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Sole Trader Mortgage or Business Loan

A sole trader running a camping site has three different types of debt.

1) Personal Mortgage on the owner's house
2) Business Loan
3) Business Overdraft

Interest incurred on the business loan and business overdraft is a tax allowable expense. The mortgage interest on the owners house is not.

Mortgage interest rates are lower than the interest paid on the other forms of debt.

Is it acceptable to re-mortgage, secured on the business, repay the loan and the overdraft and *retain* the benefit of the tax shield. i.e. treat the new enlarged mortgage loan interest as tax allowable (either in part or in entirety)

Your comments are much appreciated,
Dan Griffiths

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By admin
18th May 2001 23:40

Cost of Capital
When you compare the cost of various types of loans, you must take account of tax reliefs available to a business. For example, if the business loan rate is 7%, the effective cost to the sole trader will be 4.20% (7% less 40% tax relief) for a higher rate tax payer. I doubt whether you can get mortgage rates as low as 4.2% The average rate at present is about 6.5% and so if you gross this up, similar busines loan rate should be about 10.83%.

Hence, you need to be careful before you repay your mortgage bearing in mind you may need to provide security (your house) to get additional business loan anyway.

If you have surplus funds in business bank account, I don't see why you can't use these funds as you you wish. It is your money after all. the problem arises when you try to borrow additional funds to run your business following withdrawal of surplus funds.

There are schemes already being exploited where a newly qualified accountant wishes to buy a share in a partnership. Instead of using his spare cash, he could borrow to buy a share and use the any surplus funds to buy himself a nice house and a car!

Hope this helps.

Jay Tanna

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18th May 2001 12:22

Thank You All,
Thanks to everyone who replied. So, to extract maximum benefit from this scenario, if acceptable to the revenue, it appears that following two steps could be taken:

1) Take drawings from the accumulated owners current account and use these to repay the personal mortgage. An extension of the business debt will be required to make this large one-off drawing although the owners current account will not become overdrawn. The interest on the increased business debt is all tax allowable.

2) Then, re-negotiate with the bank, the business loan and overdraft to secure more preferable interest rates if possible, perhaps a new business mortgage.

But, without opening a can of worms here, what is actually wrong with rearranging ones affairs purely to gain a tax advantage anyway? I wouldn't be thinking about this at all if MIRAS still applied.

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17th May 2001 19:14

Thanks, Chris
This is indeed how the argument is usually kicked off. You can argue that depreciation should be ignored etc etc. You will probably need professional help for this, which is how the costs begin to mount up.

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By newmoon
18th May 2001 08:16

Isn't the question about repaying the business loans?
Isn't the question about repaying the business loan and overdraft by increasing the mortgage (at a lower rate of interest), rather than repaying the mortgage by increasing the business loans?
On this basis, presumably, if the loans are replaced directly, with a clear transfer of the loan and overdraft to the mortgage, part of the mortgage can be allocated to the balance sheet, and that proportion of interest that relates to the original business loan and overdraft claimed for tax as previously?
Are there duality of purpose questions on the interest taken as whole?
To move to the points discussed, could the overdraft be increased and mortgage decreased prior to the transaction (and with some distance)by withdrawing funds within the capital account balance, and then remortgage, thereby benefiting from lower interest rates and tax relief on a higher proportion of the mortgage?
Finally consideration should be given to how much of the overdraft is 'hard'- there is no point in paying interest - even low interest, if not required.

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17th May 2001 16:44

Be Careful
If you can repay the domestic mortgage by withdrawing capital from the business and without overdrawing the proprietor's capital account, then this is potentially a good idea. What you need to avoid is taking out more in drawings than the sum of the accumulated profits to date less previous drawings. Much has been written on this board and elsewhere about the validity of the Revenue's attitude in these circumstances and there are good arguments on both sides. That is however, as they say, another story. The Revenue attitude if you overdraw the proprietor's capital account is that a proportion of the business borrowings are effectively disallowable as being for private purposes because you have drawn out more than the business has made in profits and that this is to subsidise personal and private expenditure. This means that you are back to square one.
You should also consider the possibility that you would be accused of rearranging your affairs purely to gain a tax advantage. This is not to say that you would not win an argument on this point, but it would be a long and expensive one culminating in defeat at worst or pyrrhic victory at best.
Don't be obvious. Don't do it all on the same day. Make the transactions look as independent of each other as you can.

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By cbales
17th May 2001 18:17

Re overdrawn capital accounts
Dan
Phil's statement "What you need to avoid is taking out more in drawings than the sum of the accumulated profits to date less previous drawings" ought to be considered in the light of a Balance Sheet drawn up on a cash basis and not on an accruals basis. The difference is frequently very significant.

If a balance sheet drawn up on a cash basis shows the capital account to be positive instead of overdrawn on an accruals basis, there are no grounds to restrict relief on interest charged in the accounts. Interest is charged on the actual movement of funds and not on figures distorted by unpaid balances, accruals and paper write off's such as depreciation. We have argued the point with the Inland Revenue and received agreement.

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By admin
17th May 2001 20:36

Accruals cut both ways
Sometimes the argument is not worth the powder and shot. As Phil says, the costs mount up. If you are dealing with a business on credit sales or with longterm contracts you may have to watch that you do not strip out too much by way of credit sales as that will reducethe profits and take you to overdraft more quickly.

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