What are the tax implications that different types of loans can have on your business?
Scenario one: The startup loan from family or friends
Many new businesses get a helping hand in the startup stage from family and friends.
Chances are the loan is interest-free. Therefore, there is no tax deduction allowed as no interest is charged. Payment against the loan does not affect your profit and loss but goes on the balance sheet, reducing the current or non-current liabilities.
Scenario two: Loans from a financial institution
Loans that have been taken out in the business name mean the interest can be taken as a tax deduction. You can apply for a loan here.
(However, what happens when a partner in a partnership, or a director of a company, borrows personally and lends the funds to their business? See below.)
Scenario three: A partner takes out a personal loan for a partnership
There is no longer a deduction on loan interest on such loans taken out after October 15, 2013, unless the new loan is replacing an existing loan made before October 15, 2013.
As of January 1, 2017, there is no tax deduction on personal loans even if they were taken out before October 15, 2013.
This rule does not apply to farming partnerships. In practical terms, the best solution to funding the partnership may be to take out a personal loan.
However, no tax deduction is allowed on a personal loan.
Scenario four: A director takes a loan and gives it to a company
If a director takes a personal loan and lends it to their company, the interest payable on the loan is allowed, but the director must declare the interest receivable as taxable income.
For example, Mick personally borrows €35,000 and lends it to his company, where he is a director. The annual interest is €2,400 a year.
The repayment of the loan from the company reduces the loan on the balance sheet. However, the interest of €2,400 must be declared as interest received and is taxable under PAYE, PRSI, and the USC.
(I have not commented on the possible closed company issues that are relevant in this example.)
Conclusion – don’t assume loans are tax deductible
It’s a common mistake that business owners think they can take out a personal loan for their partnership or company and enjoy a reduction on the interest paid. Before you take any action, you should consult your accountant.