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HMRC internal manual

Savings and Investment Manual

Relief for interest paid: interest in excess of a reasonable commercial rate: examples

Interest in excess of a reasonable commercial rate: examples

Example 1

A loan of £100,000 is taken out for 10 years at a rate of 7% (considered to be a reasonable commercial rate)

The loan agreement requires the interest for the entire period £70,000 (£100,000 x 7% x 10 years) to be paid £50,000 in year 1, £15,000 in year 2 and £5,000 in Year 3.

In year one the ‘reasonable commercial amount of interest’ would be £7,000 (£100,000 x 7%) and this would be the amount allowed for relief. The disallowed amount of interest, £43,000 (£50,000 - £7,000) is ‘lost’ and will attract no relief now or in the future.

In year two the ‘reasonable commercial amount of interest’ for that year would be £7,000. Since the loan has now existed for more than one year this amount is added to all the interest relieved in previous periods, £7,000 giving a total of £14,000 for the two years.

£7,000 has already been relieved in Year 1 leaving £7,000 to be relieved in Year 2, therefore £8,000 (£15,000 - £7,000) is disallowed in Year 2 and lost.

In Year 3 the interest paid of £5,000 is added to the interest relieved so far £14,000 giving a total of £19,000. This is less than £21,000 (£7,000 x 3) so all the interest paid in the year, £5,000, is allowed.

In Years 4 - 10 no interest is paid and no relief is due.

Doing the calculation for each year ensures that where the interest paid in a particular tax year plus the interest paid in earlier years represents no more than a reasonable commercial rate over the whole period to that point, then that interest will be allowable even if it is (at that point) at a rate above a reasonable commercial amount.

Example 2

John borrows £100,000 for 10 years on terms under which no interest is paid in the first year, the rate of interest in the second year is 5%, and in the third and subsequent years is 8.125%. Supposing a reasonable commercial rate of interest is still 7%.

In Year 1 no interest is paid and no interest is due.

In Year 2 he pays £5,000 (£100,000 x 5%) which is added to £0 paid in Year 1. The resulting figure of £5,000 is less than £14,000 (£100,000 x 7% x 2) so all the interest is allowed.

In Year 3 he will have paid an aggregate of £13,125 (£0 + £5,000 + £8,125) which is less than £21,000 (£7,000 x 3) and therefore all the interest he paid in the year, £8,125, is allowed.

Years 4 -10 if these steps are repeated for these later years you will see that all the interest paid in these years (despite being at 8.125%) will be allowable. By year 10 interest of £61,875 will have been allowed in previous years (all the interest paid) and the interest in that year, £8,125 will bring the total paid to £70,000. As this does not exceed £70,000 (£7,000 x 10) all the interest is relievable.