Inter-Company Lending: Tax Implications and Key Considerations

Exploring Lending Between Companies

In a challenging economic climate, many smaller businesses still thrive and accumulate healthy cash reserves. However, with interest rates on bank deposits remaining relatively low, some companies seek alternative ways to utilize their surplus funds. One option is lending to another company, particularly if investing further in their own business is not feasible or desired.

For connected companies, lending to one another can often be done without significant tax implications, provided they comply with the loan relationship rules. This can be beneficial in scenarios where one company has excess funds while another within the same group requires financial support for investment or operational needs.

What Defines Connected Companies?

HMRC classifies companies as ‘connected’ under specific conditions. Companies are considered connected when:

• The same individual has control over both companies.
• One person controls one company, and individuals connected with them control the other.
• Two or more individuals jointly control both companies.

Understanding this classification is crucial when structuring inter-company loans to ensure compliance with tax regulations.

Loan Relationship Rules and Their Impact

The UK tax system imposes special rules on a company’s loan relationships. These rules govern all loans, whether made in cash or another form and apply to both lending and borrowing companies. A fundamental requirement is that transactions must be conducted at arm’s length—meaning they should reflect terms that would exist between unrelated parties.

Under these rules:

• Income, expenses, gains, and losses from loan relationships must be properly accounted for.
• Interest deductions are recognized when they accrue in the accounts rather than when they are paid.
• The actual transfer of cash for a loan does not create a taxable event—only interest charged and received generates tax consequences.

Practical Considerations for Interest Charges

For UK-based connected companies, there is no legal or tax requirement to charge interest on inter-company loans. Consequently, many such loans are interest-free. However, if interest is charged:

• It becomes taxable income for the lending company.
• It is deductible as an expense for the borrowing company.

This means businesses should carefully evaluate whether charging interest is beneficial in their specific circumstances.

Investing in Property Through Inter-Company Loans

Many trading companies opt to invest in property, but it is often preferable to do so through a separate non-trading company. This ‘ring-fencing’ approach helps protect assets and provides tax advantages. Key reasons for using a separate entity include:

• Avoiding personal tax liabilities when withdrawing funds from the business.
• Protecting property assets in case the trading company faces financial difficulties.
• Preserving eligibility for Business Asset Disposal Relief on future sales or wind-ups of the trading company.

To structure the investment, the trading company typically lends its surplus cash to a property investment company, which then acquires the property in its name. If the purchase involves both an inter-company loan and an external mortgage, it is generally advisable for the property to be owned by the non-trading entity. This helps business owners avoid personal guarantees or debentures over their trading company, which many lenders require when financing property under a trading company’s name.

Loan Repayment and Write-Offs

In most cases, inter-company loans are repaid when the property is sold. However, in some instances, the lending company may choose to write off the loan. If the companies involved are connected, writing off the loan is typically tax-neutral—meaning there is no taxable charge for the borrowing company and no tax relief for the lending company.

Formal Loan Agreements: Are They Necessary?

There is no strict legal requirement to draft a formal loan agreement between connected companies, particularly if both entities are owned by the same person, a sole director, or a husband and wife team. Since the likelihood of legal disputes is minimal, companies often proceed without formal agreements. However, documenting the terms can still provide clarity and avoid potential complications in the future.

Final Thoughts

Inter-company lending can be an effective strategy for businesses to optimize cash flow and facilitate investments. However, companies must navigate tax implications carefully and ensure compliance with HMRC’s loan relationship rules. Consulting with a tax professional before proceeding with such transactions can help businesses maximize benefits while avoiding unforeseen tax liabilities.

Partner Note: Part 5 CTA 2009, CFM35810.

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