Is this right

Is this right

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I was reading a property company tax book by Carl Bayley and he is discussing personal v corporate borrowings.

In his example for a higher rate taxpayer he says that relief when borrowings are made by the individual he says that relief is at 15%

ie    £7,000 borrowed.  Tax saved  £2,800.

Dividend paid to finance borrowings is £7,000.  Extra tax to pay £1,750.

£2,800 - £1,750 is £1,050.  Ie 15%.

Surely the dividend just needs to be £4,200

Extra tax £1,050

So £2,800 - £1,050 is £1,750  Ie 25%

Am I missing something here?

Replies (5)

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Stepurhan
By stepurhan
30th May 2014 11:45

Things missed.

That borrowing itself is not tax deductible. I am assuming that £7,000 is the interest on the borrowing, not the borrowing itself.

The other thing you are missing I think is more to do with timing. He will need £7,000 now to pay the £7,000 interest due now. Any tax saving comes later so you can't just net the two off as you are suggesting.

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By RatPackfan
30th May 2014 11:46

Sorry, that should say 20% because the dividend needs to be £5,600 (so tax payable is £1,400)
 

So no different to borrowing funds via company.

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By RatPackfan
30th May 2014 11:49

Thanks for this Stephurnum.

I agree that there is a cashflow difference, but I am looking at the net result.  So, ignoring timing differences.

Yes, the £7,000 is the interest, not the borrowing.

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By KarenCCarr
30th May 2014 13:22

You are right RatPackfan. 

You are right RatPackfan. 

As Steve suggests there are timing differences of course, but it will work out the same in the end.

If the TP was an additional rate payer, he would have got relief at 45% on the interest, and would have paid 30.52% on the net dividend which works out he would get relief at 21%

ie £3,150 relief on £7,000.

He would need £5,542 dividend on which  £1,693 extra tax is payable.

£3,150 - £1,693/£7,000  =  21% ish

 

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Stepurhan
By stepurhan
30th May 2014 14:58

In the end

It is true that, if nothing else changes, the net effect is as described. There are two problem with taking that view.

The first I've touched on already. The position now is that a dividend of £7,000 (net) is required. If you did these calculations and said only £4,200 (net) was required then they would not have enough money to pay the interest. It is important to take the timing of events into account when looking at these things in the real world. If you get into the habit of ignoring timing differences, then you risk coming unstuck in future.

The second is that you should be looking at the tax saving based solely on what is happening now. Any tax saving in the future years, from needing £2,800 less income to pay their tax bill, depends on conditions in future years. If their income stays the same, except needing less to pay their tax bill, then the saving will be the same. What if next year he decides to take a year off and live on his savings, having taxable income below the personal allowance? What if the next year his income increases so he becomes a 50% taxpayer or even loses personal allowance? Both of these will result in radical differences to your calculated figures. Your calculation only works if you assume nothing will change, which is always a dangerous assumption to make.

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