Your company needs cash to help it during the coronavirus period. It could try to borrow it or you could dip into your personal savings to help it out. Choosing the latter option might have a tax advantage. What is it?
Company borrowing
The cost of business borrowing varies widely. Annual interest for an arranged overdraft starts at around 5% for low risk companies, but for small businesses, especially start-ups, the rate can easily be double that. Add to this arrangement fees and the bank’s business manager’s charges for reviewing the overdraft, and a facility of £10,000 can easily cost £1,000 per year and probably more.
Personal savings
On the other hand, if you can get interest at 1.5% before tax on your savings you’re doing okay. For £10,000 of savings, assuming interest is paid once a year, you’ll receive £150, which, if you’re a higher rate (40%) taxpayer would net you as little as £90. Tip. Use your savings account as an overdraft facility for your business and charge your company interest broadly equal to the total of the bank’s charges. In other words, swap the derisory £150 before tax for something close to £1,000.
Tax efficiency
On the face of it our tip makes good sense; you’ll be better off by £850 while your company is no worse off. If the interest you charge works out to a similar amount as the bank’s charges, HMRC won’t have a problem with the arrangement. But how tax efficient is it?
Company’s position
For tax purposes a loan/facility to the company, whether from you or the bank, is a “loan relationship”, which means the interest you charge isn’t directly deductible from its profits. Instead it counts as a loan relationship debit. That limits the situations when it can be deducted, but as long as your company makes a taxable profit there’s no problem. So the net cost to your company of paying you £1,000 interest is £810 (assuming a corporation tax (CT) rate of 19%).
Your position
Interest paid by your company is savings income and taxed the same way as interest paid by a bank. This means it qualifies for the savings zero rate band (known as the savings allowance (SA)) of £500 for higher rate taxpayers and £1,000 for basic rate payers. If you’re not currently using all your SA, then lending to your company will be especially tax efficient. Even if you fully use your SA, the tax efficiency is better than that of dividends.
Example. If your company paid a £1,000 dividend, as a higher rate taxpayer you would net £675. But for the same net cost to your company it could pay you interest of £1,234 (after CT relief at 19% is £1,000), which after tax would give you £740.
Tip. If your spouse doesn’t use their SA, or even if they do, but they pay tax at a lower rate than you, provide the loan facility through them as this will be more tax efficient. There might be no tax to pay on it at all. If they don’t have enough savings to lend the company you can give them the money to do it. HMRC can’t raise any objection to this as long as the money is a genuine gift.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.