Tax relief on loans to property investment company
Written by Ray Coman
One method of saving tax on a rental property is to loan the company funds and deduct interest on this mortgage from general income.
This has two tax benefits:
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The individual can obtain tax relief from the loan even when the property is loss making; and
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The restriction on deduction of mortgage interest from rental property would not apply.
The loan should be for a qualifying purpose under ITA 2007, s 392(2)(b) https://www.legislation.gov.uk/ukpga/2007/3/section/392 as the investment is “for the purpose of making investments in land, or estates or interests inland, in cases where the land is, or is intended to be, let commercially.” To this extent the property could not be let to connected persons such as family members.
The company must be a close company, which typically means for a company five or fewer shareholder each with 5% stake. Further definition of “close investment-holding company” is found in CTA 2010, s 34(2)(b).
A loan is often raised via mortgage or second mortgage on the company’s owner’s home.
Potential pitfalls of the arrangement explained above are listed below:
There is a risk that such arrangement could be successfully challenged by HMRC by invoking section 384A of the same act: https://www.legislation.gov.uk/ukpga/2007/3/section/384A
“Relief is not to be given … for interest paid by a person on a loan if the arrangements seem to have been designed to reduce any income tax or capital gains tax to which the borrower… would be liable apart from the arrangements.”
Loan interest cannot be greater than £50,000 or 25% of the taxpayer’s income. This would include any income, for instance in the form of dividends (or other profit extraction) from the company.
There is a risk that gains on disposal of the propriety would be subject to corporation tax and on post tax funds subject to capital gains tax. This double tax charge could result in combined rate of tax of 35.2% on the gain, compared with a rate of 28% for property held personally. The structure therefore works most effectively for property with high yield rather than expected growth potential.
Capital gains tax would apply to any pregnant gains in property previously owned by the shareholder. Company ownership is therefore rarely practical for an existing portfolio of rental property.
Comments
I advise that a company is entitled to tax relief on mortgage interest. From 6 April 2020, an individual is not entitled to treat mortgage interest as an expense. Instead, a 20% tax reducer is available to reduce any liability arising on rental income.
Technically, if you make a loan to a trading company, you can deduct interest on that loan from your taxable income for that year.
You note however that I quote https://www.legislation.gov.uk/ukpga/2007/3/section/384A in my article above.
My opinion is that a personal loan to buy to let company gains a tax advantage specifically because of the new mortgage restriction rules. While I cannot find any specific HMRC guide disallowing such interest, I would not advice such a scheme on the basis of the above.
Prior to the new rules, I would have considered entertaining such a setup.
The usual arrangement for a company is for the company itself to borrow. Reduced profit in the company will eventually limit exposure to personal tax, and inasmuch achieve something similar to what is envisaged.
what do you make of the above thread?
confused?
what about late interest and roll up and the 12 month rule... for the company to be able to get tax relief.
Saw your article on a google search
but it did not quite fit the thread above
tmann