You always need help when you’re looking forward to investing in a new business prospect. But how much tax relief one must expect on all those loans for small businesses? Christmas is one of the most trending topics these days, and people are grabbing every opportunity to invest in a long-term plan. But what about the interest on these loans? Do you have to pay taxes and VAT on all these loans for small businesses too?
HMRC doesn’t consider the capital element of loans for income tax relief purposes. If the loans are exclusively for business purposes, interest paid on loans would be a deductible revenue expense. Let’s say you’re looking forward to investing in the machinery for your small business. The machinery is counted as a revenue expense, therefore it’s allowable for income tax or corporation tax.
The loan you ask for in the form of cash is deductible for tax. Especially if the business owner is to borrow the loan personally. He may opt to introduce the cash in the form of a loan. The person borrowing a specific amount should make sure that they’re not just figuring out the tax amount but also maintaining whatever amount is due to them. You must know what you aim to do with the cash you’re borrowing for a loan. If you’re aiming to buy capital, its always a good idea to go for the capital. Make sure you take care of this part. Also, note that the capital may not be qualified if Broadly, the loan will become non-qualifying if either the capital ceases to be used for a qualifying purpose or is deemed to be repaid.
For example, Bob borrows £100,000, secured on his house, and lends this to his business. The loan is a qualifying loan, so he can initially claim tax relief on the interest payments. Unfortunately, the rules relating to the repayment of qualifying capital mean that each time a capital credit is made to the account it is deemed to be the repayment of a qualifying loan. Since the capital value of the loan is reduced every time a payment is made, credits totalling £50,000 per year will mean that all tax relief is lost within just two years. Re-borrowing shortly after making repayment is not a qualifying purpose so future relief is also lost.
It is also worth noting that a business cannot claim a deduction for notional interest that might have been obtained if money had been invested rather than spent on (for example) repairs.
Double counting is not permitted, so if interest receives relief under the qualifying loan rules, it cannot also be deducted against profits so as to give double tax relief.
Restrictions under the Cash Basis
Tax relief on loan interest is restricted where the ‘cash basis’ is used by a business to calculate taxable profits. Broadly, businesses using the cash basis are taxed on the basis of the cash that passes through their books, rather than being asked to undertake complex and time-consuming accruals calculations.
Under the cash basis, bank and loan interest costs and financing costs, which include bank loan arrangement fees, are allowed up to an annual amount of £500. If a business has interest and finance costs of less than £500 then the split between business costs and any personal interest charges does not have to be calculated. Businesses should review annual business interest costs – if it is anticipated that these costs will be more than £500, it may be more appropriate for the business to opt out of the cash basis and obtain tax relief for all the business-related financing costs.
Private Use of Assets
Where a loan is used to buy an asset that is partly used for business and partly for private purposes, only the business proportion of the interest is generally tax-deductible. Commonly cars and other vehicles used in a business fall into this category. Note, however, that a deduction for finance costs is not allowable where a fixed-rate mileage deduction is claimed.
Bob takes out a loan to buy a car and calculates that he uses it in the business 40% of the time. The interest on the loan he took out to buy the car is £500 during 2020/21. He can therefore deduct £200 (£500 x 40%) for loan interest in calculating his trading profits. Finally, interest paid on loans used to fund the business owner’s overdrawn current or capital account is generally not deductible for tax purposes.