Operating a business at any scale involves numerous expenses, many of which are tax-deductible. To reduce your company’s annual tax burden, identifying all possible tax deductions is important. But what about business loans? Are these financing products also tax-deductible?
Whether you have an existing business loan or are considering one, understanding the tax ramifications goes a long way.
Key Points
- Businesses can recoup many operational costs through tax deductions, including the interest portion of a business loan.
- The principal portion of a business loan is not tax-deductible.
- Other expenses businesses may deduct to reduce their tax burden include a home office, business vehicle, advertising, and utilities.
- It’s important to consult with a tax professional to maximize of all eligible tax deductions and remain compliant.
Are Business Loans Tax Deductible?
Business loans have taxable and tax-deductible parts. When you make payments toward the loan principal, the earnings used remain taxable.
The principal loan amount does not constitute a part of business operations. It’s an amount the business received and subsequently repaid.
Conversely, the amount paid in interest is considered a business expense and is therefore tax-deductible. This is because the loan proceeds are used by the business, making interest payments a cost of doing business. By properly tracking the interest you pay, it’s easier to prepare your business taxes.
Can You Deduct Your Business Loan Interest Costs?
When deducting business loan interest, the specific amount you can claim depends on four key factors:
- Intent to Earn: To claim this expense, the company must demonstrate that it’s using the loan proceeds with the intention of generating revenue. The earnings are not required to exceed the interest.
- Interest Repayment Schedule: To deduct the interest costs, the business must have paid them during the taxable year for which you’re making the claim.
- Legal Expectation: Qualifying for this deduction requires a legal mandate to repay the interest. This prevents businesses from claiming non-existent interest. To verify that the interest meets the necessary criteria, consider whether the lender can take legal action if you do not pay it. If the company is legally required to pay, then it is a business expense.
- Reasonable Value: The amount of interest you repay must be reasonable pursuant to standard market value. This is set forth by the Canada Revenue Agency (CRA) and works to prevent companies from making false claims and serves as a benchmark for reasonable interest. Basically, you can set an interest rate that’s well below current market rates.
| Note: In Quebec, provincial tax regulations set the deduction limit as the investment income limit. While you can backdate unused expenses for three years and keep them indefinitely, the annual claim is fixed against investment metrics. Throughout the rest of Canada, you can claim the interest without substantiating earnings. |
Are Business Loans Considered As Taxable Income?
The majority of business loans are not classed as taxable income, given the need to repay them to the lender. As a result, businesses are not legally required to claim the loan income when filing taxes.
Since the loan is classified as a liability, it never falls into the income category. A noteworthy exception is in situations of debt forgiveness.
Companies filing for insolvency have different tax requirements for the loan amount. Since the amount lent was spent by the company, not repaid, and then forgiven, it is considered taxable income.
What Expenses Can You Deduct As A Business?
The following are examples of tax-deductible business expenses:
Business Start-Up Expenses
Your company can deduct costs incurred prior to commencing business operations. The caveat is that your company can only claim expenses incurred if the business operated during that period.
Business Tax, Licensing Costs, Regular Dues, & Fees
Most fees you pay related to running your business may be tax-deductible, such as incorporation fees, registration, and licensing. There are always exceptions, so it’s essential to speak with a professional if you have any questions or concerns.
Office Expenses & Supplies
Any office supplies and expenses may be deducted, as long as it’s a valid business expense. This is true even if the item is used indirectly. For instance, a software company can deduct the cost of pens, since the supply contributes to business earnings.
Home Office Expenses
If you conduct business from your home, you may be able to deduct a portion of your home expenses. Calculated based on the square footage of the office space relative to the home, this deduction enables you to take a percentage of home expenses and claim them for your business. The claim must accurately represent the space used by the business in the home.
Some additional home expenses you could claim include:
- Property taxes
- Rent
- Mortgage interest
- Maintenance costs
- Utilities
- Insurance
Management & Administration Fees
The fees associated with banking or merchant services count as business expenses. Provided you spent the fee for business purposes, you can claim it. An example is being able to claim banking fees on your business account, yet not your personal savings account.
Interest & Bank Charges
If your company paid interest on borrowed funds, your business can claim it, up to a limit. The money must go toward property acquisition or other business operations, and there must be a good faith intent to earn.
Business Advertising
Advertising fees are tax-deductible, whether digital, via radio, television, or print media. The advertisement must be for the business and be made in a good faith attempt to promote the company, with a view to generating revenue.
Rent & Property Taxes
If you paid rent on any property used for business operations, you can deduct that amount. This applies whether the rent is paid for land or real property.
Insurance
Businesses can deduct company-related insurance fees. This applies to insurance on the office space, equipment, and machinery. However, this doesn’t include motor vehicle costs, as this falls into a different category.
Car insurance falls under motor vehicle expenses and must be claimed as such.
Learn more: Business Insurance In Canada
Telephone, Internet, & Utilities
Provided you incurred the expense to generate revenue, then your business can claim the utility. Possible claims include heating, water, or cable. If only a part of the bill is a work expense, the claim must accurately represent that percentage. For example, if you use your cell phone 50% of the time for work purposes, you can claim 50% of your bill as a business expense.
How To Minimize Business Tax Debt
If your business is facing a high tax burden or is dealing with substantial tax debt, there are available solutions. By taking specific steps, you can minimize the tax costs associated with operating your business.
| Keep Accurate Records | Maintain detailed financial records and receipts to ensure accurate tax reporting and avoid penalties. |
| Claim All Eligible Deductions & Credits | Take advantage of all credits and deductions to reduce taxable income. |
| Plan and Forecast Taxes Regularly | Regularly estimate your tax liability to set aside enough money to avoid surprises at year-end. |
| Make Estimated Tax Payments | Pay quarterly estimated taxes to spread out your tax burden. |
| File on Time | Submit your tax returns and payments on time to prevent late filing penalties and interest. |
| Limit Cash Transactions | Keep clear records of all transactions to prevent errors and potential audits. |
| Consult A Tax Professional | Work with a tax advisor to identify tax-saving strategies. |
What Can You Do If You Can’t Manage Your Tax Burden?
If you remain under a heavy tax burden, you can:
- Contact the CRA: The CRA can provide guidance on available options, such as payment plans or relief programs. This can help you avoid penalties, interest, and collection actions while working toward resolving your tax debt.
- Look Into Personal Loans: Whether by pursuing a better interest rate or simply ensuring that you can repay the amount regularly, personal loans can cover tax debt. You can use this type of tax loan to avoid possible penalties for non-payment.
- Approach Debt Consolidation Services: If you continue to struggle and do not have a plan to get out of debt, consult with a debt consolidation professional. In a type of loan, the creditor purchases your existing debt, selling it back to you at a lower interest rate and with a single fixed payment schedule.
CRA Audit Red Flags To Avoid
Specific activities may alert the CRA, which can lead to an audit and penalties if issues are discovered. Be sure to avoid making the following mistakes to avoid raising red flags:
| Excessive Expense Claims | Deductions that seem unusually high compared to your income. |
| Mixing Personal & Business Expenses | Claiming personal costs as business write-offs without explanation. |
| Luxury Travel & Entertainment | Writing off high-end trips or expensive meals without a clear business purpose. |
| Excessive Home Office Deductions | Claiming a home office without meeting CRA’s criteria for use. |
| Consecutive Business Losses | Reporting losses year after year may prompt CRA to wonder whether it’s a legitimate business. |
| Inconsistent Expense Patterns | Sudden spikes in deductions without explanation or documentation. |
Final Thoughts
When it comes to calculating tax deductions for your business, planning is key. Determining the best business loan involves more than just integration and amortization; it is also a matter of optimizing taxes. Understanding how a potential business loan would impact your tax burden gives you a better picture of your financial landscape.
