For business owners, when any money goes in or out of your company, you need to consider tax, and business loans are no exception. The quick and easy answer to the question posed about whether business loans are tax-deductible is yes, to a certain extent. However, like any financial question, the devil is in the details. 

In this article, we dig deeper into the relationship between business loans and tax implications, including how loans affect your company tax and how to make the most of your borrowing from a tax perspective.

What elements of business loans are tax-deductible?

It’s important to be clear that you can’t claim any tax back on the capital (or principal) you borrow in a business loan agreement. However, the good news is that the interest charged on the loan is tax-deductible. Additionally, any other lender fees associated with the finance facility, such as arrangement fees and any charges for early repayment, are also eligible for tax benefits.

The quick-glance table below gives you an idea of what elements of business loans are tax-deductible and which aren’t:

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Let’s take a more detailed look at the main tax considerations for business loans. 

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Is a business loan treated as 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. However, the answer is 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. 

This means you don’t have to pay income tax on a business loan. However, if a loan is written off for any reason, 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. Let’s look at how that works.

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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 use an example to give you an idea of how this works. Say you take out an unsecured business loan of £30,000 over two years, here is a breakdown of how the interest and tax deduction play out:

• An example monthly payment figure could be £1,330 (so, amounting to £15,960 over 12 months). 
• 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.

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Key considerations for businesses looking to deduct tax from interest incurred on loans  

Be aware that to qualify for tax deductions, you’ll need to keep your records in order and ensure you meet your obligations. Consider the following guidelines:

• 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.
• Responsible 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. 

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Can I use a business loan with capital allowances?

Capital allowances are forms of tax relief 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 reduce your taxable profit and, consequently, your tax bill. 

Here are the key steps for leveraging capital allowances:

1. Identify qualifying assets: These include assets like 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, known as writing down allowances.

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

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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. Consult with a tax professional to ensure you're compliant with VAT regulations and to understand which expenses can be claimed back.

Why not consider using a VAT loan? This is a business loan used specifically to cover VAT payments, easing cash flow problems, especially for businesses impacted by seasonality.

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Tax planning strategies and the use of loans

Effective tax planning can enhance the benefits of using business loans and ensure you’re leveraging all relevant opportunities for tax relief, which is key in a time of rising business costs and increasing tax obligations.

Here are some tax planning 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 business 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, such as expansion, upgrades 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 business loans not only support growth but also offer crucial tax benefits.

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Business loan tax FAQs

Can I pay my corporation tax or VAT bill with a business loan? 

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

There are specific loans available to help businesses pay their VAT bills, or you could use a flexible small business loan, like iwoca’s Flexi-Loan, which is a convenient, short-term funding solution for SMEs, helping you cover your tax payments and repay capital in affordable monthly instalments, aligned with your cash flow.  

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Are directors’ 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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Are business loans tax-deductible for sole traders?

Yes, like with limited companies, the interest on business loans offered to sole traders, plus any associated fees involved in the finance facility, is tax-deductible. So, interest incurred during the borrowing period and charges, like set-up fees, can be submitted for tax deductions when filing self-assessment returns.

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Get a flexible business loan and enjoy tax relief on interest payments

Iwoca is a leading flexible business loan provider supporting SME funding needs and helping companies invest in their future and manage their working capital and cash flow effectively. You’ll only pay interest on the funds you draw down (with interest being tax-deductible), and we don’t charge for early repayment. 

You can borrow between £1,000 and £1 million for a few days or weeks up to 60 months and enjoy tailored, manageable repayments. We make accessing business finance quick and easy, with hassle-free online applications and funding decisions within 24 hours.

Find out how to apply for an iwoca Flexi-Loan and use our loan calculator to see your likely repayments. 

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