Under Income Tax Act 2007 (ITA) s383, interest paid on ‘qualifying loans’ is deductible in the tax computation.
Interest is deducted first from non-savings income, then from interest income and the remaining amount will be set against any dividend income.
Relief is not given for interest paid on an overdrawn account or on a credit card, or at a rate that is higher than a reasonable commercial rate of interest.
For a ‘mixed loan’, the interest relief is given only to the ‘qualifying part’ of the loan (ITA07/S386). Any repayments of a mixed loan are apportioned between the qualifying and non-qualifying parts. A different rule applies, however, where capital has been recovered from an investment funded from the qualifying part of the loan. So if the taxpayer takes a loan to buy shares in a close company and then he sells those shares, he is deemed to have repaid the loan with the proceeds of sale.
Loans that qualify for tax relief are:
Loan taken out to buy plant or machinery for partnerships or employment use. The interest is allowed in the year of the loan and the next three years. The plant or machinery must be such that the partnership (in the case of the partner) or the individual (in the case of the employee) is entitled to capital allowances on it. Where the plant or machinery is used partly for private purposes, only a percentage part of interest will qualify for relief, which is the same percentage as the restriction for capital allowances claim.
Loan taken out to buy into a partnership or in providing a partnership with a loan. Such interest is a liability of the individual and not of the partnership and therefore is not allowable as an expense in computing the partnership’s profits.
Loan taken out by an individual to purchase shares in a close company or in lending money to a company, which then uses the loan wholly and exclusively for the purposes of its business. A close company is a UK company controlled by five or fewer shareholders. The person claiming relief must either work for the company or hold more than 5% of the company’s share capital. Relief is not due where the individual or his spouse makes a claim for relief under the Enterprise Investment Scheme.
Loan taken out to pay inheritance tax. The personal representatives of someone who has died may obtain relief on interest on a loan taken out to pay inheritance tax. The loan interest is eligible for relief only for the first 12 months of the loan being made.
Loan taken out to acquire any part of the ordinary share capital of an employee-controlled company. The shares must be acquired by the individuals either before the company became employee-controlled, or no later than 12 months after it became employee-controlled. A loan to invest in a co-operative also qualifies for relief.
The limit on income tax reliefs restricts the total amount of qualifying loan interest relief and certain other reliefs in each year to the greater of £50,000 and 25% of ‘adjusted total income’.
For more information about the limit on income tax reliefs, please see HMRC Helpsheet 204.