A business loan is money borrowed by a business in lieu of interest from a lender. In the UK, businesses often take a business loan for expansion or to pay expenses. However, it is important to understand how business loans work in the UK, how they impact tax reporting, and whether they are tax deductible.
Continue reading to know the answers.
Is a business loan a business cost?
The answer is ‘no.’ Since the loan is a form of funding for the business to expand or meet its expenses and needs to be paid back to the lender within the agreed timeframe, it is not considered a business cost.
Are Business Loans Tax-Deductible?
No, a business loan is not tax deductible. However, the interest paid on the loan is taken as business costs and can be tax deductible subject to certain conditions. This applies only when the loan is used for business purposes and not for personal purposes.
If the loan serves only business purposes, the interest repayment can be claimed as a tax deduction. If it is used for personal and business purposes, the deduction can be claimed only on the amount spent on business purposes.
Are Business Loans Classified As Taxable Income?
No. Since these are borrowed funds, they are not considered profits; therefore, these loans are not classified as taxable income. Instead, the funds are treated as debts, which need to be paid back within a predetermined duration.
It is important to mention here that any amount earned by your business (through sales of products & services and individuals investing in the company) is classified as taxable income. However, a business loan is not an earning option, even though it helps your finances. Also, since loans attract interest, therefore, loans are not taxable income. However, interests are tax deductible.
There is one exception. If your lender, who could be a friend or a family member, partially or wholly writes off the business loan, the forgiven amount is classified as income and will be taxable.
Can A Business Loan Be Used To Pay VAT or Tax Bills?
Yes. Business owners need to pay HMRC quarterly VAT. Often, owners fail to set aside an amount to pay VAT or fall short on funds for the said purpose. In such cases, they can take a VAT business loan. However, it is imperative that the business owner does not make this a habit; instead, make sure to budget accordingly for the next VAT payment.
Business loans can be used to cover tax obligations, especially if the deadlines are close by and there could be penalties for late filings. In such cases, when the loan is used for VAT or tax payments, the loan interest may not be tax deductible. Speak to seasoned accountants to understand the specific conditions for interest on loans being tax deductible.
Understanding Limited Company Business Loan
A business loan for an LTD company is a case where registered limited companies borrow money. In most cases, these business loans are unsecured, which means that the funds are given by lenders without any collateral. However, the lenders might want the directors’ personal guarantee. As a director, you should be well-versed with the liabilities in such cases, especially if the business fails and becomes insolvent.
A limited company business loan is usually given against certain conditions; for example, the company might need to have a required turnover. The company will certainly need to be registered as a limited company in the UK. Before the loan is given, the lender will cross-check the director’s personal credit score and the business’s credit score. They may also ask to see the business plan, turnover details, cash flow, and a detailed picture of the business’s current financial health.
Private limited companies can also get business loans, provided the company’s ownership is divided into shares owned by shareholders. Businesses that are new or have no trading history should typically ask for a start-up loan.
Limited Company Director Loans
A limited company director loan involves the director either taking a loan from the company or lending money to it. A limited company is legally distinct from its directors. If a director borrows money from the company, it is considered a loan if it’s not expenses, salary, dividends, or money previously loaned to the business.
When a director takes such a loan, it results in an overdrawn director’s loan account, which must be recorded. This director’s loan account keeps track of all money borrowed from or paid into the company by the director.
Tax Liabilities of Business Loan of LTD Company
You must also record this loan in your balance sheet and think that it may be taxable. Tax obligations depend on whether you owe the company money or if the company owes you money.
There is no tax liability if the entire loan amount is paid back within a given period, which is usually 9 months and 1 day from the limited company’s year-end. Those who fail to do so are penalised as per Section 455 at 33.75% tax, calculated on the loan amount (applicable for loans after April 2022). Once the overdrawn account is completely settled, the tax can be reclaimed.
Please note that if the company faces insolvency, the director must pay off the outstanding loan amount.
If a loan amount is taken from the company and is paid to friends, family, or business acquaintances, the transaction has to be noted. If the interest rate is not decided as per the official rate of 2.25% and is discounted (applicable from 6th April 2023 onwards), then the loan will be considered as a benefit and can be taxable. Similarly, if the loan amount is more than £10,000, the shareholder’s approval is mandatory; it can be considered taxable.
Tax Obligation on Limited Company Director Loans
As explained earlier, a director’s loan is either a loan taken from a limited business or a loan given to the business.
When the company gives the loan, the director’s loan is a fund type that is not used for repayments, salaries, or dividends. This needs to be listed in your annual accounts, and there are applicable charges.
In case you have given a loan to your limited company, you can charge interest. This interest will be classed as a business expense, and you must add it to your self-assessment tax return. When the company pays you the interest, it should deduct income tax at 20% and file income tax through the CT61 Form. Regarding the loan amount, the company is not required to pay any corporation tax.
Even though a director’s loan is not tax-deductible, the entire landscape is complex and requires a clear understanding of the intricacies. Therefore, it is advisable to hire professional accountants to help you with limited company director’s loans and tax obligations.
Self-Employed Loans and Tax Liabilities
Sole traders or self-employed individuals run their businesses using their personal accounts, so they can use the overdraft facility for their bank accounts or credit cards. That’s because the legal entity of the owner and the business are the same. This usually happens when you need funds urgently and quickly for personal use. However, technically, you cannot lend money to your business or take a loan from your business.
In this case, the interest you pay on the loan cannot be classified as a business expense. This is only possible when you use a business bank account. There are options for using sole trader business accounts that come with benefits. You need to consult with your accountant before making a decision.
Business Loan Arrangement Fees
Arrangement fees are often charged by lenders when giving businesses a business loan. It helps them cover the costs involved with processing the loan. Arrangement fees are tax deductible. These are classified as business expenses. This applies only when the business pays interest repayments. However, if the interest is paid upfront, the fees are not tax deductible.
Conclusion
The concept of how business loans work in the UK can be quite complex. Business loan interests are usually tax-deductible, be it self-employed or limited companies. In both cases, the loan should be used only for business purposes. The deduction received thereof can help ease your financial burden to a great extent.
It is advisable to keep accurate records of all transactions. Most importantly, you must speak with a tax professional or an accountant like TaxCan or Cangaf Accountants to navigate the complex ecosystem of business loans. They will help you ensure compliance with the laws and optimize potential deductions.
