Many start-up businesses take out loans to get going, e.g. to purchase stock needed to sell, or to make the first rent payment or rent deposit. Whether that business is set up as unincorporated or as a company will impact on when interest paid before trading is allowable for tax purposes.
Unincorporated business
The most straightforward situation is where the business is set up as a sole trader or partnership. In this situation, any interest incurred pre-trading but paid personally will be treated for tax purposes as if incurred on the first day of trading.
Companies
Two situations present themselves here: firstly, of an individual who borrows in their own name and lends to the company and secondly, where the company takes out the loan in its own name.
· Individual finances the company
An individual borrowing to lend to or acquire shares in a close company will generally be able to claim tax relief against income tax paid provided that the borrower (and associates) controls more than 5% of the company's ordinary share capital or the borrower works in the company's management team and holds some part of the company's share capital, however small.
Note: a 'close company' is one that is under the control of five or fewer participators (or any number of participators if those participators are directors), or where more than half the company's assets would be distributed to five or fewer participators, or to participators who are directors, should the company close.
· Company borrowing
The position is different where the company takes out the loan as tax relief for interest incurred is subject to special rules known as the 'loan relationship rules'.
These rules apply to income and expenses relating to 'money debts', e.g. interest paid or received. Until the company starts to trade, any 'money debt' will be treated
as a non-trading debit under the loan relationship rules. Where there are insufficient profits to offset in the accounting period, such debits are carried forward and offset against total profits in subsequent periods.
Election
The way to ensure tax relief is obtained is to make an election to HMRC to treat the interest and other relevant costs as a trading expense once the company starts to trade. As ever with any tax claim there are conditions:
· the election must be made within two years of the end of the accounting period in which the non-trading debit arises; and
· the company must begin to trade within seven years of that period; and
· the non-trading debit amount would have been treated as a trading debit had it been incurred in the period since trading commenced.
Second 'trap'
HMRC’s guidance states that the interest, etc must be incurred in an accounting period to be allowable. The 'trap' is that an accounting period only starts when a company has a source of income.
Pre-trading loan trap – sole trader v company tax relief | Go Figure Financial | Bookkeeping Services Manchester
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