Personal Tax and NI cost of borrowing from your company

If you borrow money from your company it can result in a tax charge. HMRC allows you and your company to use different methods to work out the taxable amount. But which is the most tax efficient?

Loans not earnings

We recently explained how to ensure HMRC can't treat money you borrow from your company as earnings on which PAYE tax and Class 1 NI is payable. Nevertheless, you'll have to pay income tax under the benefit in kind rules if the amount you borrow exceeds £10,000 at any time during a tax year. The good news is that it's a relatively low charge and there are ways you can reduce it.

Annual averaging

The normal method for working out the taxable amount is to multiply the average balance of the debt by the "official rate" of interest (currently 2.25% per annum). This rather blunt method can produce odd and unfair results.

Example: Jake is a director of Acom Ltd. On 6 April 2020 he owes it £500. On 31 March 2021 he borrows a further £70,000. The normal method of working out the taxable benefit involves adding together the debt balances at the state and end of the tax year, dividing by two and multiplying the result by the official rate. In this case that's £794. Any interest Jake is required to pay onthe debt is deducted to arrive at the taxable amount. Had Jake let if it until 6 April to borrow the £70,000 the taxable amount would be zero.

(Note) If the borrowing is first made part way through a tax year, or is fully repaid before it ends, the taxable amount is reduced proportionately, e.g. if in our example Jake first borrowed from Acom on 1 July 2020, the taxable amount would be reduced by £187 (86/365 x £794).

Tip: The disproportionate taxable amount as illustrated in our example can be avoided even if Jake doesn't or can't delay borrowing the £70,000 until after the end of the tax year. The lender (Acom Ltd) can elect for the taxable amount to be worked out on each borrowing separately. In our example, this would reduce the taxable amount to just £37. However, this trick only works if the debts can be separately identified. It won't work if all borrowing goes through the director's loan account.

Alternative calculation

The borrower can elect to work out the taxable amount using the daily balance of th debt instead of the annual average. This produces a similar result to the election to tax each debt separately, but importantly can be for directors' loan accounts. In our example, because the vast majority of the debt only existed for six days of 2020/21 the tax charge would again be reduced to £37. The deadline for the election is twelve months from the 31 January following the tax year to which you want it to apply. However, to be effective in reducing the company's Class 1A NI it must be submitted by 6 July following the end of the tax year, e.g. for 2020/21, by 6 July 2021.

Tip: Another way of reducing the taxable benefit, where the normal averaging method is used is to pay off a large chunk of the debt just before the end of the tax year. This can work even if you borrow the money against soon after the start of the next tax year.

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