BIM45680 - Specific deductions: interest: change in use of funds or asset

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 business working capital.

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

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 business 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 business 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 BIM72075 (final paragraph).