Acquire assets and borrow money tax efficiently

Most businesses will need to borrow money at some point, whether when starting up, funding growth or purchasing equipment. 

It is possible to cut the cost of borrowing by doing it in a way that reduces your overall tax bill. Tax relief on borrowings is not sufficiently exploited by some businesses.

Tax relief may offset the costs of some types of borrowing – though not all. Careful consideration must be given to the implications of all borrowing.

This guide illustrates some tax-efficient methods of borrowing for example, if you intend to buy, rent or lease assets or perhaps borrow from the directors’ pension scheme.

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Tax relief for buying or leasing assets

The tax relief available when acquiring business assets depends on whether you buy them outright, or on the type and length of the lease. This also affects whether VAT will be charged upfront or periodically.

The cost of renting or leasing an asset is deductible as a business expense so this can reduce your overall tax bill.

If you expect to own the asset at the end of the lease or hire purchase period, this is a supply of goods for VAT purposes. So you will have to pay VAT on the whole value at the start of the contract. If you are VAT-registered and want to reclaim VAT and sell the asset, you may have to account for VAT on your selling price. You may also have to account for VAT on the value of the asset if you give it away for free.

If you will not become the owner of the asset at the end of the lease or hire purchase contract, this is a supply of services for VAT purposes. So VAT will be payable periodically.

Note that if the leased asset is a vehicle, the right to recover VAT is restricted in some circumstances. Find out about reclaiming VAT on leased and purchased cars on the HMRC website- Opens in a new window. 

See the page in this guide on calculating tax relief when acquiring an asset.

Capital allowances

When you buy plant, machinery and IT equipment, you can deduct a proportion of the cost from your taxable profits each year – known as capital allowances.

You can claim capital allowances if the equipment is:

• bought outright
• bought through hire purchase
• supplied under a long funding lease – find a definition of long funding leases on the HM Revenue & Customs (HMRC) website.- Opens in a new window

You can’t claim capital allowances with shorter leases – ie less than five years and sometimes less than seven – but the leasing company can, so you should benefit indirectly through lower rental charges. Also, because it’s a trading expense, you can usually deduct the full rental costs from your taxable income.

For more information, see the page in this guide on calculating tax relief when acquiring an asset.

For further information on what you should consider when borrowing money to buy assets see the page buying equipment outright in our guide on how to decide whether to lease or buy assets.

Remember, businesses only pay tax if they are making profits. If your business is making a loss, minimising the impact of buying a new asset is likely to be more important to you than borrowing money tax efficiently – in which case, leasing might be a more suitable option.

For guidance on acquiring assets and the pros and cons of buying or renting, see our guide on how to decide whether to lease or buy assets.

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Calculating tax relief when acquiring an asset

The tax relief available when acquiring business assets depends on whether you buy them outright, or on the type and length of the lease. For more information, see the page in this guide on tax relief for buying or leasing assets.

When you buy plant, machinery and IT equipment, you can deduct a proportion of the cost of buying it from your taxable profits each year – known as capital allowances.

Capital allowances are usually a fixed proportion of the cost of the equipment, but many small and medium-sized businesses get a higher allowance in the year they buy the asset. See our guide on capital allowances: the basics.

For example, businesses can claim a 100 per cent ‘annual investment allowance’ on the first £100,000 of allowable expenditure from 6 April 2010 – £50,000 in 2008-09 and 2009-10. Allowable expenditure includes plant and machinery, excluding cars, and assets with a useful economic life of at least 25 years – known as long-life assets.

The annual investment allowance will be reduced to £25,000 from April 2012.

There is also a 100 per cent capital allowance if you renovate or convert vacant or under-used space above shops or other commercial premises, to provide flats for rent. This means you can claim up-front tax relief on this capital expenditure. You can read guidance on capital allowances on the HM Revenue & Customs (HMRC) website- Opens in a new window.

An example of tax relief when acquiring an asset
 

Two businesses need new machinery for their work. Business A borrows to acquire an asset and Business B leases an asset.

Borrow to acquire an asset

Business A buys some new machinery for £15,000, ignoring VAT. To finance the cost, the business takes out a bank loan for five years at a flat rate of 5 per cent – total interest cost for the whole period is £750. The business also pays £50 a year for maintenance and in the first year spent £125 on repairs.

Lease an asset

Business B leases the machinery over five years at a monthly instalment of £312. The business makes an advance payment of two months’ rental.

The leasing company is responsible for the repairs and maintenance of the machinery.

Tax relief

Each business acquired and started using the asset on the first day of its financial year. Since 6 April 2008, capital allowances have been available at 100 per cent of the capital cost. The maximum annual investment allowance is £100,000 (£50,000 in 2008-09 and 2009-10).

The deductions from taxable profits for the first year are as follows:

	Business A Borrow	Business B Lease
Interest
One-fifth of total interest cost	150.00	–
Lease payments
12 months plus two in advance	–	4,368.00
Capital allowances	15,000.00	0.00
Repairs	125.00	0.00
Maintenance	50.00	0.00

In this illustration Business A benefits in the first 12 months from greater tax relief from low first-year payments. In subsequent years, Business B will benefit overall because the tax deductions from leasing will be greater than from borrowing.

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Borrow money for capital investment from pension schemes

Employers are not generally allowed to borrow from a business’ pension scheme. One exception is with small self-administered schemes (SSAS).

SSAS are occupational pension schemes designed for shareholding directors of small limited companies. The schemes are permitted to lend money to the company for any purpose including capital investment, ie for capital assets (tangible property that cannot easily be converted into cash and will be held long-term) or fixed assets.

However, there are restrictions on loans that can be made from the SSAS:

• you can only borrow up to an amount that does not exceed 50 per cent of the value of the scheme assets (the assets being the aggregate of the cash sums and net market value of other assets held by the pension scheme immediately before the loan is made)
• the loans must be secured as a first charge on an asset of equal value to the amount of the loan, including interest (the asset charged does not have to belong to the business and the security provider does not have to be the business receiving the loan)
• they must be for a fixed term (the maximum allowable term is five years) and at a commercial rate of interest, eg at least 1 per cent above the clearing banks’ base rate

Such loans are tax efficient for the pension scheme as the interest income earned is not subject to tax. The company itself can claim tax relief for the interest payable. Its owners are usually the SSAS members so they benefit from its tax-efficient investment – effectively they are borrowing money from and paying interest to themselves.

There are five key tests that a loan must satisfy to qualify as an authorised employer loan, which are:

• security
• interest rates
• term of loan
• maximum amount of loan
• repayment terms

The scheme would have to be registered with HM Revenue & Customs (HMRC) and a formal loan agreement should be drawn up. Read about SSAS on the Pensions Advisory Service website – Opens in a new window.

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Claim loan interest against tax

Interest paid on loans taken out by businesses is a deductible expense from your final profit or loss figure when your tax bill is calculated. The loan interest can only be deducted from profits if the loan is exclusively for a business purpose or a property letting if it is part of your business premises.

Interest on overdrafts and credit cards can be treated as a deductible expense for calculating the profit for tax only if the overdraft or credit cards are used for business purposes. If you are a sole trader or part of a partnership and you also use the overdraft or credit cards for personal use, then you cannot claim interest payments as a business expense.

In the case of an individual, you may also be able to claim tax relief against income tax for interest paid on a loan if the loan was a qualifying loan, as defined by HM Revenue & Customs (HMRC).

Qualifying loans include those used:

• to buy shares in or to lend money to a business in which you own more than 5 per cent of the shares
• to buy shares in a limited company in which you work full time
• to buy shares in or lend money for business purposes to a partnership

There are conditions attached to such qualifying loans:

• the business must be a close company – where five or fewer directors or shareholders control the company
• the lender must own more than 5 per cent of the shares or work as part of the management

Download guidance on interest eligible for relief on qualifying loans from the HMRC website (PDF, 41K) – Opens in a new window.

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