Revealed – High street banks are charging small firms 20% interest

This was the headline which greeted me when I located the Business and Money supplement amongst all the other sections of the Sunday Times on 31 December 2017 last year.

Absolute joy! The article is now scanned into my tax planning file should it be needed later on.

Why my excitement?

Well we use interest as a tax efficient mechanism for business owners to extract reward from their companies. It has become more tax efficient since the Government introduced the additional levy of 7.5% on dividend income.

How does interest score:

• No NIC unlike salary
• Corporate Tax deduction unlike dividends which are declared out of post-tax income.

If the business owner can control his income so that he is a basic rate taxpayer, the interest is broadly tax neutral.

Of course, many business owners are not wealthy enough and cannot keep enough retained income in the company in order to build up a positive director’s loan account balance. There are other issues, inter alia:

• The loan account has to be sufficiently large to make the saving worthwhile.  This is because the company has to deduct basic rate tax from the interest and pay it over to HMRC.
• A director’s loan account, unlike share capital does not qualify for business property relief against inheritance tax.  One must assess which is the more pressing issue.
• HMRC could challenge whether the funding is needed for the business.  I believe we can always defend this with commercial arguments.

This leaves the central issue of how much interest can be charged.  The Times article alleges that one clearing bank is charging up to 29% for lending through its on-line platform, this being supported by a personal guarantee.

Another bank’s APR for online small business loans ranges from 4.9% to 25.9%, underpinned by the security of personal assets.

The report judged that other clearing banks were charging interest rates at around 10% on fixed term loans.

I would just add that I have recently seen a business forced to seek finance from second-tier lenders because of a lack of appetite on the part of the clearing banks, with the business being forced to pay an elevated rate for the money.

All of this would lead me to conclude that a rate of around 10% for unsecured finance provided by the business owner would be perfectly reasonable.

I will be looking out for more help in articles from the Sunday Times.  A few years ago they published details of a public company where directors had injected funds into the company and charged 15%, their argument being that they could not secure funds anywhere else for lower rates.  It is all grist to the mill.

Posted by Paul Short