Mark McLaughlin highlights a potential trap for company owners seeking tax relief for interest on loans to acquire shares or lend funds to property investment companies.
Many landlords set up companies to own investment properties. There are several possible reasons, such as increased flexibility of company ownership compared with owning interests in properties personally, and the ability to extract profits by dividends.
Financing property acquisitions via a company might be through company borrowings. Alternatively, company owners may borrow funds to invest in the company.
Financing the company
Tax relief is available for interest paid on a loan to purchase ordinary shares in the company if certain conditions are satisfied. Alternatively, a relief claim may be possible if personal borrowings are lent on to the company, which uses them for business purposes.
Broadly, tax relief is available (under ITA 2007, ss 383, 392) provided:
- the company is a ‘close’ (i.e. broadly a closely-controlled) company;
- the company is not a ‘close investment-holding company’ (CIHC; see below) when the interest is paid;
- a ‘capital recovery condition’ is met (i.e. broadly, the individual has not recovered capital from the company between the loan being used and the interest being paid (other than recovered capital treated as a loan repayment); and
-
the individual either meets a ‘material interest’ condition when the interest is paid, or they own ordinary shares in the company when the interest is paid, and work for the greater part of their time in the actual management or conduct of it (or an associated company) between the loan being used and the interest being paid (ITA 2007, s 393(3)–(4)).
The interest must not relate to an overdrawn account, credit card etc., and must not exceed a normal commercial rate. Furthermore, the loan must be used for the specified purpose within a reasonable time and must not previously have been applied for another purpose (ITA 2007, ss 384, 385).
Property lettings
As indicated, interest relief is not available on borrowings to acquire shares in a CIHC, or to lend money to a CIHC for its business (ITA 2007, s 392(2)). Furthermore, interest on a loan within section 392 is not eligible for relief if the company is a CIHC when the interest is paid.
Importantly, a close company is automatically treated as a CIHC unless it exists wholly or mainly for certain ‘permitted purposes’, including investments in land for commercial letting. The letting of land is taken to be commercial unless the land is let to a ‘connected person’ or certain other persons including the spouse (or civil partner) or relative of a connected person, or their spouse, etc., (ITA 2007, s 393(A)).
The company is ‘connected’ with someone who controls the company, either alone or with others connected with that person (ITA 2007, s 993(6)).
For example, if a company’s buildings are let (or intended to be let) rent-free to the adult offspring of the controlling shareholder (Fred), they will not qualify for exclusion from CIHC status. Consequently, Fred would be ineligible for interest relief on a loan for the company’s shares or its business.
Practical tip
If interest relief is available, it is given against total income (ITA 2007, s 383(4)), subject to an overall limit of income tax relief each tax year, being the greater of £50,000 or 25% of the individual’s adjusted total income (ITA 2007, s 24A).
