Tax relief on loans to property investment company
Written by Ray Coman
One method of saving tax on a rental property is to loan the company funds and deduct interest on this mortgage from general income.
This has two tax benefits:
The individual can obtain tax relief from the loan even when the property is loss making; and
The loan should be for a qualifying purpose under ITA 2007, s 392(2)(b) https://www.legislation.gov.uk/ukpga/2007/3/section/392 as the investment is “for the purpose of making investments in land, or estates or interests inland, in cases where the land is, or is intended to be, let commercially.” To this extent the property could not be let to connected persons such as family members.
The company must be a close company, which typically means for a company five or fewer shareholder each with 5% stake. Further definition of “close investment-holding company” is found in CTA 2010, s 34(2)(b).
A loan is often raised via mortgage or second mortgage on the company’s owner’s home.
Potential pitfalls of the arrangement explained above are listed below:
There is a risk that such arrangement could be successfully challenged by HMRC by invoking section 384A of the same act: https://www.legislation.gov.uk/ukpga/2007/3/section/384A
“Relief is not to be given … for interest paid by a person on a loan if the arrangements seem to have been designed to reduce any income tax or capital gains tax to which the borrower… would be liable apart from the arrangements.”
Loan interest cannot be greater than £50,000 or 25% of the taxpayer’s income. This would include any income, for instance in the form of dividends (or other profit extraction) from the company.
There is a risk that gains on disposal of the propriety would be subject to corporation tax and on post tax funds subject to capital gains tax. This double tax charge could result in combined rate of tax of 35.2% on the gain, compared with a rate of 28% for property held personally. The structure therefore works most effectively for property with high yield rather than expected growth potential.
Capital gains tax would apply to any pregnant gains in property previously owned by the shareholder. Company ownership is therefore rarely practical for an existing portfolio of rental property.