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HMRC internal manual

Corporate Finance Manual

Loan relationships: computational rules: what is interest?

What is interest?

Interest is the most common example of the credits and debits that arise on a loan relationship.

There is no statutory definition of interest for tax purposes. It you need to decide whether a sum of money is interest, for example when establishing whether the loan relationships rules apply, consider the following principles that are derived from case law.

  • Interest is the return or compensation for the use or retention by one person of a sum of money belonging to or owed to another.
  • For interest to exist there must be a principal sum; that is, a sum of money advanced or a debt incurred.
  • Interest can only arise by virtue of a legal right.
  • A voluntary or gratuitous payment cannot be interest.

What is interest: case law

The question of what constitutes interest has been the subject of much case law over the years. Perhaps the best known quotation on what interest is comes from Rowlatt J in Bennett v Ogston (15TC374). He described interest as ‘payment by time for the use of money’.

This theme was developed in Westminster Bank v Riches (28TC153) where it was said ‘… the essence of interest is that it is a payment that becomes due because the creditor has not had his money at the due date. It may be regarded either as representing the profit he might have if he had had the use of the money, or conversely the loss he suffered because he had not had that use.’ The general idea is that he is entitled to compensation for the deprivation.

The requirement that for interest to exist there must be a principal sum from which the interest originates was considered in Re Euro Hotel (Belgravia) Ltd (51TC293). In his judgement Mr Justice Megarry said ‘there must be a sum of money by reference to which the payment which is said to be interest is ascertained.’ 

The concept that interest is something that accrues over time is supported by the cases of Wigmore v Thomas Summerson (9TC577) and Willingale v International Commercial Bank (52TC242). These cases indicated that true interest accrues from day to day or at periodic intervals.

What constitutes interest is a question of legal substance rather than terminology. In his judgement in the Re Euro Hotel case, Mr Justice Megarry said ‘It has, quite rightly, not been suggested that the language used by the parties to an instrument in describing the payment to be made under it can bind the Inland Revenue, or affect the operation of the statute. The question must always be one of the true nature of the payment.’ 

The case of Seaham Harbour Company v Crook (16TC333) demonstrates that a voluntary or gratuitous payment cannot be interest. This is so even if the payment is paid in lieu of or is equivalent to interest.

Certain amounts are treated as if they are interest for the purposes of the loan relationships rules - see CFM33040.

There is more on the case law on interest in the Savings and Investment Manual (SAIM2030+).