Tax time is right around the corner and you’re looking to make deductions on your business tax. Could you use your business loan as a way to reduce your taxable income?
Small business loans could be the key to success for your business.
That’s exactly what the owner of a women’s fashion store discovered after using an unsecured loan.
After achieving a decent level of success in its niche, the store found itself running into some problems.
While there was plenty of demand for the store’s products, they couldn’t quite fulfil it. Specifically, cash flow issues meant that they struggled to stock products in all possible sizes.
An unsecured business loan* resolved that cash flow issue and helped the store boost its stock levels. Now able to serve a higher number of customers, the store placed itself in a position for growth. The expenses incurred in using the loan for business finances and operational costs can have tax implications.*
While it’s clear that a business loan can help your company, it can also create some issues. You need to make repayments on the loan each month, which increases your costs. However, only certain costs, such as the interest component of the repayment, are considered a business expense and may be eligible for a tax deduction, while the principal is treated as a capital expense.
Naturally, you may start to think about ways to mitigate this cost. And you may strike on the idea of deducting your business loan from your tax bill. In reality, only the interest component and certain related expenses are eligible for a tax deduction, not the principal repayment.
That thought brings us to the key question for this article – can you deduct business loans on taxes?
The Answer’s More Complicated Than You Think
Unfortunately, we can’t answer this question with a simple yes or no. Instead, we have to say yes and no.
Certain portions of your loan payments are tax-deductible. Specifically, you’re able to deduct the interest expenses you pay on the loan from your tax return, along with certain related expenses that qualify for tax deductions. The principal portion is not considered a business expense for tax purposes and is not deductible.
For example, let’s say you make monthly repayments of $500 on your business loan. From that $500, $150 is an interest payment that goes directly to your lender.
It’s this payment that you’re able to deduct. In this example, it means you could deduct $1800 for your tax bill at the end of the financial year. Understanding the total interest paid over the life of the loan is important for accurate tax treatment and planning.
Of course, the flipside to this is you cannot deduct the portion of the repayment that goes towards the loan’s principal. Attempting to do so will lead to a refusal of the deduction from the ATO. If you’d tried to get a larger deduction than you’re eligible for, this refusal could have serious cash flow implications.
Thus, it’s crucial that you fully understand the breakdown of your loan repayments before you make deductions. Proper documentation and strategic planning can help optimize your tax position.
Find out how much of your repayment goes towards interest and towards the principal of the loan. And remember, this number may vary by the month.
For example, you may find that the interest payment changes regularly if you have a variable rate loan.
The end of a fixed-rate term could also lead to changes, as could your continued repayment of the principal. As the principal falls, the amount of interest you have to pay goes down along with it.
Maintain accurate records for all of your loan repayments, including keeping bank statements and loan agreements as evidence of how loan funds were used and to support your tax position. And if you’re unsure about what you can deduct, speak to a tax professional for further guidance. It is also recommended to seek professional advice from a tax advisor to ensure you are maximizing your tax strategies and understanding the tax implications and tax deductibility of your business loan.
How Your Business Structure Affects Loan Deductions
Your business structure plays a crucial role in how you can claim deductions for business loans and the associated interest payments. For sole traders, the process is relatively straightforward: you can claim deductions for interest on business loans directly in your personal tax return, helping to reduce your overall taxable income. However, it’s essential to keep your business and personal expenses clearly separated. Mixing the two can complicate your tax return and may lead to issues with the ATO if you claim deductions for costs that aren’t strictly used for business purposes.
If you operate as part of a partnership, the rules are slightly different. Interest on loans taken out by the partnership for business purposes is generally deductible at the partnership level. This means the partnership can claim deductions for interest payments, providing tax benefits that flow through to the individual partners according to their share of the partnership.
For companies, interest on business loans used for business purposes is typically tax deductible against the company’s income. This can help reduce the company’s tax obligations and improve cash flow. However, companies must ensure that the borrowed funds are used for business activities and not diverted to personal expenses, as only the business portion is generally deductible for tax purposes.
No matter your business structure, maintaining proper documentation and ensuring that loans are used for business purposes is key to maximising your tax benefits and staying compliant with Australian tax laws.
Can I Make Deductions if I Use the Loan to Pay My Taxes?
This is where we see an added complication thrown into the mix.
Generally speaking, you can deduct the interest paid on any form of business finance from your taxes. Such forms of finance include business loans, lines of credit, and your business credit card.
This is simple enough when you’re borrowing to buy stock or pay for equipment.
But what if you’re using the loan to pay a tax bill? Are you able to claim deductions on the interest in that scenario?
The ATO’s specific instructions regarding this are as follows:
“Where a taxpayer carries on a business for the purpose of gaining or producing assessable income and, in connection with the carrying on of that business, borrows money to pay income tax (whether to preserve the assets of the business, maximise the return on them, retain sufficient money to fund the business or otherwise) then it is considered that the interest incurred on those borrowings is a normal incident of conducting that business.”
In other words, you can claim the interest on a loan that’s used to pay a tax bill. However, you can only do this for a business tax bill. If you get a loan to repay a personal tax bill, you will not be able to claim the interest on it.
The reason is that using the loan to pay a personal bill has no direct relation to the business. Specifically, it does not allow you to generate assessable income for the business. However, using the loan to pay a business tax bill does. Only interest and certain fees, such as application fees and origination fees, may be deductible when the loan is used for business purposes, not for personal purposes.
If you pay the business’ tax bill with the loan, you’re likely preserving assets that you use in the operation of the business. By retaining those assets, instead of having to sell them to make the tax payment, you affect the business’ income.
Thus, you can deduct the interest from the loan that you used to make the tax payment. Interest deductions are available when the loan is used to pay business tax debt, in accordance with the Income Tax Assessment Act. Eligible businesses may also benefit from tax advantages and tax concessions when using loans to manage business tax debt.
Private Purposes: When Business Loans Aren’t Deductible
It’s important to remember that not all interest payments on business loans are tax deductible—especially if the loan is used for both business and private purposes. According to the Australian Taxation Office, you can only claim deductions for the portion of interest that relates to business activities. For example, if a business owner takes out a $100,000 loan and uses $80,000 to purchase equipment for the business and $20,000 for personal expenses, only 80% of the interest payments on that loan would be tax deductible.
To claim deductions correctly, you must keep detailed records showing exactly how the loan funds were allocated between business and private purposes. This means tracking every dollar and maintaining documentation to support your claims in your tax returns. Failing to properly apportion your interest payments can lead to missed deductions, incorrect tax returns, or even penalties from the ATO.
By carefully calculating and documenting the business and private portions of your loan, you can maximise your tax benefits and ensure you’re meeting your tax obligations. Always consult a tax professional if you’re unsure about how to apportion your expenses or if you want to avoid costly mistakes at tax time.
Getting the Deduction Right
As you can see, this is a more complicated issue than it first appears, especially if you’re borrowing to pay a tax bill.
To ensure you can claim your deductions smoothly, we recommend working with a tax professional. There are also a few things that you can do to get this right:
- Maintain up-to-date and accurate records relating to all of your business loans.
- Keep track of changes in your interest payments.
- Keep loan agreements and documentation of related expenses to support claiming deductions for business expenses.
- Stay up-to-date on any regulatory changes that the ATO may introduce.
Business owners, especially small business owners, should be aware of eligibility criteria such as aggregated turnover and net small business income when claiming deductions. Interest charges on business loans, as well as certain related expenses, can be claimed as deductions by eligible businesses.
Get Your Business Loan Today
So, you can deduct portions of your business loan for your business’ tax bill.
This fact may help you overcome any worries you have about getting a business loan. After all, it means that the repayment burden isn’t as heavy as you may expect.
Now, you just need to work with a loan provider that will give you the best loan for your needs.
That’s where Unsecured Finance Australia comes in. We offer both small business loans and unsecured business loans that don’t require you to use an asset as security.
See our FAQ. Apply online today. The process only takes minutes and you will receive a response within 24 hours.
