Which is better – going overdrawn at the bank or going overdrawn with your company?
Because the taxman introduced new anti-avoidance rules a couple of years ago for director’s loans, is it still tax effective to borrow from your company?
Well, as the changes simply reinforced the existing rules that have been around for years, HMRC didn’t exactly moved the goalposts, so it’s not necessarily all bad news.
So what is the tax cost?
If you borrow from your company you pay tax on a benefit in kind (BIK). This currently equates to 3.25% of the average loan balance, plus your company will pay tax equal to 25% of the outstanding loan, which is then refunded when your loan is repaid.
OK, let’s show you some numbers so you can see how this works.
Bill is a director/shareholder of CTU Ltd (yes we’re fans of ‘24’). At the start of April 2014 Bill borrowed £40,000, interest free from CTU Limited to build some security enhancements to his home. Bill won’t be repaying the loan for 5 years.
The tax and NI costs are as follows:-
Bill Tax is due on 3.25% of the average loan. Bill is a higher rate taxpayer so this amounts to £520 (£40,000 x 3.25% x 40%).
CTU NI of £179.40 per annum is paid on the BIK (£40,000 x 3.25% x 13.8%) plus the company pays a one-off tax charge of £10,000 (£40,000 x 25%). This is refunded when Bill repays the loan although CTU loses the interest it could earn on the £40,000 and the temporary tax charge.
Over 5 years, Bill’s tax bill amounts to £2,600 and CTU’s NI bill (net of corporation tax relief) is £717.60.
This seems a lot of hassle so why doesn’t Bill extend his mortgage instead?
Well, let’s assume CTU didn’t have the cash available to lend to Bill, he would therefore need to raise the cash by re-mortgaging.
The APR would typically be around 4.75% to 5.99% (plus an arrangement fee to the lender) whereas the APR on an unsecured loan will be even higher than this.
Still not convinced borrowing from your company is better?
Well let’s do a like for like comparison with Bill’s company loan and a 5 year interest only loan at 5% APR which will cost him £10,000 in interest payments.
As you can see it makes financial sense for Bill to borrow from his company. He would also have to make capital repayments on a mortgage which wouldn’t be necessary if he borrowed from his company.
Wouldn’t the monthly repayments reduce the amount of interest on the mortgage?
Yes they would, however the repayments would be funded out of Bill’s income after tax so overall the cost to him would still be higher.
As a general rule we still think interest-free company loans are a tax (and cost efficient) BIK, plus if commercial interest rates increase, the advantage will be greater.
However, the tax interest rates given in the examples are as at January 2015. If you do decide to borrow from your company we would recommend you check the position each time there’s a change in tax or interest rates.
For more help on this or any other company loan tax issues, feel free to email our friendly tax adviser on [email protected].
And remember, these tips are not a replacement for professional advice tailored to your precise needs and circumstances.