Are business loans tax-deductible?

What is a business loan?

A business loan allows companies to access additional funds to cover various needs, from daily operations to significant investments. Business owners can apply for these loans from banks or other lenders and receive an agreed amount of money, which they repay with interest over time. 

Like business structures, business loans come in different forms, such as secured ones, which require collateral and unsecured loans, where no collateral is needed, allowing companies to choose the best fit for their needs.

There are many other types, including term debt, which is a loan with a predetermined repayment schedule or revolving debt that doesn’t involve set monthly payments.

Are business loans tax-deductible in the UK?

If you’re getting a business loan, it’s worth determining whether it is tax-deductible.

While the original amount you borrow (loan principal) is not tax-deductible, some associated expenses, such as interest payments and specific fees, may qualify as tax-deductible expenses. 

So, while the business loan itself isn’t tax-deductible, some related aspects can be.

To clarify, when referring to business loan tax-deductible components, this focuses on costs allowed as deductions when calculating taxable profit, reducing the company’s overall tax liability.

Principal repayments on the loan are typically non-deductible as they represent a repayment of debt rather than an expense. However, the interest you pay, along with some fees linked to obtaining the loan, might be deductible as business expenses.

If you’re self-employed, you can claim interest payments as a business expense if you have a business account. 

Distinguishing between deductible and non-deductible items can make a big difference in your tax planning.

What is the tax deductibility of interest on business loans?

Interest is typically the most significant tax-deductible expense for business loans. As long as the loan is strictly used for business purposes, HMRC considers interest a legitimate business expense, so you can claim it as a deduction, helping to lower your taxable income and reduce your tax bill.

For the loan’s interest to qualify, it must be used ‘wholly and exclusively’ for your business. So, if you take out a loan to purchase business assets, the interest you pay can be deducted.

To support this, you’ll need documentation showing the loan was used only for business activities. If a loan covers business and personal expenses, you can still deduct the business portion of the interest, but only that part.

Claiming deductible interest can provide significant tax relief by reducing a company’s taxable profits. This makes loans an attractive option for businesses that need funding while keeping their tax liability in check.

What are some other tax-deductible business loan costs?

Besides interest, there are a few other related business loan tax-deductible costs.

Some fees, such as arrangement fees, may qualify as deductions if they are associated with securing the loan and not paid upfront (as you won’t be able to deduct this from your tax bill). 

Other types of payments may be tax-deductible such as overdraft and credit card interest and interest on business finance deals, but it’s worth double checking. 

These fees usually count as financial expenses, meaning they can be deducted over the loan’s term rather than all at once.

Legal fees are usually deductible, too, if they’re directly linked to the loan and used exclusively for business purposes. These expenses are generally included as part of a firm’s operating costs.

Director’s loans: are these tax-deductible?

If a director loans money to a business or borrows money from it, this is known as a director’s loan.

A director’s loan is not tax-deductible, but if the money is lent to a firm and interest is charged, this is seen as personal income and a business expense, so it must be reported to HMRC.

It’s worth both parties talking to a financial adviser or accountant to fully understand how director’s loans work and any tax liabilities. 

What documentation is needed to claim tax deductions on a business loan?

To claim any deductions, companies need to keep accurate documentation. HMRC’s guidelines require that expenses be ‘wholly and exclusively’ for the business to qualify as deductible, so it’s essential to have proof of all loan-related costs.

You should keep any loan agreements, records of interest payments, and receipts for any fees associated with the loan.

It’s also worth considering working with an accountant. They can help ensure that any deductions are claimed correctly and that all documentation complies with HMRC’s standards.

This can be especially helpful when a loan is used for mixed purposes, ensuring only business-related expenses are deducted.

What are the pros and cons of taking out a business loan?

The advantages 

• It reduces tax liability: Deducting your interest payments (from your business loan) lowers your taxable income, which can help reduce your tax bill. For example, if a small business has a taxable profit of £50,000 and pays £5,000 in interest on a business loan, this deduction reduces the taxable profit to £45,000. At the small profits corporation tax rate of 19%, this leads to a tax saving of £950.
• Supports business growth: Loans may provide crucial funding to drive expansion or finance new projects. However, it’s worth having a long-term plan and ensuring you can repay your business loan on time.
• Helps you retain ownership: Unlike raising capital by selling equity, taking a loan allows businesses to access funds without giving up control or shares in the company.
• Improves cash flow: Loans can cover short-term needs such as payroll or operating expenses, helping the business maintain cash flow for smooth operations. If you’re using a loan to cover short-term needs, it’s advisable to have a long-term plan.
• Builds business credit: Timely repayment of a business loan can strengthen the company’s credit profile, potentially unlocking better financing options in the future.

The disadvantages

• Principal repayments aren’t tax-deductible: Only the interest and specific fees may qualify for deductions, so you still have regular repayments.
• You still need to pay interest: While interest on a business loan is tax-deductible, so you don’t pay corporation tax on it, it’s still an expense that needs paying.
• Risk of debt dependency: Over-reliance on loans may lead to a cycle of debt, where the business continually relies on borrowing to stay afloat, creating long-term financial risks.
• Defaulting risk: Missing loan repayments can damage a business’s credit score and limit its ability to secure funding in the future. There’s also the risk of a business taking on too much debt.
• Restrictive loan terms and covenants: Some loans include covenants that may limit the business’s financial flexibility, restricting actions such as taking on additional debt or making certain investments.

Get expert financial advice

Knowing if a business loan is tax-deductible can make a difference when calculating tax liabilities. 

By keeping detailed records of your loan-related expenses, you can maximise these deductions, ease your tax burden, and keep more funds available to reinvest in growing your business.

Let Unbiased match you to a professional financial adviser or accountant to make the most of your company’s tax-deductible expenses.