Fund your business with tax-efficient personal borrowing

Tax for couples

Being married or in a civil partnership can have tax advantages but generally every person is taxed separately. This means that transactions between one individual and another can have tax consequences for both. For example, if you borrowed money from your spouse, civil or unmarried partner and paid them interest it would count as their taxable income. Interestingly, in the right circumstances this can work to your advantage.

Qualifying loans

While interest received is taxable on the recipient, it’s tax deductible for the payer where the loan it relates to is a qualifying one. For example, subject to conditions, a loan is qualifying if it’s used to buy shares in a trading company, or provide it with funds to buy equipment or working capital. This is one situation where paying interest to your other half can give you a tax advantage, as the following examples show.

Example 1. Peter, who is a higher rate taxpayer, owns and runs his own business, Acom Ltd. It needs to finance the purchase of new machinery. Acom’s bank will lend to it but the interest rate is high. Peter could provide some of the money needed but he doesn’t want to dig into his savings. Peter’s partner Jane, a basic rate taxpayer, also has savings which could be used to provide the cash Acom needs. On advice from their accountant Jane lends Peter £90,000, which he lends to Acom and charges interest at 10% per annum.

The loan to Peter from Jane is interest free and Peter must pay tax on the interest he receives from Acom at 40%, after taking into account his savings rate tax band (£500 at 0%). He uses the loan repayments he receives from Acom to repay Jane her capital. The overall tax picture is:

Example 2. The circumstances are the same as our previous example except that Jane charges Peter interest at the same rate that he charges Acom. The interest Peter pays relates to a qualifying loan and so he can claim a tax deduction on the £21,000 interest he pays to Jane. Jane must pay tax on the interest she receives. Remember, she is a basic rate (20%) taxpayer and has a savings rate tax band of £1,000 at 0%.

The overall picture now shows a tax saving of £4,000 compared with Example 1, i.e. the net cost of tax in Example 1 is £3,800 compared with net tax relief of £200 in Example 2.