Loan Interest Relief

By | 5 June 2012

Securing tax relief for loan interest paid can be difficult. For example, the borrowings must be structured properly, and certain statutory conditions must be satisfied. Separate provisions apply for individuals and companies; this article is concerned with loan interest relief for individuals.

The legislation concerning interest payments (ITA 2007, Pt 8, Ch 1) provides for tax relief in respect of loan interest payments for specific purposes, such as loans to buy an interest in a close company, or to invest in a partnership. There are provisions to reduce or deny loan interest relief in certain circumstances, including some general restrictions. For example, interest is specifically excluded from relief if the debt was incurred by going overdrawn on an account (ITA 2007, s 384(1)(a)).

In Green v Revenue & Customs [2011] UKFTT 660 (TC), the taxpayer appealed against HMRC’s refusal of tax relief claims for interest paid against interest received from his and his wife’s company. Mr and Mrs Green personally owned land, which the company was to develop. A bank offered Mr and Mrs Green a personal overdraft facility of £1,045,000. Mr and Mrs Green intended to transfer the overdraft borrowings and development site to the company. In the interim, they were to provide funding for the company to develop the site, and were to be reimbursed the interest they paid to the bank. The company paid interest to Mr Green, including £128,464 during the year ended 30 June 2005. He argued that the payments were reimbursement by the company of overdraft interest paid personally by himself and Mrs Green in respect of working capital provided for the company to pay development costs.

HMRC pointed out that the interest should have been shown on his tax return. This was accepted by Mr Green, but it was argued that relief should be given for interest paid to the bank on his personal overdraft account “thereby reducing the interest received from the company to nil”. HMRC stated that relief could not be given in respect of interest on a debt incurred by overdrawing an account. Mr Green’s representative argued that the interest he received was directly referable to and of the same amount as the interest paid to the bank, and that Mr Green had not profited from the arrangement.

The tribunal held that the borrowing was by way of overdraft, in respect of which interest is specifically ineligible for relief (see above). The tribunal expressed sympathy for Mrs Green, and observed: “Plainly had Mr and Mrs Green set up the initial borrowing in the name of the company, relief would have been granted to the company in respect of interest payments on its borrowings”. However, the tribunal said that its decision had to be “…based on the facts as they existed and not on what they may or may not have intended.” The taxpayer’s appeal was dismissed.

Overdrawing accounts

In the Green case, HMRC had referred to Lawson (Inspector of Taxes) v Brooks [1992] STC 76 in support of its argument that tax relief is not available to individuals for interest incurred in overdrawing an account. In the Lawson case, the taxpayer had overdrafts on several bank current accounts which he used partly to finance the acquisition and redevelopment of property and partly for other business purposes. The overdrawn balances from several accounts were consolidated and transferred to bank loan accounts, and a building society loan was subsequently used to reduce the outstanding balances on one of the loan accounts. The taxpayer contended that he was entitled to relief on part of the interest paid on both loan accounts, as the overdrafts had arisen substantially in consequence of the acquisition and redevelopment of property.      

The High Court held that although the word ‘loan’ had a potentially wide meaning, the legislation denied relief for interest on a debt incurred by overdrawing a loan account. In addition, when the overdrawn current account balances were consolidated and transferred to the loan accounts, nothing was used to defray money applied for any of the qualifying purposes set out in the legislation, and the moneys were not applied in paying off a loan, the interest on which would have been eligible for relief. The taxpayer’s interest relief claims were therefore dismissed.

Close Companies

As mentioned, interest relief is available on a loan to buy an interest in a close company. The relief applies to payments of interest on loans to acquire ordinary share capital of a close company (but not a close investment holding company (CIHC)). In addition, relief is available for interest on loans (including replacement loans) used to lend money to such a company. The money lent must be used wholly and exclusively for the purposes of the company’s business, or for the business of any associated company which is also a close company (and not a CIHC) (ITA 2007, s 392).

In addition to the requirement that the company is not a CHIC when the interest is paid, two further conditions must be met. The first of these is a ‘capital recovery’ condition, i.e. broadly that the individual has not recovered any capital from the company in the period between the loan being used and the interest being paid, other than any recovered capital already taken into account as a loan repayment (ITA 2007, s 393(2)). The second requirement is that either ‘full-time working’ or ‘material interest’ conditions are met. The ‘full-time working’ conditions are that the individual holds part of the company’s ordinary share capital when the interest is paid, and that the greater part of the individual’s time has been spent in the actual management or conduct of the company (or an associated company) between the loan being used and the interest being paid (s 393(3)).

One of the ‘material interest’ alternative conditions (condition B) includes a requirement that the individual (whether alone or with associates, or any of the individual’s associates) beneficially owns or is able to control more than 5% of the company’s ordinary share capital, or alternatively possesses or can acquire rights (e.g. on the winding up of the company) giving an entitlement to more than 5% of distributable assets (ss 393(4), 394).

‘Material interest’?

The ‘material interest’ test was considered in the recent case Nowosielski v Revenue and Customs [2012] UKFTT 212 (TC). In that case, the appellant was a director and shareholder of APA Ltd. He held 50 out of the 100 issued shares in the company; a Mr and Mrs Pinchin held 49 shares and 1 share respectively. The appellant was also a director of V Ltd but held no shares in that company, the shares being held by Mr and Mrs Pinchin (60,001 and 59,999 shares respectively).

The appellant lent V Ltd £100,000, which he raised through a mortgage on his house. V Ltd paid the appellant interest, to cover the interest he was paying on the mortgage. The appellant disclosed the interest received from V Ltd on his tax return, and also claimed tax relief in respect of the £100,000 borrowings. HMRC denied tax relief for the interest paid, on the grounds that relief could only be claimed if the companies (APA Ltd and V Ltd) were ‘associated companies’ and the appellant had a ‘material interest’ in the borrowing company, V Ltd.

The tribunal found as a fact that the two companies were associated companies (within what is now CTA 2010, s 449). V Ltd was controlled by Mr Pinchin as he had a controlling shareholding. With regard to APA Ltd, the tribunal reviewed the accounting evidence and concluded that Mr Pinchin was entitled to receive the greater part of the company’s net assets upon winding up, by reason of the amount owed on his director’s loan account with the company (especially as by reason of his shareholding he was already entitled to 49% of any surplus after all creditors had been paid). Mr Pinchin therefore had a controlling interest in APA Ltd (under what is now CTA 2010, s 450(3)(d)).      

The tribunal then considered whether the appellant had a ‘material interest’ in V Ltd (within what is now ITA 2007, s 393) as defined (in s 394), by reason of his commercial loan of £100,000 to V Ltd giving him an entitlement to receive more than 5% of the assets available for distribution to participators on a winding up of the company. The tribunal held that the appellant was a loan creditor as far as V Ltd was concerned, and accordingly was a participator. It therefore followed that he had a ‘material interest’ in the company, on the basis that he was owed £100,000, giving him the right to far more than £100,000 on a winding up. The appeal was allowed.


Even if the conditions for loan interest relief are satisfied, care is needed to avoid a subsequent restriction or denial of relief in respect of a loan to a close company (and in certain other cases) if capital is wholly or partly recovered from the company (see ITA 2007, ss 406, 407). For example, where the recovery is unintentional (e.g. capital is withdrawn but not used to repay the original qualifying borrowings) it is seemingly not possible to restore funds to the company and continue claiming interest relief as if the capital recovery had not taken place (see SAIM10250).

As mentioned, the interest relief provisions can be difficult. A detailed review of the legislation (and HMRC’s guidance in the Savings and Income Manual at SAIM10000 onwards, and generally in the Business Income Manual at BIM45650 onwards) may therefore be helpful in terms of avoiding potential pitfalls.

The above article is reproduced from ‘Practice Update’ (May / June 2012), a tax Newsletter produced by Mark McLaughlin Associates Ltd. To download current and past editions of Practice Update, see the Newsletters section.