Interest on business loans

Conditions

1. Sole traders: GOV.UK lists interest on bank and business loans, hire purchase interest and alternative finance payments, for example Islamic finance, among the financial costs you can claim. It also says you cannot claim for repayments of loans, overdrafts or finance arrangements.
2. For calculating trading profits, interest is an item of a revenue nature, whatever the nature of the loan (section 29 ITTOIA 2005). The test it has to pass is that no deduction is allowed for expenses not incurred wholly and exclusively for the purposes of the trade (section 34 ITTOIA 2005).
3. What the borrowing is spent on decides it. HMRC's guidance is that interest is an allowable deduction where the borrowing is used for business expenditure or acquisition of assets used in the business. In HMRC's example, a business overdraft is used mostly for stock and partly towards a private car, and the interest on the part used for the car is not allowable (BIM45700). Where an expense is incurred for more than one purpose, an identifiable part or proportion incurred wholly and exclusively for the trade can still be deducted (section 34(2) ITTOIA 2005).
4. Taking money out of the business can affect borrowing that looks like a business loan. HMRC says simply exchanging existing capital for loan finance does not on its own satisfy the wholly and exclusively test (BIM45700). Where private drawings have made the capital account overdrawn and the overdrawn capital account has been funded by bank borrowings, HMRC looks at what the loan funds were spent on, and sometimes uses a reasonable basis as an approximation (BIM45705). This is detailed and fact-specific, so it is worth working through with an accountant.
5. Cash basis: from 6 April 2024 all eligible businesses must use the cash basis unless they elect to calculate profits under generally accepted accounting principles (BIM70000). On the cash basis expenses count in the period in which they are paid (BIM72005), and GOV.UK's examples of allowable expenses include interest and bank charges, for example interest on bank overdrafts.
6. The cash basis rules that restricted loan interest (section 51A ITTOIA 2005 and section 57B ITTOIA 2005) were omitted by the Finance Act 2024 for the 2024 to 2025 tax year and later years. For earlier tax years, HMRC's guidance describes a deduction of up to £500 for interest and incidental costs of obtaining finance in total for any trade period (BIM70040).
7. Traditional accounting: if you elect out of the cash basis, GOV.UK says you record income and expenses by the date you invoiced or were billed.
8. Partners can also have separate reliefs for some loans, such as a loan to buy plant or machinery for partnership use or a loan to invest in a partnership (Income Tax Act 2007, Part 8 Chapter 1). They work differently from the trading deduction and are outside this page, so ask an accountant.
9. Limited companies: a limited company cannot use the cash basis. HMRC's Income Tax guidance on interest does not apply for Corporation Tax, where there are separate rules in the loan relationships legislation (BIM45650). Where a company is a party to a loan relationship for the purposes of a trade it carries on, the debits are treated as expenses of the trade (section 297 CTA 2009). How those rules apply to a particular company's borrowing, including borrowing that is not for its trade, is a question for an accountant.
10. Employees: an employee can deduct an expense only where they are obliged to incur and pay it as holder of the employment and it is incurred wholly, exclusively and necessarily in the performance of the duties of the employment (section 336 ITEPA 2003).
11. Employees: separately, Part 8 Chapter 1 of the Income Tax Act 2007 has a narrow relief for interest on a loan used to buy plant or machinery for use in an employment. The relief has its own conditions, which this page does not set out, so ask an accountant whether it applies to you.

Common mistakes

• Claiming loan repayments as well as interest. GOV.UK says you cannot claim for repayments of loans, overdrafts or finance arrangements.
• Applying the old £500 cash basis limit to 2024 to 2025 or a later year. The sections that imposed it were omitted from that year.
• Treating a loan as a business loan because it is secured on business property or shown in the business accounts. In HMRC's example a loan secured on the factory and shown as a trading liability still needed looking into, because part of the money had been used for a non-business purpose (BIM45700).
• Missing the interest inside hire purchase payments. GOV.UK lists hire purchase interest as a cost you can claim, so ask the lender how each payment splits between interest and capital.

What to keep

• Loan agreement showing the principal, the purpose of the loan, and the interest rate.
• Annual statements or payment schedules from the lender showing the interest charged or paid.
• Evidence that the loan proceeds were applied to a business purpose — for example, an invoice for the asset purchased or a bank transfer showing the funds going into the business.

Real-world example

A sole trader on the cash basis takes out a £20,000 business loan and spends all of it on new workshop machinery. In the tax year she pays £1,100 of interest, which is an allowable expense because the money was used for the business. Her repayments of the £20,000 itself are not: GOV.UK says you cannot claim for repayments of loans. On the cash basis the machinery is claimed as a normal allowable business expense rather than as a capital allowance, so the purchase is relieved through the machinery, not through the loan.

Frequently asked