When you avail of a business loan for your small business, your major worry will be paying off your loan with interest after a specific tenure. There is good news for you – the interest on your business loan is eligible for a tax deduction as it is a business expense.
But wait! Before you meet your accountant to know about your business loan eligibility criteria you must have to know about the “interest tax deduction on it”, you must fulfill some prerequisite conditions. These are:
- You and the lender must not be family or friend but should have a right lender-debtor relationship
- You’re legally eligible for the debt
- Both you and lender intend for repayment of the debt
Eligibility for a Business Loan Interest Tax Deduction
The following qualifications make you eligible for tax-deduction on your business loan interest amount.
- It would be best if you borrowed from an official Business loan lender:
You must avail of your business loan from an official lender, such as a bank or other NBFC. Your loan will be valid only if you are legally liable for the debt, you have an intention to pay it off, and you have an explicit schedule for repayment.
If you want to consider the interest on a business loan from a family member or friend for a tax deduction, detailed documentation will be essential.
- You must spend your Business Loan:
You have to utilize your loan to become eligible for the deduction. Money lying in the bank is an investment and not an expense, and hence, is not eligible for a tax deduction.
Types of Business Loans
Different types of business loans are available with the lender. Let us examine some of the most common business loan types:
- Term Loan:
Term loans are a funding process where the borrower gets a lump sum amount for a fixed tenure. Interest deduction on a term loan is always in the corresponding year of the repayment.
- Business Lines of Credit:
A business line of credit permits you to draw from some amount, as and when required, from pre-approved funds. You have to pay interest only on the amount that you use.
- Short-Term Loan:
This is a loan which the borrower has to repay over a short period. It is generally for a year or two. This means that you will deduct interest either within the same year’s tax filing or will split between two annual filings.
- Loans for taking over Other Business:
If you are planning to avail of a business loan to buy another business to become a part of it and operate it, then the interest generated will be tax-free.
Some Special Cases where business loan interest is NOT tax-deductible
In most cases, the interest on business loans is eligible for the tax deduction, but there are several cases in which it is not. They are as follows:
- If You Refinance Your Original Business Loan:
If you plan to refinance your existing business loan with a new loan, the second lender will not consider refinancing as a business activity, and hence, the interest amount is not tax-deductible.
- Points or Loan Origination Fees:
If you avail of a loan to purchase business property, the loan originating or processing fees is not considered as a business expense and is not tax-deductible. You can, however, add this amount to the value of the property and can deduct it over time with asset depreciation. For more information, you can check https://www.youtube.com/watch?v=L0gnvdDWqzo
If you availing a business loan for expanding your business, the interest is tax-deductible. It is advisable to consult your accountant or CA for all the intricacies of income tax rules and the mechanism for a tax deduction.