Advanced Taxation (UK) · Taxation effects of the financial decisions made by businesses and individuals

Tax Effects of Raising Finance for Companies in ATX-UK

Updated 11 October 2026 · Fact-checked

Raising finance means choosing between shares and debt. Interest on loans and loan notes is usually deductible under the loan relationship rules, so it saves corporation tax. Dividends are not deductible. Share issue costs are not deductible, but loan arrangement costs normally are. Large groups may face the corporate interest restriction.

Understand Tax Effects of Raising Finance for Companies

A company can raise money by issuing shares (equity) or by borrowing (bank loans, overdrafts, loan notes). The tax treatment of the return paid to the funder is the main difference, and it drives most exam answers.

Debt is covered by the loan relationship rules. A company has a loan relationship when it borrows or lends money. Interest and related costs are taxed or relieved on an accruals basis, following the accounts. If the borrowing is for the trade, the interest is deducted in computing trading profits. If it is for non-trade purposes, such as buying investments, the interest is a non-trading loan relationship debit and is relieved against total profits. Incidental costs of obtaining loan finance, such as arrangement fees, are generally deductible too.

Equity works differently. A dividend is a distribution paid out of post-tax profits and gets no corporation tax deduction. The costs of issuing shares are capital and are not deductible. So debt is usually cheaper after tax. At 25% main rate, £100 of interest costs about £75 after tax. Between the lower and upper profit limits the saving is higher because of marginal relief.

There are limits on the debt advantage. Interest above an arm's length amount can be restricted under transfer pricing and the thin capitalisation rules, and interest paid to a participator or connected party can be treated as a distribution in some cases. Large groups can also face the corporate interest restriction (CIR). It broadly limits net interest deductions to a fixed ratio of 30% of tax-EBITDA, with a £2 million annual de minimis amount.

Always look at both sides. The investor is taxed too. An individual lender receives interest taxed as savings income. An individual shareholder receives dividends taxed at the dividend rates (8.75%, 33.75%, 39.35%), with a £500 dividend nil rate band. A corporate shareholder will usually have UK dividends exempt. The best finance choice depends on the company's profit level, the group position, the investors' tax rates and cash flow.

Key rules to remember

Tax saving on interest: Tax saving = Deductible interest × effective corporation tax rate; Use 25% above the upper limit and 19% at or below the lower limit. Between £50,000 and £250,000 of profits the effective marginal rate is 26.5%.
Corporation tax rates (financial year 2025): Small profits rate 19% | Main rate 25% | Lower limit £50,000 | Upper limit £250,000; Limits are divided by the number of associated companies plus one, and time-apportioned for short accounting periods.
Marginal relief: (Upper limit − Augmented profits) × 3/200 × Taxable total profits ÷ Augmented profits; Deduct from tax at the main rate. Augmented profits are taxable total profits plus exempt distributions from non-group companies.
Loan relationship rule: Trade loan: interest is a trading deduction. Non-trade loan: non-trading debit set against total profits. Both on an accruals basis.; Arrangement and other incidental loan costs are generally deductible. Share issue costs are not.
Dividends: Dividends paid = no corporation tax deduction; Paid out of profits after tax. The shareholder is taxed separately.
Corporate interest restriction (fixed ratio): Interest allowance = higher of £2,000,000 and 30% × group tax-EBITDA (capped by the group's net interest expense); Applies to groups with net interest expense above £2 million a year. Disallowed amounts can be carried forward and reactivated later. A group ratio election may give a higher allowance.
Individual investor rates: Dividend rates 8.75% / 33.75% / 39.35%; dividend nil rate band £500; savings nil rate band £1,000 (basic) or £500 (higher); Use the tax tables given in the exam. Interest is taxed at normal rates.

How to solve Tax Effects of Raising Finance for Companies questions

Use this order for any question that asks you to compare or advise on how a company should raise finance.

1Identify the funding options in the scenario: new shares, loan notes, bank loan, director loan or retained profit.
2For each debt option, decide the purpose of the borrowing (trade or non-trade). This tells you where the relief goes.
3State the deduction: interest and incidental loan costs on an accruals basis. For shares, say dividends and issue costs are not deductible.
4Compute the corporation tax saving. Check the company's profit level, associated companies, and whether marginal relief applies.
5Check restrictions: connected or participator lenders, interest above arm's length, and the CIR for large groups.
6Consider the investor's tax position: interest versus dividend rates, and any reliefs that make shares attractive such as EIS, SEIS or VCT.
7Compare the net after-tax cost and the cash flow effect, then give a clear recommendation tied to the facts.
8Add non-tax factors briefly: gearing, risk, control and cost of finance. Professional skills marks reward a balanced, reasoned conclusion.

Quickest way: Net cost comparison

When to use it: Use when the question gives a financing amount and asks which option is cheaper after tax, with little time to spare.

Write the annual pre-tax cost of each option (interest or dividend).
Interest: multiply by the effective rate (25%, or 26.5% if profits sit between the limits) and subtract the saving. Dividend: no saving.
Compare net costs in one small table-style list of lines.
Add one line on each of: investor tax, any restriction (connected party, CIR), and a recommendation.

Common mistakes in Tax Effects of Raising Finance for Companies

Treating dividends or preference share dividends as deductible.
Students think of anything paid to a funder as a finance cost, as in the accounts.
Fix: Dividends are distributions from post-tax profits. Only interest on debt gets relief. Say this explicitly in your answer.
Deducting the costs of issuing shares.
Issue costs look like an expense, and loan arrangement fees are deductible, so the two get confused.
Fix: Share issue costs are capital and not deductible. Incidental costs of loan finance are generally deductible.
Applying 25% to the interest when profits fall between £50,000 and £250,000.
Students forget marginal relief changes the effective rate on the last slice of profit.
Fix: Compute tax with and without the interest, including marginal relief. The saving is at 26.5% in this band. Check associated companies first.
Applying the corporate interest restriction to small companies or ignoring the £2 million de minimis.
Students remember the 30% ratio but forget it only bites for larger net interest expense.
Fix: Work out the allowance as the higher of £2 million and the fixed ratio amount. Only the excess net interest is disallowed.
Ignoring the investor's tax position.
Students stop once the company's saving is calculated.
Fix: Compare how the funder is taxed: interest at normal or savings rates versus dividends at dividend rates, and any relief for share investors such as EIS, SEIS or VCT.
Assuming all interest is automatically deductible whatever the terms.
Students overlook connected-party and arm's length rules.
Fix: Check whether the lender is connected or a participator and whether the rate is commercial. Excessive interest may be disallowed or treated as a distribution.

Worked examples

Example 1

Alpha Ltd, a single company with no associated companies, has trading profits of £200,000 before finance costs for the year to 31 March 2026. It needs to raise £500,000 and can either (a) borrow at 8% interest or (b) issue shares carrying a dividend of £40,000 a year. Compare the annual after-tax cost and corporation tax payable under each option. Ignore the effect of the funder's tax.

Show the solution

Option (a), loan: interest is 8% × £500,000 = £40,000, deductible as a trading loan relationship debit. Taxable total profits = £200,000 − £40,000 = £160,000.
There are no exempt distributions, so augmented profits = £160,000. Profits are between £50,000 and £250,000, so marginal relief applies.
Tax at 25% = £40,000. Marginal relief = (£250,000 − £160,000) × 3/200 × (£160,000 ÷ £160,000) = £90,000 × 0.015 = £1,350. Corporation tax = £38,650.
Option (b), shares: dividend is not deductible. Taxable total profits = £200,000. Tax at 25% = £50,000. Marginal relief = (£250,000 − £200,000) × 3/200 = £750. Corporation tax = £49,250.
Tax saving from the loan = £49,250 − £38,650 = £10,600. Check: £40,000 × 26.5% = £10,600.
Net annual cost of the loan = £40,000 − £10,600 = £29,400. Net cost of the dividend = £40,000 with no relief.

Answer: Corporation tax is £38,650 with the loan and £49,250 with shares. The loan costs £29,400 after tax and the dividend costs £40,000, so the loan is cheaper by £10,600 a year on tax grounds alone.

Example 2

The Beta group has net interest expense of £3,500,000 for the year and group tax-EBITDA of £8,000,000. Assume no group ratio election is made. Calculate the interest the group can deduct under the corporate interest restriction and the amount disallowed.

Show the solution

Fixed ratio amount = 30% × £8,000,000 = £2,400,000.
The de minimis allowance is £2,000,000. The interest allowance is the higher of the two, so £2,400,000.
The allowance is below the net interest expense of £3,500,000, so the restriction bites.
Disallowed interest = £3,500,000 − £2,400,000 = £1,100,000.
The disallowed amount can be carried forward and reactivated in a later period if the group has spare capacity.

Answer: The group can deduct £2,400,000 of net interest. £1,100,000 is disallowed in the year and carried forward for possible later relief.

Exam tips

Always compare the company's saving with the investor's tax cost. Examiners reward a two-sided answer.
Show the marginal relief working when profits are between £50,000 and £250,000. Check for associated companies to adjust the limits.
State rules in words first (for example, dividends are not deductible), then compute. Marks are often for the reason, not only the figure.
For CIR questions, use the information given on tax-EBITDA and net interest. Show the 30% calculation, the £2 million comparison and the disallowed amount.
Finish with a clear recommendation and one or two non-tax factors such as gearing or cash flow. This supports your professional skills marks.

Practice questions from Taxation effects of the financial decisions made by businesses and individuals

Tax Effects of Raising Finance for Companies in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

ACCA Applied SkillsThe Finance Gap and Barriers to Raising Finance

Tax Effects of Raising Finance for Companies: frequently asked questions

Is interest on a company loan always tax deductible?

Usually, under the loan relationship rules, on an accruals basis. Trade borrowing gives a trading deduction and non-trade borrowing gives a non-trading debit. Deduction can be restricted for non-arm's length terms, connected-party lenders, or under the corporate interest restriction.

What is the difference in tax treatment between interest and dividends for a company?

Interest is generally deductible, so it reduces corporation tax. Dividends are paid out of post-tax profits and get no deduction. That is why debt is normally cheaper after tax for the company.

When does the corporate interest restriction apply?

It applies to groups with net interest expense above £2 million a year. Broadly, deductions are limited to the higher of £2 million and 30% of tax-EBITDA, unless a group ratio gives a higher figure. Questions will give you the figures needed.

Are the costs of raising finance deductible?

Incidental costs of obtaining loan finance, such as arrangement fees, are generally deductible as part of the loan relationship. The costs of issuing shares are capital and are not deductible.