Can You Claim Tax Relief on Personal Interest? Here’s What You Need to Know
We often hear that there are two certainties in life: death and taxes. However, for business owners and investors, paying interest on loans is another near certainty. When interest is incurred for business or investment purposes, it is possible to claim tax relief under certain conditions, helping to reduce the overall tax burden.
Qualifying Criteria for Tax Relief on Loan Interest
If you pay interest on a loan taken for business purposes, you may be eligible for a deduction from your profits. Provided the interest meets the “wholly and exclusively” rule. For companies, this deduction can also be applied to non-trade interest under the loan relationship rules. Individuals operating as sole traders or in partnerships can receive relief through their tax computations when interest is related to a residential property business.
When an individual pays qualifying loan interest, they can claim tax relief as a deduction from their total income under Income Tax Act (ITA) 2007, section 383. Some of the key qualifying investments where this relief can be claimed include:
- Purchasing shares or lending money to a close company where the individual owns more than 5% of the ordinary share capital.
- Buying shares or lending money to a close company where the individual owns any share capital and spends most of their time managing the company’s business.
- Acquiring an interest in a trading or professional partnership or providing funds to such a partnership or a limited liability partnership for business purposes.
- Purchasing plant and machinery for an employee or a partnership.
- Paying inheritance tax.
Restrictions on Claiming Tax Relief
Not all types of interest are eligible for tax relief. For example, interest on personal overdrafts or credit cards does not qualify. Typically, qualifying loans come from banks or other financial institutions.
There is flexibility around when the loan was taken out versus when the investment was made. Meaning that the loan does not need to predate the investment. However, the loan must be applied for a qualifying purpose. Once loan funds are used for one purpose, they cannot later be repurposed for a qualifying investment. Relief may also be denied if the loan is not used within a reasonable timeframe or if the interest rate is not commercially reasonable.
What Happens When Capital is Recovered?
If you sell an investment or receive repayment of a loan after an investment has been made, restrictions may apply to the relief on future interest payments. Under ITA 2007, section 406, tax relief on interest payments is reduced proportionally to the capital recovered. This ensures that individuals do not continue to receive tax relief on loans after they have recouped their investment. In cases involving mixed loans (partly for business and partly for personal use), capital recovery is applied to the business portion first.
How to Apply Tax Relief
Qualifying loan interest is deducted from your total income before personal allowances are applied. However, the deduction is limited to the higher of £50,000 or 25% of your total adjusted income. To maximize tax relief, you can choose the order in which reliefs are applied to avoid wasting any unused amounts. For example, it might be more advantageous to offset qualifying loan interest before using other reliefs like trade losses. Which can be carried forward or back to other tax years.
Joint Loans and Tax Relief
When a loan is taken out jointly, such as between spouses or civil partners. Tax relief on the interest depends on who took the loan and made the qualifying investment. If the loan was taken out jointly, but only one spouse made the qualifying investment. The investing spouse may claim full tax relief on the interest payments. If both spouses made qualifying investments, relief is divided in proportion to their respective investments. However, if one spouse took the loan while both made investments. Only the loan holder can claim relief based on their share of the investment.
Business Successions and Continued Relief
If a business partnership undergoes a change or succession, ITA 2007, section 409 allows continued tax relief on qualifying loan interest. This applies when a partnership composition changes, or when a partnership becomes a close company or employee-controlled company. However, relief may not continue in cases like disincorporation of a close company or when certain securities are converted.
Interaction with Beneficial Loan Interest
If an employee receives an interest-free loan from their employer. This is typically considered a benefit-in-kind, meaning that the notional interest is taxed. However, if the loan is for a qualifying purpose under ITA 2007, section 383. The benefit-in-kind charge is cancelled out by the deduction for qualifying loan interest. This exemption only applies if the entire loan is used for a qualifying purpose.
Final Thoughts
Understanding the rules surrounding tax relief for personal loan interest can help individuals and business owners reduce their overall tax liabilities. However, it’s essential to ensure that loans are used for qualifying purposes, and that records are maintained to support claims for relief. Whether you are investing in a business, partnership, or property, carefully managing your loan interest can provide valuable tax savings.
If you’re uncertain about your eligibility for claiming tax relief on loan interest or need advice on how to optimize your tax position, consult with a qualified tax advisor or accountant to ensure you’re making the most of the available reliefs.
