Q&A: Tax-efficient borrowing

Most businesses will borrow money at some point. Whether you are investing in new equipment or better premises, you can cut the cost of borrowing by doing it in a way that reduces your total tax bill

Stuart Rogers, corporate tax consultant at Target Accountants, tells Simon Wicks how you can borrow money tax-efficiently.

I've taken out a loan to buy equipment for my business. Can I claim any of it back?

SR: If you borrow to buy plant, machinery or IT equipment, you can class it as a capital allowance. In the first year, you can deduct 50 per cent of the capital cost from your taxable profits if you're a small business [40 per cent if you're medium-sized].

So if I borrowed £4,000?

SR: You can take £2,000 off your taxable profits. So if you're paying tax at 20 per cent, you will have saved £400. You can also claim for repairs, maintenance and interest on the loan.

Hasn't the 2007 Budget made a difference to capital allowances?

SR: An 'annual investment allowance' has been proposed, which may enable businesses to claim 100 per cent tax relief on plant and machinery to the value of £50,000. But this is the subject of consultation.

What about loans for other purposes?

SR: You can claim some of the loan interest as a deductible expense when you calculate your tax bill. If you're a sole trader or in a partnership, you deduct a percentage of the interest equivalent to your level of income tax. Say you've borrowed £5,000 and you're paying the bank £500 in interest, if you're earning the higher rate of income tax, you can reduce your tax bill by 40 per cent of the £500 - tax relief with a value of £200.

Can limited companies claim tax relief on loan interest?

SR: Yes, but in a limited company your rate of relief is equal to your rate of corporation tax. The 2007 Budget has just pushed this up to 20 per cent for small limited companies, rising to 22 per cent by 2009.

So limited companies have a lower rate of relief. Is there any way round that?

SR: You might be better off borrowing the money personally and making a director's loan to the business. This way, your interest payable is offset against other personal income, so 40 per cent relief is available if you are in the higher rate bracket. But it's likely that you'll be able to borrow more as a limited company than you can as an individual, so borrowing as a business might be more appropriate.

Are there any other borrowing arrangements I can benefit from?

SR: You could try finance leasing, which is like a secured loan. The finance lessor owns the equipment; you pay monthly rental; but if you default, the lessor can sell the equipment. Finance leasing can be cheaper than an orthodox loan, because the lessor can pass on to you the tax advantages it has as the legal owner. Start-up businesses can't take advantage of tax allowances in the same way a lessor can. And lower rentals provide tangible benefits to owner-managers in the form of enhanced cashflow.