Tax Deduction for Overdraft Interest

It’s hardly an unusual situation for a director to incur expenses on behalf of their company and for it to make a reimbursement. The outcome of this arrangement is usually that the company gets a deduction for the cost while for the director the transactions are tax neutral. But if the director takes for example a £1 million personal overdraft to fund the start up of their company, HMRC takes a different view

The director wasn’t involved in any clever tax avoidance, they simply borrowed from the bank and used the money to develop their business. He paid interest on the overdraft and in turn their company paid them interest to balance the books. The trouble started when the HMRC spotted that the company wasn’t deducting tax from the interest payments it made to the director and assessed the company to collect the amount it should have charged.

Trap. Where a company pays interest to an individual, it must deduct basic rate tax, currently 20%, from the payment and hand this over to HMRC each quarter with Form CT6.

Personal tax on interest

The Taxman checked the directors personal tax returns and noticed they didn’t show the interest the company had paid to them. They argued that the interest they received was balanced by the amount they paid to the bank. In financial terms this was correct but the trouble was that while the interest they received was taxable, the interest they paid wasn’t tax deductible as they had assumed.

Trap. The legislation specifically excludes a tax deduction from general income for overdraft or credit card interest. This is only tax allowable against profits made by anyone who is self-employed or in partnership. But directors’ earnings are employment income and so no deduction is due

The conclusion is that

01.  The director would be taxed on all the interest the company paid to them

02.  He would receive no tax deduction for the interest they paid to the bank even though it was clearly for a business purpose,

03.  The company could claim a Corporation Tax deduction for the interest it paid the director.

The director would have avoided a tax bill if

01.  They had taken a personal loan instead of an overdraft, because interest on a loan to provide capital for your company is tax deductible

02.  He had guaranteed an overdraft or loan for the company, even if they paid the interest until the company had enough money to reimburse them.

For all tax queries, contact KVS Accountants for help. We act as accountants for  businesses in the areas of Richmond, Earlsfield, Balham, Notting Hill, Clapham South and Chiswick on issues relating to their tax.

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