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8 December 2011
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Commercial and personal considerations of whether you need to, wish to or can afford to borrow money should always outweigh the tax considerations. The rates of return on investing cash are, unless you can find a magic swan, unlikely to be greater than the rates of borrowing, but if you have a personal aversion to debt and already have the private funds available, then taking out a business loan solely for tax relief purposes may not be the right decision for you.
If your new partner did decide to take out a loan for the purpose of injecting working capital into the practice, then he would be able to claim tax relief on the interest element of the loan. He would receive income tax relief at his marginal rate of tax and his class 4 national insurance contributions payable would also be reduced to take into account the loan interest paid. Effectively the tax relief receivable means that the total net cost of the business loan is lower than it would have been if taken out at the same rate of interest for a non-tax relievable personal loan.
He can only claim tax relief on the loan interest as long as his capital introduced remains in the practice as working capital for the period of the loan (ie, he cannot subsequently draw it from the business and continue to claim full tax relief on the interest payments). The rule of thumb for this is that the capital amount outstanding on the loan should not be higher than the value of the partner’s current account, otherwise the amount of tax relief claimable on the loan interest should be restricted on a pro-rata basis.