There are various ways in which you can get income tax relief on loan interest. However, there are conditions which have to be met and also possible restrictions in the amount of relief that you can obtain.
Essentially, the loan has to be secured for a “qualifying purpose” as a starting condition. Broadly, the most common qualifying purposes to get tax relief on loan interest include:-
- Buying shares in, or making a loan to, a close company;
- Injecting money into a trading partnership (as a partner in that partnership);
- Buying a property to let out.
In the case of the first two scenarios, the allowable interest is given as a deduction against total income. In the 3rd case, the allowable interest is currently given as a deduction against the rental income (although see below).
It’s also worth pointing out that in the second scenario, the allowable interest will not only give you income tax relief at your highest rate but will generally also count as a deduction for Class 4 NIC purposes.
For those of you old enough to remember, there is no longer any income tax relief on mortgage interest suffered to buy your own home.
Ok, so you’ve got a loan which qualifies for income tax relief, but how much relief will you get?
Restrictions on tax relief on loan interest.
There are a number of restrictions which can limit the amount of interest that can be claimed:-
- The most obvious, if you’ve got a repayment loan or mortgage, you won’t get relief for the total payments you make, as these include a capital repayment element. Only the actual interest (as shown on an annual mortgage statement) will be allowed.
- In the case of a loan to a close company, if your loan is partly repaid and dips below the amount you originally borrowed, a restriction will be applied to the interest you can claim. Similarly, if you inject money into a partnership but your capital/current account falls below the amount borrowed, a restriction will also be imposed.
Tip: To avoid this type of restriction, use any capital withdrawn from the partnership or company to reduce the borrowings to the same extent.
- In the case of a loan to buy shares in a company, if you sell the shares, the loan will no longer qualify from the date of disposal. Similarly, if you retire from the partnership, the loan will no longer qualify. In both cases, try to repay the borrowings as soon as possible to minimise the period where you are paying interest which no longer qualifies.
- In the case of interest relief which is given as a deduction from total income, please remember that from 6 April 2013, there is an overall cap (£50,000 or 25% of adjusted total income) which applies to all such deductions.
- If your loan is in respect of let property, then you should be aware of the restrictions which are coming into effect over the next few years from previous updates. If the property is a residential letting (as opposed to commercial), then the loan interest which is currently allowed in full as a deduction against the rental income will instead be given as a tax reducer (at 20% only). Although the allowable interest won’t be restricted as such, the rate of tax relief that it obtains will be.
These restrictions apply to loan interest outside a business structure, but it is also worth noting that interest paid within the business accounts can also potentially be restricted. If the business has an overdrawn balance sheet, then HMRC could argue that part of the business borrowings are financing drawings which would result in a restriction on the allowable interest within the financial statements.
Also don’t forget that if your business uses the cash basis, loan interest relief is restricted to a maximum of £500 a year.
Whilst commenting on loan interest relief, it would be appropriate to mention one common piece of tax advice for partners which can convert non-qualifying borrowings into qualifying borrowings.
This article is intended merely as an overview of the issue of income tax relief on loan interest and possible restrictions involved. For detailed guidance of how this may apply in your own personal circumstances, please contact us for further information.