Are business loans tax deductible

For business owners, any money going in or out of your company raises the question of tax, and business loans are no exception. For those looking for a quick answer: yes, if you use the loan for business purposes, the interest that you pay on a business loan is usually tax-deductible. 

This means that you can claim the interest as an expense. However, you can’t claim the loan itself as an expense – the repayments of the principle are not tax deductible.

So that’s the short answer, but like any financial question, the devil is in the details. So here we’ll dig into how various kinds of small business loans affect your tax, which types of tax matter most and how to make the most of your borrowing from a tax perspective.

Is a business loan income? 

Tax primarily applies to money that you’re earning in your business, so since a business loan brings money in, it’s natural to wonder if this counts as income. 

No, business loans are not considered taxable income as long as they are repaid. That’s because the funds from a loan are borrowed, not earned, and therefore do not count towards your taxable income. That means you don’t have to pay income tax on a business loan. However, if a loan is forgiven, it may be considered taxable income under specific circumstances​.

Since interest on business loans can typically be deducted from your taxable income, it can reduce your overall tax liability. So let’s look at how that works.

Is interest on business loans tax-deductible? 

While repayments as a whole are not tax-deductible, interest on business loans is generally tax-deductible, provided the loan is used for business purposes. This deduction reduces your taxable income, lowering your overall tax liability. 

Let’s look at an example. 

Say you take out an unsecured business loan of £30,000 business loan over 2 years.  

• Your monthly payments would be about £1,330. 
• Over the first year, you might pay around £1,800 in interest, which is tax-deductible. 
• The remaining £14,160 of your payments would go towards repaying the principal, which is not deductible. 

This same principle applies in the second year, with the interest portion decreasing and the principal repayment increasing as you pay down the loan.

However, be aware that in order to qualify for this you’ll need to follow the relevant guidelines, including:

• Legal Liability: You must be legally responsible for repaying the loan, with your name on the loan agreement.
• Proof of Repayment: Keep detailed records of your repayments, including bank statements and receipts.
• Debtor-Creditor Relationship: Demonstrate a genuine transaction where the lender expects repayment under fair market terms.
• Business Use of Funds: The borrowed funds must be used for business purposes, not just held in a bank account.
• Qualifying Business Purpose: Ensure the loan is used for operational expenses, asset purchases, or business expansion. If they are used for a mix of personal and business purposes, you can only claim interest on the business-related spending.
• Incidental Costs: Expenses related to obtaining the loan, like legal fees, may also be deductible if incurred wholly and exclusively for business purposes.
• Comprehensive Documentation: Maintain thorough records of all loan-related documents. 

Can I use a business loan with capital allowances?

Capital allowances are tax reliefs that businesses can claim on certain purchases or investments, like machinery or equipment. When you finance these assets through a business loan, you can still claim capital allowances, which reduces your taxable profit and, consequently, your tax bill. Here’s how:

1. Identify Qualifying Assets: These include machinery, office equipment, and vehicles used for business purposes.
2. Claim Annual Investment Allowance (AIA): Most businesses can claim 100% of the cost of qualifying assets up to the AIA limit.
3. Utilise Writing Down Allowances (WDA): For assets that exceed the AIA limit, you can deduct a percentage of the remaining value each year.

By combining a loan with your capital allowance, you can offset the cost of assets, making your investment more tax-efficient.

VAT and Loans

While the principal amount of a business loan is not subject to VAT, some related expenses might be. For example, legal fees incurred when securing a loan are subject to VAT. It’s important to consult with a tax professional to ensure you're compliant with VAT regulations and to understand which expenses can be claimed back.

Tax Planning Strategies and Use of Loans

Effective tax planning can enhance the benefits of using business loans. Here are some strategies to consider:

1. Interest Deduction Maximisation: Ensure your loans are structured so that the interest is fully deductible. This might involve consulting with your lender and accountant.
2. Timing of Purchases: Plan significant purchases towards the end of the financial year to maximise your capital allowances.
3. Loan Allocation: Use loans for specific, high-impact business activities like expansion or large asset purchases, which are more likely to yield tax-deductible expenses.

Proactive tax planning helps you make the most of your financial strategies, ensuring that your business loans not only support growth but also offer tax benefits.

Business Loan Tax FAQs

Can I Pay My Tax or VAT Bill with a Business Loan? 

Yes, you can use a business loan to pay your tax bill. This can be a strategic move, especially if it helps you avoid late payment penalties or allows you to manage cash flow more effectively. However, it's essential to ensure that the loan terms are favourable and that you're not incurring more debt than necessary.

There are also special VAT loans available for businesses to pay their VAT bills.

Are Director’s Loans Tax-Deductible? 

Director’s loans, which are funds borrowed by a director from their own company, are not tax-deductible for the director. The interest paid on these loans, however, can be treated as a business expense by the company if it is incurred wholly and exclusively for business purposes. If a director repays a loan to the company, it is not deductible as it is a return of funds, not a business expense.

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