Deduction of interest

By Tolley
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The following Owner-Managed Businesses guidance note by Tolley provides comprehensive and up to date tax information covering:

  • Deduction of interest
  • Loan relationship rules
  • Anti-avoidance legislation
  • Transfer pricing

Loan relationship rules

Since the introduction of Finance Act 1996 (subscription sensitive), interest payments for a limited company fall under the loan relationship rules, even if the company entered into the loan relationship for the purposes of its trade. There is, then, a distinction between trading and non-trading loan relationships. Generally speaking a trading loan relationship will arise where a borrower has entered into the relationship to provide funding for its trade, otherwise the relationship will be a non-trading loan relationship. The loan relationship rules are now found in CTA 2009, Part 5. For guidance on loan relationships, see the Corporate debt - overview guidance note.

For a property developer, finance will normally be required to some degree for a property acquisition and / or the development work itself. In this situation, the loan interest will be regarded as a trading loan relationship. CTA 2009, s 297(3) provides that trading loan relationship debits are treated as expenses of the trade and are therefore taken into account in computing the profits or losses of the trade for that period. CTA 2009, s 297(4) makes it clear that the loan relationships legislation overrides CTA 2009, s 54.

What constitutes interest can take a number of guises and it will be necessary to consider carefully any financial instrument entered into to distinguish what interest element may exist. The loan relationship legislation uses as a starting point interest as stated in the accounts for this purpose.

Where interest costs are capitalised (as they can be under accounting principles on the creation of a fixed asset), it might be thought that because there is then no interest expense in the accounts as such, there can be no relief for the interest expense (given in particular the propensity to use accounting profit as the starting point for determining taxable profit). However, in this case the loan relationship

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