Interest Deductibility: what you need to know about your business loans

When a self-employed person finances the purchase of professional equipment, the choice of loan can have significant tax consequences. What if the business purchase is financed by a mortgage on a personal residence? For the unincorporated self-employed, understanding these rules can help avoid costly mistakes.

Personal or Business Loans: What Tax Rules Apply?

For interest to be deductible for tax purposes, certain conditions must be met. It must be genuine interest, paid or payable during the year under a legal obligation, and the amount must be reasonable. These criteria ensure that the expense is justified in a business context.

Certain payments, although not interest in the strict sense, may still be considered as such for tax purposes. This is the case for interest rate reductions, early repayment penalties, discounts, taxable benefits linked to reduced or zero rate loans, and amounts that can reasonably be assimilated to interest.

Use of Borrowed Funds

For interest to be deductible, it must arise from a genuine lender-borrower relationship. In other words, interest is only deductible if the money has actually been borrowed. It is not enough to have an informal agreement or an intention to borrow.

The use to which the borrowed funds are put is also decisive. For interest to be deductible, the funds must be used to generate business or property income. The Supreme Court has stated that there must be a reasonable expectation of income at the time of investment. Note that interest on funds used solely to generate a capital gain is not deductible.

You must also demonstrate a direct link between the borrowed funds and their eligible use. This means that the funds must be used directly to generate income, and not for personal or non-eligible purposes.

Finally, it is the current use of the funds that is taken into account when determining whether interest is deductible, and not just their initial use. This means that interest is only deductible if the funds are used to generate income during the period in question.

Need help validating the deductibility of your interest?

In short, for interest to be deductible, the money borrowed must actually be used to make money. And you have to be able to prove it. It's not the nature of the loan (mortgage or non-mortgage) that counts, but the actual use of the money borrowed. If the funds are used directly for your professional activity, the interest could be deductible.

Need some guidance? Contact our team of corporate tax specialists today for a personalised analysis.