Profit extraction via interest on Director loan account

Small company owners can lower their tax bill by charging interest to their own companies.

Where company owes money to shareholders. Shareholders can charge interest to the company on the outstanding loan balance.

In case interest is charge on a loan for a period less than a year there is no need to deduct tax and complete form CT61.1

Interest rate should be a commercial rate i.e. few points above BOE base rate. In case, rate charged is too high HMRC can treat it as remuneration or dividend.1

Company gets relief in the accounting period when interest is actually paid or within 12 months after its end. So simply crediting interest amount in Director Loan Account will not work.2

Interest Income received by the director will be added to his taxable income but it is taxed on receipt basis.2

Main advantage of this interest over dividends is:

  • No tax on starting rate of savings upto £5,000. So directors save income tax.
  • Company gets deduction for interest paid.

Notes on form CT61

  • In case loan is for a period over one year, 20% (basic rate) tax will need to deducted and deposited with HMRC using Form CT61.
  • CT61 returns are filed every quarter.
  • Nil returns not needed.
  • Return cannot be downloaded. A structured email needs to be sent to HMRC; they will send the form in post.
  • Both Returns and Tax deducted are due within 14 days from the end of the return period.
  • Company can issue Form R185 to the person whose tax has been deducted.

Source:
1. Para 1.148 Bloomsbury Tax Planning Book.
2. Para 2.47 Peter Rayney’s Tax planning for owner managed companies.