When is a Business Loan not allowed for tax relief: What HMRC looks for

What is a loan for an unallowable purpose? It is essentially what it says it is. It is when a business borrows money and uses it for something that tax rules say isn’t allowed for tax relief.

What is a loan for an unallowable purpose?

If you’re not familiar with what a loan for an unallowable purpose is, you wouldn’t be alone, but it is essentially what the title says – it is when a business borrows money and uses it for something that tax rules say isn’t allowed for tax relief.

HMRC calls this an ‘unallowable purpose’ because the main aim of the loan is not to benefit the taxable business.

Things like using the loan money to fund tax-free investments, spending the loan money on non-business expenses, or using the money for activities not aimed at generating taxable profits for the business.

In UK corporation tax, this is important as interest on such a loan cannot be deducted when working out your tax liability, even if you’re still paying it back.

Examples of a loan for unallowable purpose

Many business owners would think that if you can get the loan through the business and it’s a business loan that therefore the interest will attract tax relief. Unfortunately, it’s not that straightforward.

Legislation prescribes that a loan must not be for an unallowable purpose, or the deduction is denied. An unallowable purpose means where the company’s actions are not aligned with its business or commercial objectives. This would also include a scenario where the main purpose of the transaction is to achieve tax avoidance.

An example could be where the loan is used to promote the personal interest of one of the directors, and not that of the company. In addition to the examples given above which may be more obvious, some more complex examples would include:

• External debt financing, and the choice to route it via a UK subsidiary for a non-UK subsidiary to acquire shares in a non-UK company from a third party
• The choice to enter into wholly internal debt financing between a parent and a UK subsidiary which the UK subsidiary uses to acquire shares in a group company from a non-UK company
• The choice to create new loans where there is no commercial requirement for loans

HMRC are clamping down

HMRC have recently written to companies where they suspect that there are loans for an unallowable purpose asking them to consider their position following the conclusions of three key court cases.

HMRC has invited those companies to consider the position and discuss the matter with HMRC so that it can be resolved, on a without prejudice basis. The idea being, if you come forward now penalties will either not be imposed or significantly reduced. If you don’t come forward now and HMRC later finds a loan for an unallowable purpose they would then seek full penalties which can be as much as the tax liability itself.

If you have a business loan, and you think there is a risk it could be considered unallowable, then let’s talk!

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