A client borrowed more money to cover up the interest payments for the first 3 years. Are these interest payment tax deductible?
HMRC has an example below:
" Example
Kirsty is a director of, and owns 90% of the shares in, K Ltd. She makes a loan to the company of £10,000. The loan carries interest of 10% per annum, payable annually on 31 December, but under the terms of the loan, interest may be rolled up and added to the principal, whereupon it will itself bear interest. In years 1 – 3, the company’s funds are fully committed in paying trade and bank creditors, and Kirsty is unable to draw on her loan account. The situation is therefore:
Interest credited Loan principal
31 December Year 1 £1,000 £11,000
31 December Year 2 £1,100 £12,100
31 December Year 3 £1,210 £13,310
On 1 January Year 4, the company makes a repayment of £5,000 to Kirsty. It is agreed between the parties that this should be allocated first of all to interest, with the remaining balance treated as repayment of the £10,000 capital.
The company therefore makes an interest payment of £3,310 on 1 January Year 4. It must deduct tax at the savings rate from this payment, and account for the tax to HMRC. "
What I am confused with is the last sentence ' It must deduct tax at the savings rate from this payment, and account for the tax to HMRC. " Where does this saving rate come from?
Really appreciate if anybody can help.
Sue Reed
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Replies (2)
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PS
I suppose the interest for year 3 should be deductible as accrued on the basis that the interest is paid within 12 months after the AP
I would say not ...
... for one thing under the loan relationship rules interest payable to a connected party which is unpaid for more than a year after the end of the AP, it is deductible when 'paid'. That is unless the borrower is a company and brings in a loan relationship credit - see FA 1996, Sch 9, para 2.
This does however beg the question of what is meant by 'paid'. I assume your example comes from the CT manual dealng with deduction of tax, which is a slightly different issue. There is further commentary in the Corporate Finance Manual at CFM5610. This expresses the view that interest may be 'paid' by bookkeeping entry so long as the company has the funds to pay and the payee is unconditionally able to draw. Since that appears not to be the case then payment does not arise until those conditions cease to apply after year 3.
The savings rate is the usual 20%.