Nowadays it’s not always easy to get funds to grow your company – whether it is for a new piece of equipment or for day-to-day working capital.
Generally, funds come from various sources, such as banks, investors, personal funds or borrowings, and often are a mixture of these. So, if you have to borrow money personally for use in your company, how do you get it back, and what is the best way to do it?
In some instances it is not always possible for a company to borrow money from the bank, and directors are left having to borrow against personal assets, such as their house, to raise necessary funds to expand their business. Obviously this loan needs to be paid back, but is it possible for the company to reimburse you without a tax or national insurance (NIC) charge arising?
Thankfully, yes it is. There are two alternatives – the company can pay loan interest to you on the funds you have lent to the company, and as long as this is at the same rate charged on your personal loan, then you will not be out of pocket, and there will be no tax charge arising.
Alternatively, the loan could be converted to shares in the company on which it pays you dividends. It is essential not to draw the funds out by way of an additional salary, even if it equals the interest charged, as the taxman will demand NIC from both you personally and the company, which equates to a combined rate of 25.8 per cent.
So having avoided a tax charge on a salary payment, which is the best way to get funds out of the company to meet the interest costs, the best way to compare the options is by way of an example.
Assuming you are paying tax at 40 per cent, if you pay interest of £10,000 to the bank and correspondingly charge the company £10,000 on the loan to it, the two will be tax neutral as tax relief on the borrowing of £4,000 (£10,000 at 40 per cent) offsets the tax due on the interest of the same amount.
However, assume instead the company pays you a dividend of £10,000. As a 40 per cent taxpayer you will have a tax liability of £2,500 on the dividend. However, you will still have tax relief of £4,000 on the interest you have paid, therefore you are left with £1,500 in your pocket.
The downside to this is that the company itself will not get tax relief on the payment of the dividend, whereas it would with a payment of interest. This could amount to a cost of £2,000 which overall wipes out any personal tax saving.
So in summary, if you are the main shareholder of the company, due to the company’s tax liability, it is better to loan the company the money and receive interest in return. However, if you are a minority shareholder then the personal tax saving would be more beneficial and purchasing shares would be advantageous.
As always, it is not a straightforward rule of thumb, and every business decision needs to be looked at on its own merit.
At Rennie Welch, we would be pleased to discuss both the impact of your proposals both on you personally and for your business. Please get in touch with either myself at firstname.lastname@example.org or with one of my partners – alternatively, telephone 01573 224391.