Tax deduction for overdraft interest

Recently the Tax Tribunal faced the question whether overdraft interest paid by two directors to fund their company's business was claimable against their personal tax bills. Is it? 


Business Expenses It is not unusual for a company director to incur expenses on its behalf and for him to be reimbursed later. Usually this results in the company having a deduction for its cost and for the director the transactions are neutral. But HMRC took a different view when Mr and Mrs G (the Gs) took out a £1 million personal overdraft to fund their new company.


Balancing transaction This was no clever tax avoidance scheme, the Gs simply borrowed the money from the bank and used it to develop their business. They paid interest on the overdraft and the company simply reimbursed them that cost to balance the books. Trouble started When HMRC spotted that the company was not deducting tax from the interest payments it made to them and assessed it to collect the tax it should have deducted.


TRAP When a company pays interest to an individual, it must deduct basic rate tax, currently 20%, from the payment and hand this over each quarter to HMRC with a form CT61.


Personal tax on interest Their woes did not end there. HMRC checked the G's personal tax returns and noticed they contained no entries for the interest the company paid them. The G's argued the interest they received was balanced by what they paid to the bank. Whilst this was financially accurate, fiscally it was not because while the interest they received was taxable, the interest they paid was not tax deductible.


TRAP  The law specifically rules out a tax deduction from general income for overdraft or credit card interest. It is only allowable against profits made by anyone who is self-employed or in partnership. Directors' earnings a employment income and thus no deduction is due.

A tax deduction from an individual’s general income is allowed for interest paid where this relates to types of expenditure specified at s.383 Income Taxes Act 2007 (ITA). However, where the interest charged relates to the “overdrawing” of an account or “credit card” or similar arrangement no deduction is permitted; s.374 ITA.   

No Choice for Tribunal   The Tribunal expressed great sympathy for the Gs but had no choice but to completely agree with HMRC with the following results:

1. The Gs would be taxed on all the interest the company had paid them;
2. They would receive no tax deduction for the interest they paid to the bank even though clearly for a business purpose, yet
3. The company could claim a Corporation Tax deduction for the interest it paid to the Gs.

TAXTIP The Gs could have avoided a tax bill if:

1. They had taken a personal loan instead of an overdraft.Interest on a loan to provide capital for your business is tax deductible.
2. They had guaranteed an overdraft or loan for the company.