Are Business Loans Tax Deductible

At Towerstone, we provide accountancy services in Bedford to local sole traders, landlords, and limited companies. We have written an article about Are Business Loans Tax Deductible to help you see how loan interest is treated, and what restrictions may apply.

This is a question I am asked regularly by business owners who are funding growth managing cash flow or simply trying to keep things stable during a difficult period. Taking out a business loan often feels like a major financial step so it is natural to ask whether the cost of that borrowing can reduce your tax bill.

From experience I can say the answer is partly yes and partly no. Business loans themselves are not tax deductible but some of the costs associated with them usually are. Understanding the difference is essential because this is an area where I see frequent confusion and avoidable errors.

In this article I want to explain clearly how business loans are treated for UK tax purposes. I will cover sole traders limited companies and partnerships and explain which elements are allowable what HMRC disallows and how this works in practice. Everything here reflects how the rules are applied in real life rather than theory.

The key distinction HMRC makes with business loans

The most important thing to understand is that HMRC separates the loan itself from the cost of borrowing.

The loan principal meaning the amount you borrow is not a business expense. It is simply money that must be repaid.

However the interest and certain related charges are often allowable as business expenses provided the loan is taken out wholly and exclusively for business purposes.

From experience most problems arise when these two elements are mixed up.

Why the loan amount itself is not tax deductible

When you take out a business loan you are not incurring a cost in the eyes of HMRC. You are receiving funds that you must repay.

Allowing the loan amount as a deduction would distort profits because the money has not been spent it has been borrowed.

Similarly when you repay the loan capital those repayments are not tax deductible either. They are simply repayment of money already received.

This applies regardless of whether you are self employed running a partnership or operating through a limited company.

Interest on business loans and tax relief

Interest is treated very differently.

If a loan is taken out for business purposes the interest charged is usually an allowable business expense.

This means the interest can reduce taxable profits which in turn reduces your tax bill.

From experience this is where most of the tax benefit of business borrowing sits.

The key condition is that the loan must be for business use. If a loan is partly for personal use the interest usually needs to be apportioned.

Arrangement fees and loan charges

In addition to interest many loans come with fees.

These can include arrangement fees facility fees renewal fees and sometimes early repayment charges.

HMRC generally allows these costs as business expenses provided they relate directly to obtaining or maintaining business finance.

These costs are usually deducted over the period of the loan rather than all at once especially for larger fees.

From experience this spreading is often overlooked and can lead to incorrect treatment in accounts.

How this works for sole traders

If you are self employed business loan interest is usually tax deductible provided the borrowing is for the business.

If the loan is taken out in your personal name but used for the business that does not automatically disqualify it. What matters is how the money is used.

However if the loan is partly personal and partly business the interest must be split on a reasonable basis.

I often see sole traders claim full interest on loans that funded both business and personal spending. HMRC will usually challenge this.

Keeping clear records of how funds are used is essential.

Limited companies and business loans

For limited companies the treatment is similar but the structure is often clearer.

If the company takes out a loan and uses it for business purposes the interest is usually deductible for corporation tax.

This includes loans from banks asset finance providers and sometimes directors.

The company deducts the interest as an expense and the loan itself appears as a liability on the balance sheet.

From experience limited companies tend to have fewer issues here provided loans are properly documented.

Director loans and interest

If a director lends money to their company the company can usually deduct the interest it pays to the director as a business expense.

However there are additional tax considerations.

The interest received by the director is taxable income.

In some cases the company may need to deduct income tax at source depending on how the interest is structured.

This is an area where advice is particularly important because errors can lead to compliance issues.

What about overdrafts and credit cards?

Business overdrafts are treated in much the same way as loans.

Interest charged on a business overdraft is usually deductible.

Fees associated with maintaining the overdraft are also generally allowable.

Business credit cards follow similar rules. Interest and fees are allowable where the spending is business related.

From experience problems arise when personal and business spending are mixed on the same account. Apportionment then becomes necessary.

Loans used to buy capital assets

Many business loans are used to buy equipment vehicles or machinery.

In these cases two separate tax treatments apply.

The interest on the loan is usually deductible as a revenue expense.

The cost of the asset itself is not deductible as an expense but may qualify for capital allowances.

I often see people confuse these two and either miss allowances or claim deductions incorrectly.

Understanding that borrowing and spending are treated separately is key.

Loans used for personal purposes

If a loan is taken out for personal use the interest is not deductible even if you are a business owner.

This includes loans used to buy a personal car pay household bills or fund private investments.

Even if the loan is repaid from business income that does not make it a business expense.

HMRC focuses on purpose not cash flow.

What about mixed use loans?

Mixed use loans are very common especially among sole traders.

In these cases interest must be split between allowable and non allowable portions.

The split should be based on how the borrowed funds were used.

From experience HMRC expects a reasonable and consistent method rather than estimates made after the fact.

Good record keeping makes this far easier.

Are repayments tax deductible?

This is another common misunderstanding.

Repayments of loan capital are not tax deductible.

Only the interest element is allowable.

This often surprises people because repayments affect cash flow but not taxable profit.

Understanding this difference helps avoid confusion when tax bills feel high despite heavy repayments.

Merchant cash advances and similar finance

Merchant cash advances and revenue based finance products are increasingly common.

These are not traditional loans and the tax treatment can be more complex.

In many cases the finance charge element is deductible but the structure matters.

From experience these products should be reviewed carefully because the accounting and tax treatment is not always obvious.

VAT and business loans

Interest on loans is usually exempt from VAT.

This means there is no VAT to reclaim and no VAT charged.

Some arrangement fees may include VAT depending on the provider but this is less common.

VAT is usually not the main issue with business loans but it is worth checking invoices.

Common mistakes I see in practice

There are several recurring errors I see when reviewing accounts.

Claiming the full loan amount as an expense.
Claiming capital repayments as deductions.
Failing to apportion interest on mixed use loans.
Missing interest deductions altogether.
Incorrect treatment of director loan interest.

These mistakes are usually made through misunderstanding rather than intent.

How HMRC reviews business loan claims

HMRC often reviews interest and finance costs during enquiries.

They may ask for loan agreements bank statements and evidence of how funds were used.

If HMRC disallows interest they will add it back to profits and recalculate tax.

From experience HMRC is generally reasonable where records are clear and errors are corrected early.

Practical advice from experience

If you take out a business loan keep the paperwork.

Document the purpose of the loan.

Keep business and personal borrowing separate where possible.

Review interest and fees regularly in your accounts.

Do not assume cash flow impact equals tax relief.

If you are unsure ask before claiming rather than after.

Real world examples

A limited company takes out a loan to buy equipment. The interest is deductible and the equipment qualifies for capital allowances.

A sole trader takes out a personal loan partly for business and partly for personal use. Only part of the interest is deductible.

A company repays £10,000 of loan capital. This has no tax effect.

A director lends money to their company and receives interest. The company gets a deduction and the director pays tax on the interest.

These examples reflect how the rules work in practice.

Why understanding this matters for planning

Borrowing decisions are often made for commercial reasons but tax treatment affects the overall cost.

Understanding what is and is not deductible helps you compare funding options properly.

From experience businesses that understand the tax impact of borrowing make better long term decisions.

The key takeaway

Business loans themselves are not tax deductible. That part is clear.

What matters is the interest and associated costs which are often allowable if the borrowing is genuinely for business use.

Most problems arise when people confuse borrowing with spending or cash flow with profit.

Once you separate those concepts the rules become much easier to work with.

If you are taking on finance or already have loans in place it is always worth checking that interest and fees are being treated correctly. Small adjustments can make a meaningful difference to your tax position over time.

For further guidance across related topics, visit our Bedford Accounting Hub, which brings together practical advice for Bedford clients.