £7,500 he can now ‘sacrifice’ this salary and take the loan interest instead. In this case the extra interest (above market rates) is £7,500 and because there’s no National Insurance payable on interest this could potentially save Kirk up to £1,935 in NI contributions.
It’s a good idea to charge the maximum rate of interest you think can be commercially justified on any money which you loan to your company – as this could save you thousands of pounds in National Insurance.
However please be reasonable with the loan rate you choose. And remember, these tips are not a replacement for professional advice tailored to your precise needs and circumstances.
I hope you found this a useful article. Please contact me directly if you wish to examine this strategy further, with any questions about accountancy, or simply to see what I and my colleagues can do for you and your business.
You can reach me by phone or email at 01202 048696 or by email to lesley(Replace this parenthesis with the @ sign)businesswessex.org.uk[/vc_column_text][/vc_column][/vc_row][vc_row full_width=”” parallax=”” parallax_image=”” bg_type=”” parallax_style=”” bg_image_new=”” layer_image=”” bg_image_repeat=”” bg_image_size=”” bg_cstm_size=”” bg_img_attach=”” parallax_sense=”” bg_image_posiiton=”” animation_direction=”” animation_repeat=”” video_url=”” video_url_2=”” u_video_url=”” video_opts=”” video_poster=”” u_start_time=”” u_stop_time=”” viewport_vdo=”” enable_controls=”” bg_override=”” disable_on_mobile_img_parallax=”” parallax_content=”” parallax_content_sense=”” fadeout_row=”” fadeout_start_effect=”” enable_overlay=”” overlay_color=”” overlay_pattern=”” overlay_pattern_opacity=”” overlay_pattern_size=”” overlay_pattern_attachment=”” multi_color_overlay=”” multi_color_overlay_opacity=”” seperator_enable=”” seperator_type=”” seperator_position=”” seperator_shape_size=”” seperator_svg_height=”” seperator_shape_background=”” seperator_shape_border=”” seperator_shape_border_color=”” seperator_shape_border_width=”” icon_type=”” icon=”” icon_size=”” icon_color=”” icon_style=”” icon_color_bg=”” icon_border_style=”” icon_color_border=”” icon_border_size=”” icon_border_radius=”” icon_border_spacing=”” icon_img=”” img_width=”” ult_hide_row=”” ult_hide_row_large_screen=”” ult_hide_row_desktop=”” ult_hide_row_tablet=”” ult_hide_row_tablet_small=”” ult_hide_row_mobile=”” ult_hide_row_mobile_large=””][vc_column width=”1/1″][vc_column_text]
Business & Management Wessex publishes this article in the good faith that the author, who is qualified, is correct at the time of writing and as such we cannot take responsibility for the accuracy of the information or advice provided. As always we encourage and recommend you to seek professional advice on anything to do with accounting and taxation. Please contact the author directly to seek answers to your questions.[/vc_column_text][/vc_column][/vc_row]