Deducting interest on business loans: rules and limits

The basic rule and what it depends on

The CRA allows you to deduct interest on money borrowed for business purposes or to acquire property for business purposes. Its technical guidance adds that the amount must be paid, or payable for the year depending on your accounting method, under a legal obligation to pay interest, and that the deduction is limited to the lesser of the actual amount and a reasonable amount.

Reasonable is judged against prevailing market rates for debt with similar terms and credit risk. For an ordinary bank loan this is rarely a concern. It becomes relevant when the lender is a relative or related company charging an unusual rate, so keep the loan agreement and ask about it before you set the rate.

Follow the money: the use of funds test

The CRA’s folio says the test is the direct use of the borrowed money, and the purpose of that use must be to earn income. A loan that buys equipment or inventory, or funds working capital for the business, fits. A loan used to pay for a family trip does not.

The CRA is also clear that you cannot deduct interest on money borrowed for personal purposes or to pay overdue income taxes. If you borrow to cover a tax bill, the interest on that borrowing does not become a business cost, however closely the tax relates to your income.

When a line of credit mixes business and personal use

The folio explains that repayments from one account used for both purposes cannot be directed to the personal part. Here is a simplified illustration with round numbers. You draw $50,000 on a line of credit, using $30,000 for equipment and $20,000 for personal spending, so 60 per cent is for business. You then repay $10,000, leaving $40,000.

You cannot say the repayment came out of the personal part. Instead, the original 60 per cent is applied to the remaining balance, so interest on $24,000 of the $40,000 is generally deductible. Your own figures will differ, but the lesson holds: keeping business borrowing in a separate loan or line makes the claim far easier to support than untangling a mixed account later.

Special limits to know about

Two limits come up often for self-employed people. For a passenger vehicle or zero-emission passenger vehicle you use to earn income, you complete Chart B on Form T2125 to find the interest you can deduct, which is the lesser of the interest you paid and a daily maximum applied across your fiscal period. The CRA’s 2025 example uses $350 per 30 days; check the current figure when you file. The result is then reduced for personal use.

For vacant land, you can usually deduct interest only up to the income from the land that remains after other expenses, and unused interest cannot create or increase a loss or be deducted from other income. Interest tied to the workspace in your home is claimed with business-use-of-home expenses instead, which our home office article covers.

Loan fees are not always deducted like interest

Fees you pay to get a loan to buy or improve business property, such as application, appraisal, processing and insurance fees, guarantee fees, broker or finder’s fees and legal fees related to financing, are deducted over five years at 20 per cent a year, regardless of the loan term. The percentage is reduced proportionally for a fiscal period shorter than 12 months. If you repay the loan early, you can deduct the remaining fees then.

A fee to lower your interest rate, or a penalty or bonus for repaying early, is treated as prepaid interest and deducted over the remaining original term. Standby charges, service fees and similar fees that relate only to the year may be deductible in full that year. Sort each charge on your loan statement before you enter it as one line.

Capitalizing interest is a choice, not a default

When you borrow to buy depreciable property, the CRA allows you to choose to capitalize the interest, meaning you add it to the cost of the property instead of deducting it as an expense. That changes the deduction from an immediate expense to something recovered through capital cost allowance.

Deducting the interest as an expense is the usual treatment. Capitalizing affects later calculations, so discuss it with your accountant before filing rather than changing course afterwards.

Principal is not an expense

A loan payment normally has two parts. The interest is the cost of borrowing. The principal reduces what you owe and is not deductible. The CRA says you cannot deduct the principal part of loan or mortgage payments, so entering the full payment as an expense overstates your deduction.

The equipment or inventory you bought with the money is treated separately, often through capital cost allowance or the cost of goods sold. Our article on recording loan payments, interest and principal shows how to split the payment in your books each month.

If you own a corporation

If your corporation borrows, the same purpose test applies at the corporate level. If you borrow personally and put the money into the corporation, the CRA’s folio says the interest is generally deductible where the loan is interest-free to a wholly owned corporation and the money affects its income-earning capacity, though it depends on the facts. Interest on money a corporation borrows to pay dividends can also qualify in certain circumstances, which is a technical area worth a conversation first.

Records to keep and when to ask for help

Keep the loan agreement, monthly statements showing interest separately from principal, and a short note on what each draw was used for. For a line of credit, record the business and personal draws as they happen. Bring these to your accountant with the loan fee invoices so each charge can be placed correctly.