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Business Income Manual

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Specific deductions - interest: Separate loan for specific asset or purpose

This chapter applies for Income Tax purposes to the computation of trade profits and property income. References in the text to a ‘business’ should therefore be taken to include both trades and property businesses. The chapter does not apply for Corporation Tax purposes, where there are separate rules in the loan relationships legislation (see CFM11000).

S34 Income Tax (Trading and Other Income) Act 2005

This section gives examples of how the `wholly and exclusively’ rule applies where a separate loan is used for a specific purpose.

Separate loan for specific business asset

Where a separate loan is obtained to buy a specific business asset the interest on that loan is an allowable deduction in computing the business profits. The interest will continue to be an allowable business deduction unless one of the following applies:

  • the asset starts to be used for private purposes, (but see BIM45670 for part use),
  • the asset is disposed of and the proceeds are not used for business purposes.

Separate loan for specific business purpose

Where a separate loan is taken out specifically to meet business expenditure of a revenue nature and continues to be used for this purpose, the interest is deductible throughout the life of the loan. See BIM45690 on funding the business for further guidance on whether the loan continues to be used for the initial purpose; the issue was also discussed in Silk v Fletcher [2000] SpC 201, see BIM45725.

Separate loan to buy a private asset

Where a separate loan is obtained to buy a specific asset that is not used for business purposes, the interest on that loan is not an allowable deduction in computing business profits.

If the asset later starts being used for business purposes then the interest becomes an allowable deduction. Where the asset starts being used wholly for business purposes, all the interest is allowable from the commencement of business use. Where the asset starts being used partly for business purposes, a reasonable apportionment should be made based on the extent of business use of the asset, see BIM45670.

Separate loan to meet private expenditure

Where a separate loan is taken out specifically to meet private expenditure where no asset is created or acquired, the interest is not an allowable deduction whenever paid. This rule has to be applied carefully and distinguished from the situation where there is a mixed account that the proprietor uses for both business and private purposes, see BIM45695.

Example 1, no balance sheet

Mr B prepares his income statement himself and does not have a balance sheet. He has a building society loan that he used to buy his car. He uses the car both for his trade and for private purposes and he works out that half his mileage is for business. He deducts half the interest payments when working out his profit for his tax return.

The underlying facts are that the loan was used to buy a car that is used partly for trading (BIM45670). The deduction for interest is correct.

Before he pays off the loan he trades his car in part exchange for a newer one, which he then uses for his trade in a similar way to his previous use. The loan is still funding an asset that is used for part of the time in the business even though he does not own the original car for which he obtained the loan. The proportion of the interest relating to the trade use of the car is still an allowable deduction.

Example 2

Mr P borrows £7,500 from the bank to buy a delivery van for his trade. It is a ten-year loan. The van is heavily used and has to be scrapped after seven years. The interest on the loan continues to be a deductible trading expense even though the asset is no longer owned by the trade. It has not been used for private purposes and no disposal proceeds were received.

Example 3

Mr C obtains a loan, secured on trading assets, of £4,000 and uses this amount to pay for a family holiday. Interest on that loan is not an allowable trading deduction as the money was not spent wholly and exclusively for the purpose of the trade. The nature of the security for a loan (in this case trade assets) does not by itself determine the nature of the loan, see BIM45685.