From the 6th April 2015, individuals deriving their income from interest on savings will notice a marked reduction in the amount of tax they are likely to suffer on this income. The Chancellor announced in his Budget 2014 speech back in March that the starting rate of tax for savings would be reduced to 0% for the first £5,000 of savings income over and above the personal allowance (PA).
As has always been the case with the starting rate for savings, if there is other income falling above the PA the reduced rate of tax is ignored and the income is taxed at the basic rate (20%).
When the 0% rate kicks in from 2015-16, the standard personal allowance will be at £10,500. Add to this the savings rate threshold of £5,000 and an individual earning £15,500 from savings (and notably nothing else) will have no tax bill. A husband and wife with joint savings will be able to earn £31k of interest without a penny going to the taxman.
Anyone whose main source of income is in fact savings and are having tax deducted at source by the bank can apply to receive the interest gross if the changes mentioned above are likely to mean you won’t have any tax to pay. To do this you will need to fill out form R85.
However, given typical savings rates are currently around 2-3%, to earn £15k in interest per annum, you need £500,000 – £750,000 sitting on deposit. So it’s not necessarily going to affect most people while interest rates remain low.
However, there is a distinct opportunity here for owner managed businesses to save tax on both their own earnings and the income of their owners.
Charging Interest on Directors Loan Credit Balances
If the company owners invested personal funds into the company for which they are still to be reimbursed, they are entitled to charge interest on this balance. The interest is deductible for the company and is taxed at 0% if no other income is earned in the hands of the business owners.
Previously, directors would have taken a salary equal to the personal allowance and then declared dividends to keep their income within the basic rate band of tax and therefore avoided any further charge to tax. Whilst this is still the most efficient manner of getting circa £40k a year from the company, it is certainly worth considering looking at charging interest on directors loan credit balances; especially in years of poor earnings or perhaps when accounting losses deplete reserves to the point where dividends are not an option.
The Tax Savings
The advantage here is for, say, a husband and wife who own and run their own company. They can pull an extra £10k from the company in the year, pay no income tax and save an extra £2,000 in Corporation Tax, not to mention the Employers NIC saving.
If we compare a salary of £15,500 to an interest charge of £15,500, the effect is the company is better off by £814 and the owner by £1,885. So overall almost £2,700 more stays with the company and its owners for each individual who is charging interest.
The trade-off then is the restriction of earnings. If you choose to take dividends as well you lose the 0% bracket but still get the CT deduction and NIC saving.
The key to this though is having sufficient funds owed by the company to its owners and being consistent and reasonable in the rate of interest you charge. Scenarios I’ve seen in the past that lead to this mechanism being utilised are typically when business owners secure funds personally to buy premises or high value assets for the company. In this instance, further savings can be made by claiming Qualifying Loan Interest relief on the interest charged to the owner. This effectively recharges the interest to the company (assuming similar interest rates) but this will counteract the utlisation of the savings rate band.
Summary
So while the above mechanism may have limited uses, it can still provide significant savings when the conditions are right. The relief for Qualifying Loan Interest, whilst it can counteract the usability of the savings rate band, can also help. The relief is given regardless of the type of income so if owners do wish to take dividends for their tax efficiency, the relief on the interest being suffered can help increase the amount of dividend that can be taken before hitting the higher rate threshold.
Engineering the above scenario simply to get the tax deduction would be inefficient. However, if the circumstances are in place, or the owners are considering transactions that might put them in place such as providing finance for the purchase of premises, then this interest income offers some flexibility to owners wishing to extract funds from their company in a tax efficient manner.
