BIM45700 | Specific deductions - interest: Withdrawal of capital from a business

This chapter applies for Income Tax purposes to the computation of trade profits and property income. References in the text to a ‘business’ should therefore be taken to include both trades and property businesses. The chapter does not apply for Corporation Tax purposes, where there are separate rules in the loan relationships legislation (see CFM30000).

S34 Income Tax (Trading and Other Income) Act 2005

A proprietor of a business may withdraw the profits of the business and the capital they have introduced to the business, even though subsequent funding may then have to be provided by interest bearing loans. However, simply exchanging existing capital for loan finance does not on its own satisfy the wholly and exclusively test provided by S34. The interest payable on the loans is an allowable deduction where the borrowing is used for business expenditure or acquisition of assets used in the business.

Example 1

Mr P wants to substantially increase the stock levels in his business. He approaches the bank and provides details of his growing business. The bank agree to increase the business overdraft facility by £10,000. Mr P then uses most of the facility to purchase more stock, but also uses some of the available overdraft facility to help purchase a new private car. The identifiable proportion of the interest relating to the amount used to purchase new stock is an allowable deduction but the interest relating to the proportion used to purchase the new car is not an allowable deduction.

Example 2

Mrs H owns a house in London that she rents out to students as part of her UK property business. She leaves her current employment to take up a new job in Paris. Mrs H increases her mortgage on the property she rents out and uses the additional funds raised to purchase her new private residence in Paris. As the funds are used to buy a new private asset the interest on the new remortgage is not an allowable deduction in the property business.

Example 3

Mr X has taken over the family business which is a small firm manufacturing plastic dinosaur toys. It does reasonably well making a profit of £45,000 a year. The factory unit was built 20 years ago at a cost of £150,000 and is owned outright by Mr X.

Mr X has the property revalued and is able to secure loan funding of £150,000 against the property. On obtaining the loan finance Mr X uses £75,000 to expand the product lines of the business and £75,000 is immediately withdrawn to fund a holiday home in Spain.

Although the bank loan is secured on the factory and is shown as a trading liability in the accounts, part of the money has been used for a non-business purpose and therefore it is reasonable to seek further information to understand if an interest restriction is required.

In assessing what, if any, amount of the loan and the interest thereon has a non-business purpose consideration would need to be given to the purpose(s) of Mr X at the time he obtained the funding, as well as amounts that may have been capable of withdrawal from the business absent the loan funding. Further advice is provided at BIM45705.