In the course of funding and growing your business, it’s likely that you’ll take out some form of loan – and will end up paying interest on loans from directors or other third-parties. However, many businesses fail to consider the taxation requirements on these interest payments.
There are three different categories of lender to consider:
- Interest paid to an individual – usually a director or shareholder
- Interest paid to a UK limited company
- Interest paid to a non-resident company
Each of the categories has differing rules regarding how to deduct tax from interest payments. As such, it’s important to think about who you’re paying the interest to and how you should account for the requisite tax on these payments.
How to account for tax on loan payments
So, how do you account for the tax on these loan payments? And how do the rules change depending on which category of lender you’re making the payments to?
Let’s look at how this works for the three categories we’ve outlined:
- Payments to an individual – if the lender is an individual (e.g. a director or shareholder,) you should deduct tax from any interest paid at the basic income tax rate of 20%. This then needs to be remitted to HMRC on a quarterly basis, together with form CT61 – the corporation tax form re the return of income tax on company payments. Many companies are unaware of this requirement and are open to penalties and other compulsory payments.
- Payments to a UK limited company – interest paid to a UK limited company can be made without any deduction of tax, unless the company is a nominee for a person beneficially entitled to the interest.
- Payments to a non-resident company – interest paid to non-resident companies should by default have tax deducted at the same 20% rate. In many cases there may be a double-taxation agreement (DTA) in place which removes the need to deduct tax at source. If you rely on a DTA, an appropriate claim should be made – it’s not automatic. (Exception: If the non-resident company has a Double Taxation Treaty Passport then interest can be paid without deduction of tax.)
Other considerations re interest on loan payments
If you stick to the rules we’ve outlined for the three categories of loan, you can be confident that you’re applying the right tax to these payments. However, there are other considerations to think about re the tax and interest implications.
- Reclaiming deducted tax – any tax you’ve deducted from individuals can be reclaimed by the lender as part of their normal self-assessment tax return filing. If their total interest income is within the tax-free personal savings allowance, the company can claim the interest costs against its own profits, while the lender, in effect, receives it tax free.
- Annual interest – interest in this case refers to ‘annual interest’. In practice, this simply means that the loan was either expected to last for at least a year in whole or in part, or is capable of lasting for at least a year – for example, an ‘on demand’ loan with no fixed payment date. Interest on, say, a fixed-term six-months loan doesn’t fall under this. It’s also worth noting that where there are successive short-term loans, they could be considered as one continuous loan.
- Tax on interest paid – tax is deducted on interest paid. If the interest is added to the principal outstanding, and only payable at the end with the capital, then tax would only be deducted at the end, on the interest element. If the credit is to something like a director’s loan account (which could be withdrawn in whole or in part at any time), even if in practice it isn’t withdrawn, that still counts as ‘paid’ as it’s made available to the director.
Talk to us about help with your CT61 forms
If you’re unsure whether you’re accounting for tax on interest payments in the right way, please do come and talk to us.
Where you’re paying interest on loan payments to a UK limited company, we can help you by preparing the CT61 forms on your behalf.