How is interest on a loan made treated for tax purposes

Retired_Minky

I'm looking to loan someone money to help them purchase a property. I will have a charge on the property and a loan agreement drawn up. 

I know you get a certain amount of tax free for interest earned on savings but does this apply to interest earned by making a loan. 

If not what's the tax treatment on the loan. 

I'd be getting over £1000 a year in interest. 

Sea_Shell

Just as an aside...

If the worst was to happen, and you didn't get paid back, would you be prepared to take this person to court, or to force a sale of the property if it came to it?

Loan agreements are only as good as the enforcement you'd be prepared to take.


As for the interest received, AIUI it is treated as INCOME not interest, and so would be subject to income tax. 

Retired_Minky

@Sea_Shell
Thanks for the reply. The loan to value on the property is quite low (33%). If they did default the value of the property would more than cover the loan and any costs to recover it. 

If the interest earned is treated as INCOME and not interest I may have to revisit my numbers to check the profitability of doing this.

Dazed_and_C0nfused

Retired_Minky said:

I'm looking to loan someone money to help them purchase a property. I will have a charge on the property and a loan agreement drawn up. 

I know you get a certain amount of tax free for interest earned on savings but does this apply to interest earned by making a loan. 

If not what's the tax treatment on the loan. 

I'd be getting over £1000 a year in interest. 

There is no allowance for taxable interest (which this would be).

Depending on your Personal Allowance no tax is actually payable on the first £17,310 or £18,570 interest received each year courtesy of the Personal Allowance, savings starter rate (0%) and savings nil rate of tax (0%).

If you have used your Personal Allowance and don't qualify for the savings starter rate them £1,000 is taxed at 0% if you are a basic rate payer, £500 if a higher rate payer.

But as the interest forms part of your adjusted net income it can still increase your overall liability even when taxed at 0%, for instance it could mean you have High Income Child Benefit Charge to pay or get a reduced Personal Allowance.

Retired_Minky

Thanks @Dazed_and_confused

I'm a higher rate tax payer so looking at this the first £500 I receive in interest would be tax free. Over and above that I'd pay at my normal taxable rate.

I don't receive child benefit and the income earned wouldn't take me in to earnings over £100,000 and reduce my personal allowance.

Keep_pedalling

Retired_Minky said:

Thanks @Dazed_and_confused

I'm a higher rate tax payer so looking at this the first £500 I receive in interest would be tax free. Over and above that I'd pay at my normal taxable rate.

I don't receive child benefit and the income earned wouldn't take me in to earnings over £100,000 and reduce my personal allowance.

I don’t think that is the case. Interest on personal loans is not included on the list of sources tax free interest is available on, so it looks like you will pay 40% on all of it.

https://www.gov.uk/apply-tax-free-interest-on-savings

Retired_Minky

According to the link peer-to-peer lending is covered by the allowance. A personal loan is essentially a peer to peer loan isn't it?

Sea_Shell

Retired_Minky said:

@Sea_Shell
Thanks for the reply. The loan to value on the property is quite low (33%). If they did default the value of the property would more than cover the loan and any costs to recover it. 

If the interest earned is treated as INCOME and not interest I may have to revisit my numbers to check the profitability of doing this.

I appreciate that there is plenty of equity in the property, but you may still have to take court action against them and potentially have them evicted (forced sale) to get your money back.

Would you be prepared to take that action, if push came to shove?

Who are they to you?   Relative, friend?

Retired_Minky

I don't think legal action would be required but I'd be ok to enact this. 

Its not lending to friends or family. 

Dead_keen

Keep_pedalling said:

Retired_Minky said:

Thanks @Dazed_and_confused

I'm a higher rate tax payer so looking at this the first £500 I receive in interest would be tax free. Over and above that I'd pay at my normal taxable rate.

I don't receive child benefit and the income earned wouldn't take me in to earnings over £100,000 and reduce my personal allowance.

I don’t think that is the case. Interest on personal loans is not included on the list of sources tax free interest is available on, so it looks like you will pay 40% on all of it.

https://www.gov.uk/apply-tax-free-interest-on-savings

I'm not sure that your conclusion is right.  The £500 / £1,000 savings allowance is available for "savings income" and that would include interest paid by an individual.  See s18(3)(a) ITA 2007 https://www.legislation.gov.uk/ukpga/2007/3/section/18 and if you want to get geeky: https://www.legislation.gov.uk/ukpga/2005/5/part/4/chapter/2

So for a higher rate taxpayer, any amount received above £500 is taxable.

Jeremy535897

Section 18 ITA 2007 defines "savings income", which qualifies for the 0% rate on the first £500 for higher rate taxpayers, as (amongst other things) "income chargeable under Chapter 2 of Part 4 of ITTOIA 2005".

Section 369 ITTOIA 2005, which is within Chapter 2 of Part 4, states "Income tax is charged on interest".

Consequently, the interest paid on a mortgage owed by one individual to another is savings income in the hands of the recipient, and the borrower (not being a company or a partnership containing a company) is not required to deduct tax from the payment.