BIM37680 - Wholly & exclusively: duality of, or non-trade, purpose: non travel topics: interest payments

Drawings funded, in whole or in part, from borrowings

There is guidance on the statutory provisions giving relief for interest paid at BIM45650 onwards. There is guidance on the deductions arising under the loan relationships regime at CFM3000.

Where interest arises partly for trade purposes and partly for other purposes you will need to consider the amount to be allowed. Most frequently the need for a restriction arises where money is borrowed to fund drawings or make private purchases.

The guidance that follows describes a Special Commissioner’s decision in such a case. Special Commissioners’ decisions do not create a binding precedent but are indicative of the approach that they would take in similar cases.

Silk v Fletcher (SpC239/00) concerned the deduction of interest on bank loans taken out by a chartered accountant whose drawings exceeded his profits. There was a follow up case, Silk v Fletcher (no 2), where computational aspects were considered. Guidance on the computation of the amount disallowable where loan interest is not wholly and exclusively for the purposes of the trade is at BIM45650 onwards.

Silk had been a partner in a firm of accountants for many years. The partners entered into a deed of partition. Silk took out loans initially to make payments under the deed of partition for work in progress, book debts and fixtures and fittings, and subsequently took out further loans.

Silk’s accounts for each of the periods in question showed debit balances on capital account, and in all those years drawings exceeded net profits. By the end of the period the total amount of the loans was approximately the same as at the beginning. The accounts did not include any entry for goodwill.

The Revenue considered that about two-thirds of the loans and overdrawn bank accounts at the balance sheet date related to Silk’s overdrawn capital account. Therefore two-thirds of the amount of the interest and finance charges which Silk claimed to deduct was paid not for the purposes of his profession but for private purposes and should be disallowed under ICTA88/S74 (1)(a) and (b).

The Special Commissioner, Dr A N Brice, decided:

1. If an overdrawn capital account were adjusted by making entries which placed the account in credit, it did not follow that all the interest paid on loans was expended for the purpose of the trade or profession within ICTA88/S74 (1)(a) and (b). It was necessary to consider the underlying reality and to determine whether the interest was paid for professional purposes. In the instant case the fact that Silk had to borrow to purchase the assets under the deed of partition meant that his capital account was overdrawn. As drawings exceeded the net profits of the profession, some part of the loans was used to fund the private drawings, and part of the interest was not therefore deductible. Even if Silk’s drawings had been funded from his work in progress and the book debts, as the loans were initially taken out to purchase those assets, the loans were funding the drawings and so some of the interest on the loans was used for private purposes. Accordingly, even if Silk’s capital account was not overdrawn, it did not follow that all the interest was deductible.
2. It was clear that some of the loans had been used for private purposes. In determining the amount so used for the purposes of ICTA88/S74 (1)(a), an adjustment of Silk’s capital account in respect of cumulative depreciation subject to a reduction for the excess of debtors over creditors was likely to give a more accurate answer than an adjustment without such a reduction. Silk’s capital account was therefore to be increased by an amount for cumulative depreciation, but reduced by the excess of debtors over creditors.

The Special Commissioner explained the taxpayer has to prove that the interest is deductible:

In Silk v Fletcher (no 2) the Special Commissioner, Dr A N Brice, decided that the question to be answered was how much of the loans were used for private purposes.

The Special Commissioner recognised that any method falling short of analysing each and every movement on the capital account would lead to inaccuracy:

The key issue in this type of case is to determine the extent to which borrowings are used to fund drawings/other private matters; to that extent any interest or other charges are disallowable.