There are various scenarios to consider when it comes to loans – from money already lent to the company to having money available to loan to the company. Making loans to the company can be a tax efficient investment where a commercial rate of interest can be paid to the business owner. Whilst employee loans under £10k can be an effective way to motivate and retain key members of the team.

Loaning money to the business & employee loans

You may have historically lent money to the company or have funds available to lend to the company. Or alternatively the company may have money it can lend to you or the employees. Each of these scenarios is considered below.

SCENARIO 1: You have already lent money to the company

In this instance, generally the company should be paying you interest because:

• It makes commercial and legal sense to protect your investment
  
  
• The income will be ‘savings income’ which, if you haven’t used your savings allowance, you can receive up to £1k tax free per year

In many instances, business owners have lent money to the company in years gone by and don’t realise that the loan can be taken back out of the company tax free at a future point. This is important to remember, as it can form part of your value extraction strategy once funds are available in the company to repay your loan with no tax consequences.

SCENARIO 2: You have funds available to lend to the company

Before deciding whether to lend to the company, you need to also consider the commercial risk factors and seek independent financial advice, e.g. if you make an unsecured loan, the funds are available to the company and could be used to pay other creditors in the event of trading difficulties.

Generally speaking, if you have savings as cash, it will be earning very little interest. So it can make sense to instead lend some money to the company because:

• The company will benefit from the additional cashflow.

• The interest you receive will be tax free up to your ‘savings allowance’ of up to £1k. In a lot of circumstances, the tax saving made will exceed the total amount of interest you would have earned by investing the money elsewhere.

The specific tax savings depend on your overall position, but at worst it represents the ability to get an additional amount from the company tax free.

Other considerations and planning points

Where payments of interest represent ‘yearly interest’ there is a requirement for the company to withhold 20% of each interest payment and pay it to HMRC (via a quarterly CT61 return). This can increase the administrative burden. If interest payments are not ‘yearly interest’ then generally withholding tax does not apply. An example of loan interest that is not ‘yearly interest’ is where the loan term does not exceed 12 months.

The rate of interest charged has to be commercially justifiable (for example by reference to an unsecured loan from a third party) and generally can be anywhere between 5% and 15%.

It is very important to properly document the arrangement to reduce risk of any future dispute, whether with the company or HMRC. Provided the terms are legally documented, this often represents a low risk method of extracting funds from the company tax efficiently.

SCENARIO 3: The company has funds to lend to you or your employees

If the company has spare cashflow, it can be a good way to incentivise you and your employees by offering up to £10k loans, interest free. This provides a good benefit as the employee can invest the funds or help them with cashflow to purchase something. It can also act as a good retention tool as employees will have to repay the loan if they leave.

32 Ways To Save Tax and Extract Maximum Value From Your Business

These tips are from our eBook, 32 Ways To Save Tax and Extract Maximum Value From Your Business. This guide explores 32 ways to ensure you’re maximising every opportunity you could be, to improve your life, your families and your employees.

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