MOST well-advised start-up companies are formed with a small amount of share capital from the owner with further funding by way of personal loans from the owner or friends and family.

This gives significant flexibility whilst remaining tax-efficient and means that funds can be provided in many cases where the company would find it impossible to borrow from a bank.

A common scenario is for business owners or family members to lend savings to the business or to take a personal loan (perhaps extending the mortgage) to raise funds that are lent on to the company.

Provided the individual lending to the company is a participator in the company, he or she can claim tax relief on the interest paid on the loan to the third party bank lender.

Following the case of Nowosielsli v HMRC, the established understanding of the definition of participator for these purposes has expanded.

The Tax Tribunal ruled that as money the individual had lent to a company represented more than 5% of its total worth, he would be entitled to more than 5% of its assets upon winding up and, therefore, was a participator.

This meant he was entitled to claim tax relief on the interest he paid to a third party bank lender.

So if you have made a loan to a family business you may now be able to claim tax relief on financing this even if you are not a shareholder in the company.

It is worth remembering that this tax relief is available even if the loan to the company remains outstanding for some time.

Where the company is paying interest on loans expected to be greater than 12 months, it must deduct 20% tax from it at source and pay it over to HMRC.

This means that the individual lenders could be temporarily out of pocket if they simply charge the same rate of interest as the third party lender as, in most cases, relief on the interest the individuals have paid will be given through their tax returns.

On the plus side, individual lenders can agree a higher interest rate with the company than they are paying the bank.

Also, individual lenders could charge a higher rate on the loan than can be obtained by leaving their money on cash deposits.

Clearly company owners and individual lenders should take expert advice on the tax and legal consequences of proposed loans but, with care, family financing can be cost-effective all round.