When your business has spare cash, it’s tempting to make it work harder. Rather than leaving money sitting idle, some companies choose to lend it to another business. These loans can improve returns, help manage group finances, and even offer tax efficiencies. But before moving money between companies, it’s vital to understand the rules. Especially if those companies are connected.
Why Companies Lend to Each Other
Businesses lend to other companies for several reasons. Some look for better returns than bank interest. Others use loans to shift profits between group companies, especially when one company has losses or a lower tax rate. Handled correctly, inter-company loans can be both practical and tax-efficient. But handled poorly, they can trigger unexpected tax charges or attract HMRC attention.
Understanding “Connected Companies
What Does “Connected” Mean?
According to HMRC’s Corporate Finance Manual, companies are connected if one controls the other, or both are controlled by the same person. Control means being able to direct how the company is run. This can happen through owning most of the shares, holding most of the voting rights, or having control through legal documents such as the Articles of Association. In simple terms, if you or your company can tell another company what to do, they are connected.
The Tax Rules on Connected Company Loans
Special tax rules apply when connected companies lend to each other. These rules cover all types of loans — whether cash is physically transferred or not. HMRC expects these loans to be treated as if they were made on normal commercial terms. That means the rate of interest, repayment period, and documentation should look similar to a deal between unrelated businesses. Tax is charged on interest income, and deductions are allowed for interest expenses — but only when the terms are reasonable and commercially justified.
Should You Charge Interest on an Inter-Company Loan?
Interest is what turns a simple transfer of money into a taxable transaction. When no interest is charged, there’s no immediate tax effect. But when interest is charged, the lender recognises taxable income, and the borrower can claim a tax deduction.
When Charging Interest Helps
Charging interest can make sense when a profitable company borrows from a less profitable one. The interest expense reduces the borrowing company’s taxable profit. The lender, on the other hand, earns interest income — taxed at its lower rate or offset against losses. This can help reduce the group’s overall tax burden — as long as everything is done properly.
Setting a Commercial Rate
The rate of interest must be realistic. HMRC may challenge anything that looks excessive or artificial. A rate of 20% will raise eyebrows. But a reasonable benchmark is the bank base rate plus about 3%. For example, if the base rate is 4%, a rate of 7% for an unsecured loan between private companies is likely to be acceptable. Always record the basis of your rate in writing to show it’s commercial.
What Happens If the Loan Is Written Off?
Sometimes, a borrower can’t repay. When loans between connected companies are written off, they are usually tax neutral — provided they fall within HMRC’s loan relationship rules.
How the Tax Works
If the loan was for genuine lending purposes, the lender cannot claim tax relief for the loss, and the borrower isn’t taxed on the amount written off. The loan must be a money debt that arose from lending cash — not from unpaid trading balances or invoices.
Trading or Property Debts
Even though trading or property business debts don’t arise directly from lending money, “bad debts” from such activities can also be covered under the loan relationship rules. This ensures that the write-off doesn’t create unexpected tax charges on either side.
Family Companies and the “Unallowable Purpose” Trap
Things get trickier when family-run companies are involved. If two family businesses lend to each other but aren’t formally connected, HMRC might argue that the loan was made for personal or family reasons — not commercial ones. In that case, if the loan is later written off, the borrower could face a tax charge, and the lender won’t get any tax relief. To avoid this, document the purpose of the loan clearly and ensure it reflects a genuine business transaction.
Practical Tips for Safe and Tax-Efficient Lending
- Document everything. Use a formal loan agreement showing terms, interest, and repayment schedule.
- Keep rates reasonable. Stick close to commercial benchmarks like the base rate plus a small premium.
- Ensure purpose is business-related. Avoid loans that could be seen as personal or for convenience.
- Review regularly. Reassess rates and balances annually to ensure continued compliance.
- Seek advice early. A qualified adviser can help you stay tax-efficient and avoid HMRC disputes.
Loans between companies can be powerful tools — but only when handled properly. Get them wrong, and you could face complex tax issues. If you’re considering an inter-company loan, or already have one in place, get professional advice before HMRC gets curious. 👉 Book a call today with I Hate Numbers to make sure your lending arrangements are both smart and compliant.
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