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HMRC internal manual

Business Income Manual

Specific deductions - interest: Change in use of funds or asset

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

Whether or not interest is allowable as a deduction depends upon the use made of the borrowed funds during the relevant accounting period. This may remain the same throughout the life of the loan or it may change.

Example 1

Mr C decides to invest in some packaging machinery at a cost of £3,000, and obtains a loan of £3,000. The machine keeps breaking down and is eventually returned to the manufacturer and a full refund obtained. The refund is simply paid into the business bank account to decrease the business overdraft. The loan is no longer funding the purchase of plant and machinery but it is providing trading working capital.

The use of the loan has changed but it is still being used for the purposes of the trade. The interest payable continues to be allowable as a deduction in computing trade profits.

Example 2

Dr W borrows £25,000 to buy a car that he uses privately. He joins a GP practice and starts to use the car for home visits, estimating that about half his mileage is business and half is private. Both the car and the loan are included in the partnership accounts, with the full amount of interest payable appearing in the profit and loss account. One half of the interest is allowable as a deduction so the other half should be added back in computing the amount of the partnership’s profit.

In this example the car and loan are introduced into the partnership accounts. In some cases the car and loan do not appear in the partnership accounts but the tax adjustments include a deduction for half the interest. This is also allowable following the guidance at BIM82075 (final paragraph).